Friday, October 15, 2010

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.)


sb101 said...

"Lest anyone think that the TARP (which Krugman endorsed)"

This isn't fair. Krugman endorsed TARP as the best of a bunch of really bad options. Krugman endorsed full blow nationalization. He endorsed a Swedish style remedy.

"Enron's demise was not due to an accounting "scandal," nor was it a failure of corporate governance."

Sorry, but this could not be more incorrect. Yes Enron depended on the stock market and easy credit to conceal what was an insolvent company. But Enron also hid all that leverage in off balance sheet entities that were never disclosed. There financial statements were a pack of lies. There was not any mention of the Rapters in their 10-K, and no mention of the Fastow run partnerships that capitalized the hidden off balance sheet entities. All that leverage was hidden from investors, and not disclosed in their filings. The filings are still public, and no mention of this stuff. Anyone go look that up. This was beyond creative accounting. It was illegal. Their accounting was 100% illegal, since nobody knew about the partnerships. And this alone speaks to how awful the corporate governance was since either the board knew about the off balance sheet entities and supported the lies, or were too incompetent to figure this out. Either way that's an utter failure of corporate governance. Were the prosecutions abusive and illegal? Sure maybe they were. I have no idea. Not my area of expertise. But to say their accounting was 100% on the up and up is not correct.

"The late Ken Lay insisted that short sellers caused the demise of Enron; I say that the short sellers exposed Enron"

Could not agree more. The best short ideas are of companies who management is complaining about the shorts. Einhorn did us all a favor by recognizing Lehman was cooking their books as well.

iawai said...

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.

Technically, first, it was GNMA (Ginny Mae) securitizing HFA & VA loans. But the entire scheme in any event, was hatched by the gov't.

This isn't to say that such a thing couldn't be done by the market - but had it originated there the structure would probably have many more safe-guards and delineated duties and remedies.

Bob Roddis said...


Bernanke: Fed wrestling with size of program to buy Treasury bonds

And the bonds are winning! They’ve picked Bernanke up by the feet, flung him around three times and tossed him out of the ring!

William L. Anderson said...

I tend to be a bit more agnostic on what Fastow said, given that his original statements were changed drastically to fit the narrative by the prosecution. (The prosecution withheld that information from the defense, which found out after the trial. Why am I not surprised?)

I've run the question on mortgages past some of the people on a Mises listserve. There was so much moral hazard built into the mortgage bubble (and the moral hazard helped inflate it, IMO) that there can be no clean way to deal with the mess.

A friend of mine told me that when he worked with a mortgage company 15 years ago, even then there was a lot of missing paperwork when the banks were having loans securitized, and that was not an overheated market.

I only can imagine what the situation was like during 2004-2006 when the boom really was out of control. The documentation surely has to be so sloppy and so disconnected that one would need a soothsayer to put it together properly.

You have to understand that I have no sympathy for the banks and the other financial houses that drank the Kool-Aide. No one forced them to do this, and I believe that no one should be forced to bail out their mistakes.

As I see it, the market was telling the CEOs that some of their mansions in Connecticut needed to be foreclosed upon. Maybe if they had been forced to go through foreclosures, they might have found ways to better deal with the situation than creating the current mess.

As for Enron, I don't defend the company's practices. However, neither can I defend what federal prosecutors did. I've been privy to a lot of shenanigans on their part, and what I despise more than anything is a lying prosecutor, and the Enron Task Force was a den of liars and con-men. People may disagree, but as I see it, when prosecutors are not held accountable for their actions -- and very few of them ever are punished no matter how dishonest and egregious their conduct -- then we should not be surprised when those who allegedly prosecute criminals become criminals themselves.

Bob Roddis said...

As an attorney who has done numerous real estate closings, the usual procedure was for the closing to be at the office of the title insurance company. They made sure all the documents were there, they passed out payoff and loan checks and recorded the documents with the county clerk's office. Are they now finding that these mortgages were never even recorded? A certified recorded mortgage document from the county clerk would seem to be unimpeachable evidence of a mortgage as would a bank's copy of the cashed check for the loan proceeds would be good evidence of the loan itself. Or even the borrower's bank statement showing the deposit.

Problems with documents probably would stop cold a foreclosure by sale however, and require a lawsuit which could take forever (literally).

Just curious.

Anonymous said...

@AP Lerner: Is it just me, or have you cooled down over the last few posts? There seems to be a bit less anger in your posts, not to mention the shorter length. You also seem to be agreeing with Anderson more often. Maybe it's just me, but then again, I come here to watch the slug-fest. =P

Anonymous said...

The Enron demise was a business failure. Enron was essentially a highly leveraged entity that bought gas and sold electricity. When gas prices skyrocketed they were in trouble. The business model was based on borrowing against the highly inflated value of Enron stock. Once the market got wind of Enron's problems their credit dried up. The accounting scandal was merely an attempt to cover up the failure and keep Enron in business "until things picked up".

Bob Roddis said...

From Robert Wenzel:

Judge Andrew Napolitano’s Fox Business Channel show, Freedom Watch, is fast becoming my favorite television talk show. He regularly has great guests such as Lew Rockwell, Ron Paul, Walter Williams, Tom Woods and Jesse Ventura.

This morning he had on his show, tell it like it is investor, Jim Rogers.

The Judge asked Rogers about Nobel laureate and NYT columnist Paul Krugman, who is calling for a huge new government spending program. Rogers said Krugman "is an idiot" and "doesn't know anything about economics." Go Jim!


2. The mortgage problem comes from
tracking the assignments.

Since the entire concept of fiat money is based upon fraud and theft, it follows that it spawns more fraud and theft.

sb101 said...

"Is it just me, or have you cooled down over the last few posts? There seems to be a bit less anger in your posts, not to mention the shorter length."

Don't confuse passion with anger :) If I got angry at all the idiocy in the economics profession, I would have been committed a long time ago. I also tend to focus on monetary and fiscal policy, so when the posts are off those topics, I have little to say. Yes, I get passionate when folks, especially educators, take all the neo-liberal myths like crowding out, deficits are evil, money printing is evil, government securities and taxes actually fund something etc as truths despite all the real, hard evidence against all these claims. That really bothers me. If the foundation of the economics profession has it all wrong, how will we ever make progress?

"You also seem to be agreeing with Anderson more often."

If I'm going to be critical, then I must mention when I agree as all. It's only fair. I enjoy the slugfest as well, but it's important to me point out where I agree, because many like to paint me as a Krugmanite or someone married to Keynesianism. I am not. I happen to think Krugman is more correct than 99% of academics out there, especially relative to anyone that has come out of Chicago, or this moron Mankiv, who continues to poison minds with his text books and op-eds such as this:

Krugman is one of the few academic economists that I have studied that fully understands how capital markets work, which is refreshing for someone (me) who has devoted his entire life to capital markets. I have made a good bit of money over the years off Krugman's analysis. The last two years have been no different.

Anonymous said...

@AP Lerner: Meh, I don't necessarily see passion and anger as being mutually exclusive. Rather, they tend to be partners more often than not. My understanding of being passionate doesn't involve slinging insults.

And I'm sorry, but I tend to side with William in these matters. I'm afraid you're going to have to find someone else to impress with your charts. =P (Not meant offensively, more as a light-hearted jab.)

By the way, might I recommend reading your comments out loud before you post them? You seem to come off as a little bit... I'm going to say 'snobbish', as that's the closest word I know to what I want to say, but it doesn't seem to match entirely what I want to express. Anyway, reading them aloud first may help a bit with that.

sb101 said...

"By the way, might I recommend reading your comments out loud before you post them? You seem to come off as a little bit... I'm going to say 'snobbish', as that's the closest word I know to what I want to say, but it doesn't seem to match entirely what I want to express. Anyway, reading them aloud first may help a bit with that."

Actually, it's not snobbishness, it' arrogance. When you're right, and can profit from being right, then yes, it can go to your head. If you had been paying attention to my comments you would have learned something the last few months and made some money.

And PS-I have never thrown a personal insult at anyone on this blog. Pointing out lies and awful analysis is not an insult, it's a favor. You're welcome

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