by Bill McBride on 12/28/2007 03:40:00 PM
Friday, December 28, 2007
Update: added comments from Tanta at bottom.
Several recent articles have referenced my post on the possibility of a change in attitude towards foreclosure. I wrote:
One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.Although the purpose of the post was to discuss changing social norms, the primary reason the post was mentioned was because of some pretty big numbers, like the possibility of $1 trillion in mortgage losses based on a few rough assumptions. A couple of quotes:
Australia theage.com: Americans 'walk' from loans
Late last week ... Calculated Risk figured that housing losses might reach $US1 trillion and even $US2 trillion.WSJ: How High Will Subprime Losses Go?
Back in the U.S., the Calculated Risk blog sidestepped the colorful language and went straight for the big number: “The losses for the lenders and investors might well be over $1 trillion.”The $1 trillion number is a simple calculation: If prices fall 30%, then approximately 20 million U.S. homeowners will be upside down on their mortgages. If half of these homeowners walk away from their homes, with an average 50% loss to lenders and investors, that is $1 trillion in losses (the average mortgage is just over $200K).
This wasn't a forecast, just a simple exercise to show why changing social norms is very scary for the lenders.
And this isn't just a subprime problem, and these aren't just potential "subprime losses". In the original post I referred to the potential of foreclosures becoming "socially acceptable" for the middle class.
But even though the problems have spread far beyond suprime, some reporters are stuck on the subprime meme. As an example, Bloomberg columnist John M. Berry wrote: Subprime Losses Are Big, Exaggerated by Some
As the U.S. savings and loan crisis worsened in the 1980s, analysts tried to top each other's estimates of the debacle's cost to the federal government.This is subprime reporting. It's absurd to think that mortgage losses will only come from subprime loans; in fact most of the upside down homeowners will be Alt-A and prime borrowers. By focusing solely on subprime, Berry misses the larger mortgage problem.
Much the same thing is happening now with losses linked to subprime mortgages, with figures of $300 billion to $400 billion being bandied about.
A more realistic amount is probably half or less than those exaggerated projections -- say $150 billion. That's hardly chicken feed, though not nearly enough to sink the U.S. economy.
A loss of $150 billion would be less than 12 percent of the approximately $1.3 trillion in subprime mortgages outstanding. About $800 billion of those are adjustable-rate mortgages, the remainder fixed rate.
And the credit problems extend well beyond mortgages. As an example, from Bloomberg this morning: Citigroup, Goldman Cut LBO Backlog With 10% Discounts
Citigroup Inc., Goldman Sachs Group Inc., Morgan Stanley and JPMorgan Chase & Co. are offering discounts of as much as 10 cents on the dollar to clear a $231 billion backlog of high-yield bonds and loans.We don't know the exact haircut on each LBO deal, but an average 5% haircut would be over $10 billion in losses. And there are losses coming from corporate debt, CRE loans, and other consumer debt too. As Floyd Norris asked at the NY Times this morning: Credit Crisis? Just Wait for a Replay
"... just how different was subprime lending from other lending in the days of easy money that prevailed until this summer?"Short answer: not very.
Back to mortgage losses, both Felix Salmon: Are Subprime Losses Being Exaggerated? and Paul Krugman, Jingle mail, jingle mail, jingle mail — eek! bring up a key issue: recourse vs. non-recourse loans. Felix writes:
... no one is going to have a real handle on mortgage losses unless and until someone manages to get a handle on the percentage of mortgage loans which are non-recourse. If your house falls in value and you have a non-recourse mortgage, then it makes perfect economic sense for someone in a negative-equity situation to simply walk away – something known as "jingle mail". But given the amount of refinancing going on during the last few years of the mortgage boom, I suspect that the vast majority of mortgages are not non-recourse. (Refis are never non-recourse.)This is an important issue. In California, purchase money is non-recourse. If the borrower walks away and mails in the keys (Fleckenstein's "jingle mail"), the lender is stuck with the collateral. However, if the California borrower refinanced, then the lender has recourse, and can pursue a judicial foreclosure (as opposed to a trustee's sale), and seek a deficiency judgment.
The lender can enforce that deficiency judgment by attaching other assets, or by garnishing the borrower's wages. Historically lenders rarely pursued (or enforced) deficiency judgments, but that could change if many middle class borrowers, with solid jobs and assets, resort to jingle mail.
For purchase money, state law determines the recourse vs. non-recourse issue. As Felix noted, refis are always recourse, and there was significant refi activity in recent years.
But before we think most loans are recourse, we have to remember that about 22.3 million homes were purchased during the last 3 years (2005 through 2007), and in a period of rising rates, many of these homeowners probably did not refi. It's difficult to estimate the exact losses - since we don't know the percent of recourse loans, we don't know how far prices will fall, and we don't know how homeowners will react to being upside down - but we know the losses will be significant.
Note: I'm trying to find a state by state list of recourse vs. non-recourse for purchase money.
On recourse loans, Tanta adds (via email):
I suspect that you will have some very aggressive lenders and some not very aggressive lenders in that respect.
Which will tell you who thinks it doesn't have a fraud problem and who does.
Back in my day working for a servicer, we never went after a borrower unless we thought the borrower defrauded us, willfully junked the property, or something like that. If it was just a nasty RE downturn, it rarely even made economic sense to do judicial FCs just to get a judgment the borrower was unlikely to able to pay. You could save so much time and money doing a non-judicial FC (if the state allowed it) that it was worth skipping the deficiency. Plus we had a soft spot, I guess.
At any rate, the absolute all time last possible thing you could get me to do is send an attorney barging into court demanding a deficiency judgment if I had any reason whatsoever to fear that my own effing loan officer was implicated in fraud on the original loan application. Any borrower with half a brain will raise that as a defense, and any judge even slightly awake will not only deny the deficiency but probably make the lender pay all costs, or worse. And I'd call that justice.
This goes double if the loan was made as a "stated asset" deal. I can just hear a judge asking me why I deserve to get other assets now when I never bothered to make sure the borrower had any in the beginning.
So yes, some people will get hit with a deficiency. But I'm not sure it will be as many as you might think. T
Posted by Bill McBride on 12/28/2007 03:40:00 PM