Friday, October 22, 2010



For the last few weeks, I have been struggling to say something especially insightful, or even intelligent, about what looks like a redux, or merely a continuation, of what has been blithely referred to as the “mortgage crisis.” While I don’t purport to have come up with anything especially unique regarding this matter, I have come up with a coherent approach to the topic which might bring some enlightenment and convey some insight.

Two major developments have led to the manifestation of the mortgage situation we currently face. First, major mortgage servicers such as Bank of America and Chase instituted temporary moratoria on mortgage foreclosures due to flaws in the paperwork conveying home loans and the mortgages that secure them from the originators (or those a step or two away from the originators) to the CMOs and CBOs that currently hold the mortgages. It seems that borrowers are arguing that the ultimate creditors could not prove that they actually owned the loans, and the mortgages that secured them, and thus could not foreclose on the property; i.e., without a valid security interest in the property, how could a lender foreclose?

The second development was a movement on the part of the CMO and CBO holders to sue the originators (or those a step or two away from the originators) of the loans in their portfolios to force them to buy back the loans due to sloppy and/or defective underwriting and servicing of the loans.

AGs (“AG” is short for “Attorney General,” but, in practice, it could just as easily be short for “Aspiring Governor,” but I digress.) from all fifty states have jumped into this latest brouhaha with gusto, as one might expect. These notables were especially instrumental in “encouraging” financial institutions to initiate or join the foreclosure moratoria, which ended too quickly for the politicians’ tastes.

As I see it, there are three possible outcomes to this latest episode in our ongoing mortgage travails. The worst case scenario would be for some enterprising lawyers to discover that there is indeed a defect in the transference of the loans and underlying mortgages to the ultimate purported holders of those loans and mortgages and that, as a consequence, nobody owes anybody anything; i.e., all borrowers, whether current or in default, are off the hook as long as their mortgages are no longer held by the originator of their loans. So not only can banks not foreclose on deadbeat borrowers, they can’t collect from up to date borrowers. This scenario is, of course, a veritable financial dystopia that would threaten just about every financial institution, pension fund, or ordinary investor in the world, and would especially infuriate our friends across the Pacific who hold so much of this paper. Further, an outcome would make those who have been honoring their obligations feel like a bunch of chumps and thus spark plenty of societal resentment, if not outright societal breakdown, as the obligations of borrowers to lenders, honored throughout the millennia, would suddenly become passĂ© remnants of a benighted, bygone era.

Fortunately, this worst case scenario is highly unlikely to come to fruition. Surely, those who laid the legal groundwork for the modern system of mortgage finance under which we currently operate have taken the steps necessary to insure that title to the loans and the mortgages that secure them were properly transferred. At least I hope so; perhaps I am taking an unwarranted detour from my normal cynical approach to life.

Moving along the outright disaster to much adieu about nothing continuum, we come to another possible outcome: CMO and CBO holders may ultimately force originators to buy back the shoddily underwritten and serviced mortgages that comprise the collateral for those CMOs and CBOs. While such an outcome would not have the dire societal, financial, or economic ramifications of the worst case scenario outlined above, it looks attractive ONLY relative to the worst case scenario. A substantial forced buyback would cause those originators, including the nation’s financial giants, to fail (again) and force the taxpayer to bail them out (again).

One could argue that if the transfers of the loans and the mortgages that secure them were indeed fraudulent, CMO and CBO holders never really bought anything and thus can’t force the originators to buy loans and mortgages back. But if that condition were true, we would be dealing with the first scenario, which would be far worse than this second scenario. Again, though, fraudulent or otherwise defective transfer, at least in any kind of size, is unlikely.

A third scenario resides much further along the aforementioned continuum. That is that everything we have been discussing is much adieu about very little. The borrowers still owe the money and so the holders, who remain the trusts that underlie the CMOs and CBOs, still can continue to collect if they can and foreclose if they can’t. While the aforementioned AGs, desperate to pander to those elements of our society that see financial obligations as optional and the contract into which they entered voluntary as just another manifestation of the heavy-handed predations of “the man” or “the corporate criminals” and thus no responsibility of their own, would be sullen and down in the mouth with such an outcome, it is the outcome for which anyone who wants to avoid financial catastrophe should be cheering.

What is the probable outcome? God only knows, and He’s not talking. I would guess, though, that we might ultimately see something close to the second outcome; that is, originators, or those a few steps from the originators, forced by legal action to buy back some of the loans they conveyed with sloppy, or perhaps fraudulent, paperwork. This would appear to be poetic justice for those who foisted such mortgages on the market, but what about those who bought such mortgages with insufficient due diligence, relying on the models of the wunderkinds who gave life to these financial Frankensteins (i.e., the “carefully calibrated” CMOs and CBOs)? There is plenty of blame, and financial responsibility, to go around here; I fear, though, that most of the financial responsibility will fall to the taxpayers or, if current trends continue, to the Fed’s printing press. So it goes.

One more brief note in an already long winded post. According to today’s (i.e., Friday, 10/22’s) Wall Street Journal, the Obama administration has said “a government role may still be needed to preserve the long-term, fixed-rate mortgages that have become the keystone of the American mortgage market” (quoting the Journal, not an Obama spokesman). Not to unduly bash the Obama administration, because I am quite confident that the Bush or a McCain administration would also bellow such drivel, but, as the kids would say “Well, duh!” Without a government role, there would be no long-term, fixed rate mortgages; such peculiarities only came about in the ‘30s and ‘40s as the government started to take what would become its preeminent role in the mortgage market; note that Fannie Mae was founded in 1938. So of course some government involvement would be necessary to preserve the long-term, fixed-rate mortgages that have become the custom in this country, largely due to government involvement.

But why have long-term, fixed-rate mortgage loans become such a middle class entitlement? What if such juicy (to the lender) loans were no longer widely available, perhaps due to less government intervention in the mortgage market? I can already hear the wailing and gnashing of teeth about how the home market depends on such mortgages for its survival and their curtailment would surely lead to our economic and financial ruin. Baloney. People would still buy houses with adjustable rate mortgage loans, shorter term home loans, or any number of yet to be discovered loans. Without thirty year fixed rate loans, there would be less need for securitization; originating financial institutions would be more comfortable, and profitable, holding such loans, on which all the risks and embedded options are not running in favor of the borrower. Wall Street would surely scream, but people on Wall Street are, at least if you believe them, smart and resilient. They will find ways to make money. Fewer people would be able to buy homes, but is that such a bad thing? The idea that home ownership is an entitlement is one of the notions that got us into the financial soup in which we continue to swim.

Maybe it’s a good time to question the idea that “owning” one’s home by taking out a loan that, even with all the options skewed in one’s favor, one cannot afford is a sacred entitlement. Perhaps it’s time to finance homes with loans that lenders could actually hold, rather than make and immediately sell. Such a financial template worked for decades in this country before the advent of the type of enlightened thinking that has so come a cropper of late. Why must we assume that the generations that built this country were so benighted, especially when the dire consequences of my generations’ financial machinations are only beginning to become apparent?

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