What About Mortgages?

At the end of class yesterday, a student and I were discussing the housing bubble and the current situation with foreclosures and things that could be done. I remarked that I was puzzled as to why banks were not willing to do more renegotiating to keep foreclosures from happening, since traditional foreclosures are poison for banks as they deal in money, not real estate.

In his October 14 column, Paul Krugman makes some sense, but I can see that he is as puzzled as the rest of us regarding what should be done. Furthermore, I agree with much of what he says here:

Horror stories have been proliferating, like the case of the Florida man whose home was taken even though he had no mortgage. More significantly, certain players have been ignoring the law. Courts have been approving foreclosures without requiring that mortgage servicers produce appropriate documentation; instead, they have relied on affidavits asserting that the papers are in order. And these affidavits were often produced by “robo-signers,” or low-level employees who had no idea whether their assertions were true.

Now an awful truth is becoming apparent: In many cases, the documentation doesn’t exist. In the frenzy of the bubble, much home lending was undertaken by fly-by-night companies trying to generate as much volume as possible. These loans were sold off to mortgage “trusts,” which, in turn, sliced and diced them into mortgage-backed securities. The trusts were legally required to obtain and hold the mortgage notes that specified the borrowers’ obligations. But it’s now apparent that such niceties were frequently neglected. And this means that many of the foreclosures now taking place are, in fact, illegal.

This is very, very bad. For one thing, it’s a near certainty that significant numbers of borrowers are being defrauded — charged fees they don’t actually owe, declared in default when, by the terms of their loan agreements, they aren’t.

Beyond that, if trusts can’t produce proof that they actually own the mortgages against which they have been selling claims, the sponsors of these trusts will face lawsuits from investors who bought these claims — claims that are now, in many cases, worth only a small fraction of their face value.

And who are these sponsors? Major financial institutions — the same institutions supposedly rescued by government programs last year. So the mortgage mess threatens to produce another financial crisis.

Furthermore, I think he is partially correct in this next statement, taking his hyper-partisanship into account:

True to form, the Obama administration’s response has been to oppose any action that might upset the banks, like a temporary moratorium on foreclosures while some of the issues are resolved. Instead, it is asking the banks, very nicely, to behave better and clean up their act. I mean, that’s worked so well in the past, right?

The response from the right is, however, even worse. Republicans in Congress are lying low, but conservative commentators like those at The Wall Street Journal’s editorial page have come out dismissing the lack of proper documents as a triviality. In effect, they’re saying that if a bank says it owns your house, we should just take its word. To me, this evokes the days when noblemen felt free to take whatever they wanted, knowing that peasants had no standing in the courts. But then, I suspect that some people regard those as the good old days.

Lest anyone think that the TARP (which Krugman endorsed) actually solved anything, think again. As much as anything, the TARP and the willingness of so many in Congress to bestow favors to financial institutions that were busy running off the cliff certainly feeds the belief by many that the "banksters" are above the law, and even above the laws of economics.

Krugman makes another point next, and I believe it bears some discussion:

What should be happening? The excesses of the bubble years have created a legal morass, in which property rights are ill defined because nobody has proper documentation. And where no clear property rights exist, it’s the government’s job to create them.

That won’t be easy, but there are good ideas out there. For example, the Center for American Progress has proposed giving mortgage counselors and other public entities the power to modify troubled loans directly, with their judgment standing unless appealed by the mortgage servicer. This would do a lot to clarify matters and help extract us from the morass.

Indeed, Krugman is right when he points out that ill-defined property rights can cause much economic dislocation. (When he endorses socialistic schemes that, in effect, eviscerate property rights, I cannot figure out why he is shocked, SHOCKED when they don't work.)

The securitization of mortgages -- done first by the government entities Fannie and Freddie and then picked up by private Wall Street firms -- has put a huge new wrinkle into this mess. Furthermore, I absolutely agree that if a financial entity cannot establish legal title to a property (and Krugman forgets that the private title companies were the first organizations to sound the alarm on this latest scandal), then it should not be permitted to perform foreclosure.

As for Krugman's statement that it is up to the government to "create" property rights, that makes no sense. What Krugman is saying is that governments de facto own everything, but if we follow some rules given by the state, the government will let us pretend that we own property. At best, government can be a referee in this process, although I believe our government these days is so abusive and so dysfunctional that it is incapable of turning into a trusted referee.

There is one thing he writes, however, that I think absolutely is wrong:

The accounting scandals at Enron and WorldCom dispelled the myth of effective corporate governance.

Enron's demise was not due to an accounting "scandal," nor was it a failure of corporate governance. (As we can presently see, government governance is not exactly going great guns, as the Congressional Budget Office makes the Enron crowd look like A-plus prognosticators.)

The Enron collapse was the collapse of a company that depended heavily upon the stock bubble AND easy credit. When the credit dried up, the heavily-leveraged firm crashed down hard, as one might expect. The accounting measures that Enron did pushed the envelope, but were not illegal.

(I have participated in a project that takes a second look at the Enron case, and I discuss on camera both the legal and economic aspects of what happened at Enron. Now, I absolutely disagreed with the person who put this project together on the role of the short sellers. The late Ken Lay insisted that short sellers caused the demise of Enron; I say that the short sellers exposed Enron. That's a huge difference.)