by Tanta on 2/26/2008 11:54:00 AM

Some day I will learn to stop ignoring stuff. I saw this Bloomberg piece on the day it was published, my eyes rolled into the back of my head, and I realized that on a good day I haven't got the ability to unscramble this frittata of anecdote, conflation, fact and side-issue in less than 10,000 words. I certainly have a hard time doing that temporarily blinded. But I have now received a round dozen emails from you all drawing my attention to it, plus all the uncounted times it has come up in the comments. Okay, fine.

The thing starts off with its one and only specific example, and it's a doozy:

Feb. 22 (Bloomberg) -- Joe Lents hasn't made a payment on his $1.5 million mortgage since 2002.

That's when Washington Mutual Inc. first tried to foreclose on his home in Boca Raton, Florida. The Seattle-based lender failed to prove that it owned Lents's mortgage note and dropped attempts to take his house. Subsequent efforts to foreclose have stalled because no one has produced the paperwork.

``If you're going to take my house away from me, you better own the note,'' said Lents, 63, the former chief executive officer of a now-defunct voice recognition software company.

"Former CEO" seems a tad bit complimentary to Lents here--perhaps Bloomberg is afraid of getting sued by this particular piece of work. We do get this:

Lents is former CEO of Investco Inc., a Boca Raton, Florida-based developer of voice recognition software. In 2002, the U.S. Securities and Exchange Commission sanctioned Lents and others for stock manipulation, according to the SEC Web site. He lost his job, was fined and his assets were frozen. That's the reason he couldn't pay his mortgage, he said.

Well, I never miss an opportunity to go wade through the SEC website. As far as I can determine, Lents cooked up a pump-and-dump scheme, and then found a company he could take over to implement it. This part is amusing: "Investco, Inc. is a Nevada corporation headquartered in Boca Raton, Florida. Investco formerly purported to be a provider of voice recognition technology and now claims to be a provider of financial services." If it takes one to know one, we have one.

This article from January in the South Florida Business Journal gives us a touch more color on the Lents foreclosure:

Somebody has been trying to foreclose on Joseph Lents' Boca Raton home for five years. So far, they have been unsuccessful because he has legally fought them every step of the way. . . .

"I probably have been to the Palm Beach County courthouse 100 times or more over the last five years, just to observe," Lents said. "In 99 percent of the residential foreclosure cases, plaintiffs are asking the court to accept a promissory note copy as the original because it is presumed lost."

Resistance doesn't come cheap. Lents has paid more than $120,000 in legal fees and costs so far to save his 5-acre, $2.5 million home. . . .

The Lentses built their home in 1992 and, on May 15, 2001, according to public records, refinanced it for $1.49 million with Washington Mutual Bank (NYSE: WM).

Lents, a retired CPA, lost his corporate job in 2002 when the SEC charged the company he led (Ivesco/Intraco) with a pump-and-dump scheme, according to SEC documents. While the SEC agreed that Lents had not made money - he actually lost money on the transactions - the damage was done. His income stopped and he fell five months behind on his mortgage payments.

"I tried contacting WaMu [Washington Mutual] and couldn't get through to anyone who could help me reset or recast the mortgage," Lents said. He contacted the mortgage broker, Express Financial, which had helped him shop around for the best mortgage in 2001. "They contacted WaMu and were told it couldn't do anything because, even though they were servicing the mortgage, the loan had been sold. It was a Catch-22," Lents said.

In January 2003, WaMu filed for foreclosure against the Lentses.

Where's the note?

The first count of the complaint was curious, according to Lents. It said the $1.49 million promissory note was lost.

"Now, I have audited a number of banks and credit unions in my time, and I can tell you they don't lose million-dollar notes," Lents said. "If auto dealers can keep track of auto titles, surely banks can keep track of promissory notes."

West Palm Beach attorney Brook Fisher filed an objection, and WaMu filed an affidavit, swearing the note had been lost.

The employee who filed the lost note affidavit was deposed. Under sworn testimony, she said she hadn't searched for the note and just signed a stack of lost note affidavits.

WaMu's attorney filed for summary judgment in 2003. However, since the facts surrounding the allegedly lost note were in dispute, the judge set the case for trial and allowed discovery for records and depositions.

Lents acknowledged that he owed the money, but would only pay the legal note holder, whoever that might be.

In October 2003, WaMu dismissed the suit.

Nothing more happened until February 2005, when Donaldson Lufkin Jenrette (acquired in 2000 by Credit Suisse) filed a foreclosure suit against the Lentses.

In a September 2005 mediation meeting, the attorney representing Donaldson Lufkin Jenrette said it had paid a premium for the Lentses' mortgage, apparently purchased as part of a package of non-performing loans. . . .

The Lentses' case is coming to a head. A hearing is set for Jan. 8 in which Donaldson Lufkin Jenrette is seeking summary judgment. Their attorney, Miami-based Jane Serene Raskin of Raskin & Raskin, will probably be asking for the same thing. (She did not return calls for comment.)

I have so far been unable to find an update on the DLJ hearing. I cannot even tell, from this narrative, whether DLJ was the "investor" to whom WaMu had sold the loan at the time it defaulted, or if WaMu subsequently sold the loan to DLJ after it dismissed FC proceedings, as a "non-performing loan." If the latter is the case, I admit I'd like to know just how much "premium" DLJ paid for it. (Note to the irony impaired: no, I don't want to know that. I sleep better not knowing that.)

So here's what seems to be the deal. Lents, who knows a little something about obfuscation and has a lot of free time since the SEC took care of his employment opportunities, hung out at the courthouse long enough to notice that FCs are routinely filed with either a certified true copy of the promissory note or a Lost Note Affidavit (LNA), which in every instance I have ever personally seen is a sworn statement that the original note is lost, and is accompanied by a certified true copy of the lost original. (It is theoretically possible to submit an LNA without a copy, if there were a case that both the original and all copies of the note were lost. However, there would have to be other documents attached to the LNA that would provide evidence that it once existed, such as other closing documents, the loan payment history, a sworn statement of the notary or escrow officer, etc. As I said, I've never actually seen an LNA without a copy of the note attached to it.)

Having noticed that, Lents filed an objection to the FC based on the dubious standing of the LNA; discovery proceeded and it turned out, not surprisingly to me, that there was no particular evidence that WaMu had lost the note. Someone simply decided that the quick and easy way to process a batch of foreclosure filings was to grab the copy of the note that was easily available in the servicing file, slap an LNA on it, and go with that, rather than going through the process of locating the custodian who held the original note, filing the paperwork required to have it released to WaMu, etc. Based on the article, it seems possible to conclude that the original note really was lost, but since WaMu made no effort to find it in the first place, it's a no-brainer to conclude that at least one statement in that LNA was false. (They all say something to the effect that all practicable efforts to locate the original have been made and have failed, and that the affiant has personal knowledge of this.)

What this article does not say is whether DLJ has an original note or not. If DLJ owned the note at the time WaMu, the originator and servicer, tried to foreclose on an LNA, that might be why WaMu didn't have it: DLJ had it and either WaMu didn't try to get it from them or DLJ failed to produce it. If DLJ purchased the loan subsequently, as "non-performing," then either DLJ bought with an LNA (it allowed the sale to go through with only an LNA to evidence the note), or WaMu found some note for DLJ. It really drives me nuts that these news reports bring all this stuff up, and then never really report all the relevant details. My best guess is that DLJ bought a pool of junk loans and accepted an LNA instead of requiring the original note. That's probably why DLJ is having to bring other evidence into court, such as the evidence of its purchase of this pool.

I note for y'all that I have personally executed one or two LNAs in my day, and have therefore had all known hard file folders associated with this loan (the servicing file, the branch's copy, the custodial file, whatever there is), as well as all correspondence with the warehouse bank or custodian or whoever else might have had it brought to my desk, so I could personally root through it all once more before I put my officer's signature on an LNA. In all but one of the LNAs I can remember executing, I had documentation from FedEx or some other shipper that a package had indeed been lost, plus clear documentation in the loan file that this specific note had been included in that specific lost shipment. (My shipping department always put the copy of the airbill in the loan file. Always.) And of course I always had a certified true and correct copy of the note to attach to the affidavit.

I bring all this up because, Lents' self-serving nonsense aside, not only can original notes be lost or damaged, so can car titles and any other piece of paper. (I have a friend who once had to execute over 100 LNAs after a fire in an adjoining office suite triggered the sprinkler system in her post-closing department. Those LNAs were accompanied by copies of sodden bits of semi-readable paper that had been patched together on the copier plate, one at a time.) A financial institution in the business of making mortgage loans has no business routinely losing or damaging original promissory notes, and any institution that does so should be shut down by the federal regulators and I mean that.

But if consumer attorneys want to create a situation in which the simple fact of loss of or irreparable damage to an original note vacates the debt, I can promise you you will not like the consequences of that. If it turns into Total War here, don't ever lose an original cancelled check. You should know that there is actually one fairly respectable reason for doing FC filings with note copies, besides servicer laziness or loan sale screw-ups: taking your original note out of the custodian's vault to send to some local attorney to attach to a court filing creates several more opportunities for it to get lost. If it becomes a requirement that FC can proceed only with the original note in the courtroom, and the presence of an LNA always means dismissal, then the things are going to have to be handled and shipped and received with the same level of security as a million-dollar bearer bond. Like, a Brink's truck and a bonded courier carrying a briefcase handcuffed to his wrist. You want to pay the cost of that? No. You don't. But you will.

The problem here, I suspect, is that the jurisdiction in question does not provide for a legitimate way to file with a true and correct certified copy of the original note; the only way servicers can get by without giving up their original notes to the county clerk is by filing an LNA, which at minimum makes them look bad (and involves false statements). I'll leave it to the lawyers to argue about the wisdom of forcing servicers to hand over original notes at the same time they are offered no legal remedy if counsel or clerk or FedEx misplaces it. I am simply observing, once again, that this kind of half-serious half-frivolous objection to a foreclosure action can end up having consequences nobody is going to be happy with.

To return to Bloomberg, though, you will notice that an article that goes on and on at length about the dangers of the secondary market in mortgage loans and originators going out of business and so on has exactly one example, which appears to be of a loan with a note that doesn't seem to have been lost in a loan sale and the originator in question is still in business. Meanwhile, some slick operator for whom $120,000 in legal fees is cheaper than five years of mortgage payments and whose hobby is hanging out at the courthouse is creating a precedent for FC filings in Florida that will no doubt be hailed by so-called consumer advocates as a victory for the little guy.

Lost in all of this is the apparent fact, once again, that WaMu was and probably still is exceptionally sloppy with its handling of original notes; that an outfit like DLJ will apparently buy loans with nothing other than a note copy (and pay premium, too!); and that in the absence of the industry getting serious about confronting its true operating costs and failed "efficiencies," its practices are being "criminalized." Back to Bloomberg:

Borrower advocates, including Ohio Attorney General Marc Dann, have seized upon the issue of missing mortgage notes as a way to stem foreclosures.

``The best thing to do is to keep people in their homes and for everybody to take steps necessary to make that happen,'' said Chris Geidner, an attorney in Dann's office. ``These trusts are purchasing these notes, and before they even get the paperwork, they foreclose on people. They become foreclosure machines.''

Joe Lents is not the victim of a "foreclosure machine." He's a deadbeat who has found a way to go five years without making a mortgage payment. He can apparently afford $120,000 in legal fees. But little people who cannot afford the mortgages they have are being convinced to let a lawyer fight their foreclosure on the grounds that the original note wasn't in the courtroom, and all that's going to do is delay the inevitable, add legal fees and even more accrued interest to the deal, and draw this whole horrible unwind of the RE bust out into years and years of hell.

I'm sorry, but AG Dann needs to go after predatory lenders who took advantage of borrowers. If he has evidence that loans were originated with the intent to foreclose--which is predatory by definition--then he should go after that. Intervening to stop a foreclosure because an assignment was filed after the loan purchase is just pandering and grandstanding and wasting resources.

The WaMu problem needs to be taken care of by the OTS: how, I want to know, does anyone pass a safety and soundness examination with a pattern of being unable at any given time to tell you where its notes are? With a pattern of requiring some low-level employee to fill out LNAs with false declarations in them to "save time"? If this isn't a pattern, then what's with all the insinuations in the Bloomberg article that it is? If it is a pattern, it's unsafe and unsound and WaMu's charter should be in danger. This is not the kind of problem you "solve" by challenges to individual FC cases, particularly ones like Lents's--the man by his own admission hasn't made a mortgage payment in five years. He deserves to lose that house, yesterday. I wouldn't go on record defending DLJ's loan purchase due diligence practices here, but DLJ deserves to win.

The rest of us deserve to have this kind of crap prevented, rather than enabled. The regulators and the investment community have to stop putting up with sloppy operations and cavalier attitudes toward document custody. At the risk of repeating myself once more, the true costs of the secondary market in mortgages has to come onto somebody's income statement sooner or later. We are seeing what happens when you claim to have careful operations at the same time you go on a cost-cutting spree to get rid of all that back-room stuff. This problem will not be solved by enriching foreclosure-avoidance attorneys.

I suppose I should end with a nod to this one, which got featured yesterday at The Big Picture and which many of you have also emailed to me. From the Chicago Tribune:

The new buyers of a rundown graystone on the South Side showed up Jan. 9 to look at the house they won at a foreclosure auction. They took the plywood off the front door and went inside to make sure the utilities had been shut off. Then they called the police.

Sitting upright in the corner of a bedroom off the kitchen was a human skeleton in a red tracksuit. Next to him lay a dead dog. Neighbors told police the corpse was almost certainly Randy Johnson, a middle-age man who lived alone in the North Kenwood house.

The cause of Johnson's death has not yet been determined, but it is just one of the mysteries about 4578 S. Oakenwald Ave. Somehow, Johnson's house was transferred three times to new owners without anyone noticing he was inside. It's a story involving forged deeds, a corrupt title company and a South Side family that has been under investigation for mortgage fraud.

Keep reading, and you'll find that Countrywide made a 100% financing deal on this thing, either without requiring an appraisal with a physical inspection, or by having relied on a fraudulent appraisal made by an appraiser who never entered the premises, or that corpse wasn't there until after the loan was made. You really can't conclude anything with the evidence we've been given. I confess I'm a bit more startled by this part:

When Johnson hadn't appeared outside for weeks in early 2006, neighbors called the city's non-emergency number asking for well-being checks, fearing he might have had an accident. Firefighters broke down the front door and searched but didn't locate Johnson. His death remains under investigation.

Sure, the thing is worth a few bad jokes at Countrywide's expense, but honestly. If the fire department broke in and searched and didn't find a corpse in 2006, nearly a year before the CFC mortgage was made, you have to wonder when the corpse got put there. As there is evidence that the 2007 purchase with the CFC loan was entirely fraudulent, there's certainly reason to suspect that the body was hidden in the home after the loan was made and the conspirators skipped out with the money. Until we get more information, I'm not inclined to see this as "three transfers without anyone noticing."

But consider it useful evidence that the mortgage mess has gotten bad enough that absolutely any insinuation against lenders, especially Countrywide, is now considered plausible. I'm personally a bit more concerned that certain parties have figured out that foreclosed properties are great places to hide corpses in. Those green pools may not end up being the neighbors' biggest complaint . . .

by Tanta on 2/10/2008 01:58:00 PM

Much has been reported, on this blog and elsewhere, about claims by industry participants that affluent (or at least fully solvent) borrowers who could afford to pay their mortgages are walking away from them, particularly in California where lenders cannot pursue deficiency judgments on purchase-money loans. I have seen two media articles (here and here) in the last few days actually crediting us—a blog!—for being on this and related stories, so I'm going to take this opportunity to talk about where all the reporting on this subject might go from here.

I certainly appreciate the willingness of professional media outlets to attribute this blog. It suggests that editors are getting over their preference for misleading information from named sources with institutional affiliations and a book to talk up (Hi, NAR!) over solid information from anonymous bloggers who are accumulating credibility the hard way (by, you know, being credible). So I don't want the following to sound like carping from a Blogger Who Is Never Happy. I mean this to be quite constructive.

I actually believe that reporters should never abandon their skepticism anywhere, including here. This is not simply because you must evaluate us as a source: it is because the ideal result of your hanging out here is that you take what we come up with and improve it, by bringing to the table reportorial skills and access that we may not necessarily have. If we can function most of all to give you the background knowledge in how these things work, and sufficient exposure to the issues to help you know what questions to ask of your sources, we're happy to get "scooped" by you. We've done our part.

The "walking away" story is a great place to think about this idea. What we have, so far, is a series of industry insiders making a general claim that "ruthless default" is on the rise. What we do not have, so far, is any rigorous quantification of the extent of this problem, or even any really detailed definition of what "a borrower who could afford to pay" is. We have no one offering baseline measures (what, for instance, a lender's analytical models might have predicted is the "normal" level of walking away), and hence no clear sense of the magnitude of the "change" in borrower behavior and attitudes (not to mention much rigor in distinguishing between the two). Hence, we don't yet really know if it's a change in borrower behavior as much as a change in definitions, servicer data collection and interpretation, or media exposure. Or a handful of anecdotes that are being pluralized into "data."

Let me give you a for-instance: here's the claim from a recent WSJ article:

And some borrowers, even those who can theoretically afford to keep their homes, realize they owe much more than what comparable houses in the neighborhood are selling for -- and think that prices won't rebound anytime soon. So they're walking away, according to anecdotal reports as well as recent statements by top executives of both Wachovia and Bank of America. [My emphasis]

But what made them "realize" this? How do we know what they're thinking about future price recovery prospects?

We do have some data indicating that borrowers in general are not, on the whole, likely to be highly-informed about the current value of their homes unless they are actively trying to sell or refinance.

NEW YORK (CNNMoney.com) -- Despite numerous reports showing home values in historic decline, more than three out of four homeowners believe their own home has not lost value in the past year, according to an online survey.

The survey was conducted by Harris Interactive for Zillow.com, a Web site that gives estimated home values.

The survey of 1,619 homeowners found 36% believe their home has increased in value, and another 41% believe their value has stayed the same. Only 23% believe their home has lost value. . . .

Moore said it's important to remember that only a small fraction of homeowners try to sell their home in any given year, and unless they are trying to get new financing or a home equity line of credit, there's no reason most will be confronted with the decline.

Stories--for what they're worth--from the Option ARM world suggest we have at least a few borrowers who are not even very clear on how much they currently owe until they try to refinance, let alone what their home value is.

So is the claim here that people recognize that they are increasingly "underwater," attempt to sell or refinance, fail at doing so, and then decide to "walk away"? If so, how did they really know how far underwater they were before they tried listing the property or getting a refinance appraisal? If we are talking about a subsection of the borrower pool who religiously monitors such things as the current comparable sale data in their neighborhoods, and who are unsentimental enough to realize that their own homes aren't "special cases," then how big is this group? I'm quite sure that our commenting community is overrepresented there, but how representative are we of the wider world?

Or are we talking about borrowers in neighborhoods with high vacancy levels (such as unsold new developments) or already-high numbers of for-sale signs planted along the street, who cannot help but notice that either nobody wants to or is able to move in or everybody else seems to want out?

Mish at Global Economic Analysis reports the following anecdote from a reader:

The first house in our subdivision was foreclosed about 9 months ago. That wasn’t a walk away; that was a get out notice from the sheriff. A few months later, there was another house that had a for sale in the front lawn, and the owner moved out a few weeks later. Another house went on the market one day and the owner loaded up a U-haul the next and drove away at 4am. And since September, we have seen six more homes that are “for sale” but the owner is long gone. . . .

After reading your work, I began to examine the attitudes of my neighborhood. The first foreclosure was one of those borderline families you often write about. They were in over their heads and couldn’t afford the house they were living in. Most likely mortgage reset. In any event, the scuttlebutt around the neighborhood was one of scorn, shame, and embarrassment. No thought was given to the negative impact to the value of all our homes in this subdivision. With each subsequent “pre-foreclosure,” people’s attitudes softened about their ex-neighbors. Gone was the Scarlet F; it was replaced with empathy, understanding, and even compassion. Maybe the attitudes have changed because people now realize that the value of their homes have fallen off a cliff. They don’t have time to shame their ex-neighbors when they are worrying about their wealth is being vaporized or a $400 natural gas bill or car payment or the kids or whatever.

This anecdote links borrower distress, listed homes and vacancies in the immediate (visible, visceral) area, and shifting attitudes (not, interestingly, a direct report of the attitudes of the "walkers," but of the neighborhood witnesses thereto) in a way that seems difficult to untangle. I have, for instance, personally moved my household by starting out at 4:00 a.m. in a U-Haul, but I'm a coward who doesn't want to drive a long truck she's not used to handling around the city during morning rush hour, and who prefers driving in the dark in the familiar area and still having daylight at the new area. Are we even sure that what we are witnessing is "furtive" moving?

My guess is that servicers do not have the kind of information that would let us answer these questions directly. The term "jingle mail" is a fine joke (the mail "jingles" because the borrowers are just sending the keys to the servicer instead of a mortgage payment), but we need to bear in mind that it's a joke. True "walk-aways" do not call or write to the servicer to inform them of their intent to stop payment permanently and wait to see how long it takes to foreclose. (There are always some borrowers who request a deed-in-lieu when they are in distress, but that's not really what we mean by "jingle mail" or "walking away," which implies that the borrowers are letting the banks foreclose, not voluntarily surrendering the deed.) It isn't always easy, then, to identify intentional walk-aways in your foreclosure caseload.

In fact, it seems possible that the borrowers being labelled "walk-aways" are those who 1) do not respond to servicer attempts to contact them at the first or subsequent delinquencies, and/or do not respond to offers of loss-mitigation efforts (forbearance, modification, short sale, anything short of foreclosure) and 2) do not show financial distress as indicated by the servicer's review of a current credit report. If they aren't responding or cooperating, they aren't sharing details of their current income or expense situation with the servicer; it seems probable to me that the servicers are deciding that these folks could carry the mortgage payment, if they wanted to, because they have pulled a credit report and find no evidence of increased debt levels from origination or defaults on non-mortgage debt.

The no-contact borrower is a difficult one to make assumptions about, since any servicer will tell you that borrowers in true economic distress caused by circumstances well outside of their own control are quite often non-responsive: depression, shame, fear, and having had the phone cut off, among other things, often keep people who could be helped from getting help. A Freddie Mac credit policy expert notes:

Unfortunately, as detailed in a groundbreaking study conducted by Freddie Mac and Roper Public Affairs in 2005, 61 percent of delinquent borrowers did not know that there are workout options and significant percentages of those borrowers did not return lender phone calls out of embarrassment or a lack of faith that anything can be done to help them.

There is some difficulty, then, in deciding whether a "no-contact" problem involves shame or shamelessness. It is therefore unwise, it seems to me, to assume that all borrowers who seem to just "disappear" are "walk-aways."

Similarly, the assumption that a borrower's current credit report proves that they can carry the mortgage payment is fraught with difficulty. As we have seen in a number of recent reports, the customary assumption in mortgage servicing was that borrowers in distress would prioritize payments such that they would skip the credit cards, personal loans, and auto loans (in that order) before failing to make the mortgage payment. When that pattern held true, one could more confidently assume that a borrower current on all other obligations was probably able to make the mortgage payment.

However, we seem to have some observers suggesting that the divergence between mortgage and credit card delinquency rates indicates that borrowers are skipping the mortgage payment first and keeping the cards current when they are in financial distress. They may well, for instance, believe that in a temporary reduction of income, like a layoff, it's more important for them to keep revolving credit lines open for emergencies, and to keep their cars for transportation to work, than to worry about foreclosure on the mortgage, which they probably know will take some time and can probably be reinstated when they are employed again. Surveys still show, however, that the overwhelming majority of distressed borrowers indicate that they would prioritize the mortgage payment over other debt. An Experian study from last year accounts for the contradiction here by indicating that while prime borrowers still pay the mortgage first, subprime borrowers are more likely to keep the credit cards current and let the mortgage payment lapse. There does seem reason to question the automatic assumption that a clean credit report (in terms of non-mortgage debt) automatically means that the borrower in question could afford the mortgage payment but is choosing not to make it.

There is evidence that substantial numbers of foreclosure "cures" (loans with an initial foreclosure filing that do not result in ultimate foreclosure) are in fact due to borrowers making up missed payments, not to lender workouts. From the Conference of State Bank Supervisors' State Foreclosure Prevention Working Group:

The October data from Reporting Servicers shows that most mortgage payment delinquencies are resolved by action taken by the homeowners themselves. Of the loss mitigation efforts closed in October, 73% of all resolutions were due to the borrower bringing the account current.

This is not to suggest that workouts are unnecessary because most borrowers can find the money to bring their loans current; it is merely to recognize that there are borrowers out there bringing their loans current out of some source of funds other than sale or refinance. It would certainly be useful to know what that source is; I have yet to see any reported data on that, and servicers may not be collecting it consistently. Are borrowers suffering from temporary loss of income? Temporary increase in obligations? Are they paring household budgets down to ramen and bus fare in order to make up mortgage payments? Are they raiding retirement accounts to stay in their homes? If any of these things is true, that complicates the picture of ruthless walk-aways, since whether it is wise or not to make severe financial sacrifices to keep a home right now, if folks are making those sacrifices, they aren't thinking like the "rational agents" of options theory gone awry.

I suspect--but have no data to prove--that servicers are also extrapolating from bankruptcy filing rates here, the assumption being that if a borrower were truly unable to make the mortgage payment and didn't want to keep the house, he or she would file for bankruptcy. But it is also not clear to me that a borrower's failure to file for bankruptcy necessarily means that the borrower's income is sufficient to carry the mortgage, given how stringent means-tests in BK have become. I for one am not willing to assume that borrowers are not in valid economic distress just because they don't meet BK filing requirements or are unwilling to try to survive on Chapter 13 budget plans.

Aside from the obvious reasons to care about the extent to which "walking away" is a significant part of the problem or just rare but annoying food for moralists, headline writers, and bankers who want to blame their borrowers' morals rather than their own for life's troubles generally and earnings reports particularly, there is the danger that more legislation will be passed--the 2005 bankruptcy reform springs to mind here--to combat "bad consumer behavior" while not coincidentally attempting to bail lenders out of stupid credit-granting practices.

Here's a proposal, made by a writer with whom I probably agree on a lot of things (but not this):

In the future, Congress should require California to allow lenders to garnish wages of affluent borrowers who walk away from their homes. It's dishonest to have it both ways: (1) federal tax money backstops investor and bank losses when homeowners walk away from homes, and (2) California law allows homeowners to walk away without liability - even if they have money to pay. It's not that the California statute is bad alone; it's that it's wrong for federal taxes to guarantee huge loans without homeowners guaranteeing those loans too.

The purpose of non-recourse laws is not, actually, to give borrowers the motive or the means to stiff lenders without penalty. That is not a social goal state legislatures get behind, as a rule. The purpose is supposed to be to prevent bad lending practices in the first place: if lenders know they are secured only by the real estate in a purchase transaction--not by any additional recourse to other assets--then, in theory, they will institute sane LTV limits and pay attention to decent appraisals. Quite obviously that didn't work during the boom. While nobody I know is thrilled with the idea of the taxpayers bailing these lenders out, I am also not thrilled with the idea of repealing recourse laws to allow lenders to make themselves whole out of anything left in the borrowers' pockets.

It may sound appropriately populist to be in favor of making the rich pay up, but then again we could use some hard evidence that people can, in fact, afford to pay before we go down this road. My own sense is that such a proposal would be more likely to garnish wages of already-struggling families than it would to force the fat cats to liquidate the jewelry collection to pay off Countrywide. And certainly, if we impoverish borrowers in order to stave off lender failure, then we taxpayers will have impoverished former homeowners to cope with.

I am trying to lay all these questions and concerns out in hopes that we move forward from popularizing the idea of "walk aways" to some slogging through the issues and hard numbers to try to get a more nuanced view. Personally, I'm willing to believe that we have a real increase in "ruthless defaults" in the prime mortgage book; it's too rational for too many people for it not to go on. But I'm not willing to take it as a matter of faith, and I'm impatient with pronouncements from banks and rating agencies that aren't backed up with better data. Unfortunately, I am also very willing to believe that servicers and servicing platforms are broken: that we aren't collecting the right kind of data, that contact efforts (rather than just responses) are inadequate, and that it's just plain easier for understaffed outfits to credit "borrower attitudes" for rising defaults than to send those defaulting files through a rigorous analysis process, one that looks carefully at the original loan underwiting and reverifies more than just a current FICO.

We did just go through this in 2005 with the credit card lenders, who preferred to talk about consumers being irresponsible with the credit they were granted, not lenders being irresponsible to the borrowers they spent a small fortune soliciting. While the legislative efforts we're seeing at the moment seem largely pro-consumer (eliminating taxes on debt forgiveness and increasing borrowing opportunities with the GSEs and FHA passed, cram-downs at least on the table), there's always the possibility of backlashes forming as discussion of "moral hazard" shifts from lenders who took too much risk to borrowers who loaded up the U-Haul at 4:00 a.m.

I therefore suggest to the media that we've done about all we can usefully do just by reporting on unsupported claims being made about walk-aways. Granting credence to claims about motivations and social attitudes simply because the person making the claim is in the industry seems a bit rich at the moment; we haven't even distinguished ourselves lately as mortgage lenders, which is what we're supposed to be, let alone as sociologists. It's time to demand the evidence and to analyze it in the context of other information we have about borrower distress and repayment patterns. Otherwise the danger arises that an "echo chamber" starts to create conventional wisdom about default behavior, which may be hard to challenge if it turns out to be a bit of an exaggeration.

by Tanta on 1/31/2008 07:43:00 AM

PBS (thanks, ES!):

JEFF YASTINE, NIGHTLY BUSINESS REPORT CORRESPONDENT: You wouldn't call Sandra Sanchez a real estate speculator. The mother of two teaches at a private school. Two years ago, with a daughter headed off to college and the real estate boom in full swing, she purchased this house as an investment property. It seemed like a good idea at the time.

I have no idea why I wouldn't call Ms. Sanchez a real estate speculator, since as far as I can tell she was speculating in real estate. I'm sure she's an amateur speculator, but that's rather the point, isn't it?

YASTINE: Sandra Sanchez, struggling now to make payments on two homes, thinks the GOP and Democratic candidates are beginning to pay attention.

SANCHEZ: I think they're seriously thinking about the matter. And they know that a lot of the votes come from the average people, so you have to focus on the needs of the average people. You cannot sit back and let things happen to people.

YASTINE: With that in mind, Sanchez says she'll vote today and reevaluate come November. She hopes her homes haven't been foreclosed upon by then.

I'm guessing that we could, certainly, sit back and let things happen to speculators. Hence the fig leaf.

by Tanta on 12/09/2007 11:02:00 AM

CR adds: here is the link to Tanta's piece referenced in the Chronicle: The Plan: My Initial Reaction

Thanks to Bob Dobbs (and bacon dreamz) for this: we made it into a real newspaper!

From the San Francisco Chronicle, "Loan bailout is not likely to help many homeowners":

A fascinating though somewhat technical piece on the blog Calculated Risk surmises that this "convoluted and counterintuitive plan" was designed to stay "on the allowable side" of the contracts (called pooling and servicing agreements or PSAs) that govern how securitized loans are handled.

Dear media people: we appreciate being cited just like anyone else. That's what our media policy is about.

For the rest of you who've been hanging out at Calculated Risk before it was cool, a little celebration:

by Tanta on 11/26/2007 12:00:00 PM

While we're on the subject of subprime reporting . . .

This is what the Wall Street Journal reported on page one on November 2:

Merrill Lynch & Co., in a bid to slash its exposure to risky mortgage-backed securities, has engaged in deals with hedge funds that may have been designed to delay the day of reckoning on losses, people close to the situation said. . . .

The SEC is looking into how the Wall Street firm has been valuing, or "marking," its mortgage securities and how it has disclosed its positions to investors, a person familiar with the probe said. . . .

In one deal, a hedge fund bought $1 billion in commercial paper issued by a Merrill-related entity containing mortgages, a person close to the situation said. In exchange, the hedge fund had the right to sell back the commercial paper to Merrill itself after one year for a guaranteed minimum return, this person said.

While the Merrill-related entity's assets and liabilities weren't on Merrill's own balance sheet, Merrill might have been required to take a write-down if the entity was unable to sell the commercial paper to other investors and suffered losses, the person said. The deal delayed that risk for a year, the person said. . . .

"Merrill has been making the rounds asking hedge funds to engage in one-year off-balance-sheet credit facilities," Janet Tavakoli, who consults for investors about derivatives, told clients in a recent note. "One fund claimed that Merrill was offering a floor return (set buy-back price)," she said in the note, "so this risk would return to Merrill."

So, basically, this article is almost exclusively stenographic reproduction of what one person who is not named said. The Tavakoli quote certainly hints that the person is either a hedgie or is just repeating what some hedgie claimed.

Today, reporteth the WSJ:

ON NOV. 2, the Journal published a page-one article on Merrill Lynch & Co. that was based on incorrect information that the firm had engaged in off-balance-sheet deals with hedge funds in a possible bid to delay the recognition of losses connected to the firm's mortgage-securities exposure. In fact, Merrill proposed a deal with a hedge fund involving $1 billion in commercial paper issued by a Merrill-related entity containing mortgage securities. In exchange, the hedge fund would have had the right to sell the mortgage securities back to Merrill after one year for a guaranteed minimum return. However, Merrill didn't complete the deal after the firm's finance department determined it didn't meet proper accounting criteria. In addition, Merrill says it has accounted properly for all its transactions with hedge funds.

An anonymous blogger would like to know the following:

1. Why does "the person" still get anonymity? "The person" either lied or passed on unverified rumors as if they were facts. Why don't we need to know who "the person" is?

2. Did "the person" call the reporter with the tip on the original story? Why don't we need to know this?

3. Is "the person" in a position to profit from a fall in MER's share price? Why don't we need to know this?

4. What's with so-called "journalism" that merely repeats uncorroborated rumors planted by interested sources who get grants of anonymity?

5. Don't believe anything you read on some anonymous blog, for heaven's sake.

(thanks, commenter!)

by Tanta on 11/19/2007 02:03:00 PM

The OC Register has an interesting story out on the problems with the foreclosure numbers that RealtyTrac reports (and that the media tend to pick up and run with). I suggest you read the whole thing. I got fascinated by this little part:

For example, last year, RealtyTrac's data showed Colorado had the nation's highest foreclosure rate. That didn't sit well with state officials, who decided to do their own count of foreclosures and came up with a figure much smaller than RealtyTrac's. . . .

RealtyTrac counted 54,747 "foreclosure actions" in Colorado last year.

That number wasn't useful because it didn't reflect how many homeowners were actually in danger of losing their homes, said Ryan McMaken, spokesman for the Colorado Division of Housing. "We couldn't really use those numbers for having serious discussions," he said.

So McMaken put an intern to work calling all of the state's 64 counties to get a count of how many homes entered the foreclosure process last year. The number he came up with: 28,435.

This summer, partly in response to criticism, RealtyTrac began sorting its numbers to compile a separate count of properties in foreclosure, in addition to total foreclosure actions. RealtyTrac's "unique property" count, published quarterly, found 19,411 properties in foreclosure in Colorado in the first half of this year. That's within a few dozen of the 19,460 counted by McMaken.

"I think they're getting a lot closer now," McMaken said, adding that "we might not have to collect our own numbers" anymore.

So Colorado had no state-wide numbers for foreclosures. It didn't feel the need to have any until RealtyTrac made it look bad. So it got an intern to get on the telephone and call up counties and make a running list (with a spreadsheet? Or a ruled legal pad?). It then demonstrated that RealtyTrac's numbers were exaggerated. And so . . . now it can quit tallying its own numbers and go back to relying on the Associated Press to tell it what's going on in its own state? Um.

by Tanta on 11/17/2007 11:47:00 AM

This is going to be a long post. It is going to attempt to answer the question stated in the post title. It is also going to function as further proof of the old axiom that you can create quite a ruckus in 150 badly-chosen words, but it takes ten times that many words (at least) to return some sanity to the discussion. “Gotcha” reporters of course know this, which is why they do what they do. Most people don’t have the time or desire to wade through the high-attention span Nerd part to evaluate the reporter’s claim. That it’s a deadly serious business for anyone who owns shares in a publicly-traded company being compared to a criminal conspiracy on the basis of a misunderstanding of accounting rules doesn’t seem to bother writers who just want a “scoop.”

The ruckus started last week. On November 9, Fannie Mae released its 10-Q for the third quarter. This is the first time in years that Fannie has gotten a timely Q out; its 10-K for 2006 was released just in August, it never filed Qs for 2006, and the Qs for the first two quarters of 2007 were also just released in November. That little detail is important to this story. I assume everyone knows the long wretched saga of why Fannie Mae has been so far behind with its SEC filings. The point is that, in catching up, they have released a flurry of reports in a short period of time, which don’t have the same numbers on them (they shouldn’t; they are for different periods), and since they never reported quarterly numbers for 2006, we don’t have the by-quarter breakout that would provide details for some of the whole-year numbers reported in the 2006 K.

On November 15, Peter Eavis of Fortune Magazine published a breathless essay accusing Fannie Mae of having changed the method it uses to calculate its credit loss ratio in the Q3 filing. It is quite obvious that the presentation of this information has changed; the Q says so (page 54-55). Eavis, moving from a change in presentation to a change in calculation with intent to mislead at the speed of light, says “Uh oh. It’s Enron all over again.” Throughout the original article, he keeps referring to “bad loans” in such a way as to give the misleading impression that the metric in question, the credit loss ratio, is about reporting on delinquent loans, not on realized losses on defaulted loans in the current period. This allows him to accuse Fannie Mae of being “misleading” by not including fair-value write-downs on delinquent but not yet defaulted (not yet realized-loss producing) loans in the credit loss ratio.

Fannie Mae stock started to tank badly, and Fannie scheduled an analyst conference call for Friday morning to address this one very specific issue in one table in the Q. Fannie Mae explained, among other things, that the item excluded from the credit loss ratio calculation is, actually, included in net charge-offs on the consolidated financial statements. However, for the purpose of this specific metric, the credit loss ratio, fair value write-downs that have not yet produced an actual loss are excluded.

You can listen to the webcast here. Several analysts pointed out, quite nonconfrontationally, that they though Fannie could have provided more information to put this matter in context. Fannie agreed, and indicated that future disclosures would include more information. What’s amusing is that in two instances, analysts ended up asking whether in fact Fannie Mae wasn’t over-reserving for certain delinquent loans! Fannie Mae’s response was that they don’t think they’re under-reserving or over-reserving; they are simply applying GAAP rules for how fair-value write downs are taken. At no time in the conference call did anyone challenge this as a misapplication of GAAP rules.

So what did Eavis do, after the conference call and some delving into the credit loss ratio suggested that perhaps he merely misunderstood the math? He wrote a follow-up article on Friday, in which he continues to insist, even after Fannie Mae’s explanation of the issue, that the amount of exclusions from the credit loss ratio (that is, the amount of the fair-value write-downs on repurchased loans that are delinquent but not yet defaulted) is inexplicably large, and that these are forced repurchases, and that this is somehow sinister. This is after a conference call in which Fannie Mae explained, for those who have been living under a rock since last summer, why it is that write-downs on repurchased loans in Q3 can be many, many times the write-downs on loans repurchased earlier in the year, even if the total number of repurchased loans hasn’t grown all that much. There was this mere matter of a giant freeze in the mortgage secondary market, and spooked investors offering mere pennies on the dollar for delinquent mortgage paper, whether it was prime or subprime or something else. Eavis has to pretend to not remember that, I suspect, because his claim of “Enron all over again” is crumbling around his ears and he needs to keep kicking sand.

It is amazing to me that in light of all the real problems we have right now, we still want to go down expensive rabbit holes over “accounting tricks.” Nobody, least of all Fannie Mae, is trying to deny that there are severe problems in the housing and mortgage market, that large losses are being taken, and that this will hurt all over the place. I am not suggesting that Fannie’s Q is as clear as it could be, and I’m glad they indicated a willingness to report more color in future disclosures to make these numbers easier to evaluate. But writing a not completely helpful Q based on GAAP isn’t a crime in this country. I know a lot of people will argue that GAAP isn’t very helpful to the non-specialist. You get no argument from me about that, either. That still doesn’t make Fannie Mae Enron, and I for one would be livid if I were a Fannie Mae shareholder, and watched my money get flushed down the toilet for two days because, frankly, some reporter can neither read nor report. (I may well be a Fannie shareholder via indexed stock funds in one of my retirement accounts. But for disclosure purposes, I own no shares of FNM that I know about.)

Eavis could have gotten the same explanation from Fannie Mae that the analysts got in the call if he had asked for it, I am sure. No one forced him to write an article that makes accusations of willful dishonesty and implications of criminal behavior based on his inability to understand Table 26. He gave himself that assignment. And instead of apologizing for it, he continues to insist that the numbers don’t make sense.

Let me cut through the accounting archana (we can discuss that in the comments if we need to) to what I think is the real issue here. Fannie Mae has always had the option to repurchase seriously delinquent loans out of its MBS at par (100% of the unpaid principal balance) plus accrued interest to the payoff date. This returns principal to the investors, so they are made whole. If Fannie Mae can work with the servicer to cure these loans, they become performing loans in Fannie Mae’s portfolio. If they cannot be cured, they are foreclosed, and Fannie Mae shows the charge-off and foreclosure expense on its portfolio’s books (these are no longer on the MBS’s books, since the loan was bought out of the MBS pool).

Now, Fannie also sometimes has the obligation to buy loans out of an MBS pool. But we are—Fannie Mae made this clear both in the footnote to Table 26 of the Q and in the conference call—talking about optional repurchases. Why would Fannie Mae buy nonperforming loans it doesn’t have to buy? Because it has agreed to workout efforts on these loans, including but not necessarily limited to pursuing a modification. Under Fannie Mae MBS rules, worked out loans have to be removed from the pools (and the MBS has to receive par for them, even if their market value is much less than that).

There is, however, a little matter of accounting rules for booking these loans. Under GAAP, known internally to Fannie Mae as its SOP 03-3, the loan is taken onto the books at the lower of cost (par, in this case) or the fair market value of the loan at the time of repurchase. When the FV is lower than par, Fannie Mae has to charge-off the difference, at the time. This is not a true realized loss: it is a reflection of a mark to a real market value of a delinquent loan. You take the FV write-down at the time, even if you think that no loss, or a very much smaller loss, will actually end up occurring. That’s the rule. Anything else would be “mark to model” or “mark to myth.”

Now, anyone who hasn’t been living under a rock knows that bids for delinquent loans were either nonexistent or atrocious in July-September of this year. Certainly Fannie Mae knew that if it exercised its option to buy loans out of MBS in order to modify them, it, not the MBS, would have to take a nasty FV write-down. I don’t know about you, but I happen to think that a lot of private investors/servicers are refusing to do modifications of securitized loans precisely because they don’t want to have to buy them out of the pools and show that nasty write-down on their own books. They claim that it’s because securitization rules won’t let them modify loans, but I’ve never really bought that argument, nor have many regulators or the SEC.

The problem is that the market right now does not distinguish between a scratch & dent loan—one with a problem that could be cured with a modification—and defaulted nuclear waste that is facing 50% or more loss severity on imminent foreclosure. Whether it should be making that distinction or not—whether this is partly irrational panic or not—is not the point here. The point is that it just isn’t doing so, and so anyone who takes a loan to portfolio right now and uses a true market value instead of a fantasy is going to show the same huge write-down for the scratch & dent as for the nuclear waste. This will continue to be true until the market decides that everything isn’t nuclear waste any more.

So nobody wants outfits like Fannie Mae to mark to model; we want them to mark to market. We also want them to work out loans that can and should be worked out. Remember, we aren’t talking about horror subprime exploding ARMs here, we’re talking about troubled loans in typical Fannie Mae MBS. We’re talking about the kind of loans that would have taken a $60 million write-down in a past quarter, but that are taking a $600 million write-down in this quarter, solely because the market price of those loans has deteriorated so badly.

We also need to remember that Fannie has no intention of ever reselling these loans. If they can be cured, they will stay in Fannie’s portfolio. So establishing a market price is not about determining a loss Fannie would take if it cured the loan and then resold it. Establishing a market price is just a requirement of the accounting rules for a situation in which the price you must pay for a loan (par) is more than the market value of the loan. After all, what Fannie is doing here is making the MBS investor whole and taking the deteriorated asset onto its own books. The FV write-down means exactly that it is not hiding a loss this way.

Fannie Mae could avoid these write-downs by failing to exercise its option to buy the loans from the MBS. That would mean Fannie Mae refusing to work out loans with borrowers. Or, to put it another way, the price of Fannie agreeing to work with troubled borrowers is an out-sized hole in the current quarter’s charge-offs, not just because of the loan quality, but because of the total melt-down in the secondary market for nonperforming loans.

Fannie says that it does not expect most of these loans to default and produce large realized losses. You may or may not find that convincing. But Fannie does, because that’s why they bought them out of the pools. If they thought the stuff would go straight to the FC department, they’d have let the servicer take the loan out of the pool and foreclose, and let the losses hit the MBS guarantee fee income.

Fannie’s story is that in normal times, these FV write-downs of repurchased loans are included in total charge-offs, and therefore are reported in the credit loss ratio. In Q3 07, because of the enormous size of the FV write down, Fannie Mae backed out of the charge-offs the ones due to an up-front write down of delinquent but not defaulted loans. It added back any part of that write down that did, actually, become a realized loss, so that readers of the Q could get a true picture of how much the total charge-offs in Q3 were affected by repurchased loans.

Eavis is saying that this is inexplicable. Of course it’s explicable. You can and some analysts did on Friday ask Fannie Mae why it didn’t supply more information about what it was doing with those loans, and what its expected cure rate would be for these workouts. Fannie Mae acknowledged that such information would have helped and promised to provide more in future disclosures. But nobody on that conference call, as far as I remember, questioned the size of the Q3 07 FV adjustments. People who have been following the credit markets all year are not surprised here. Eavis is.

For the love of all that is holy, what does anyone think Fannie Mae (and Freddie Mac) are up to these days? The enormous pressure they are under by Congress and the public to modify as many loans as can possibly be saved has been so well-documented in the press that I’m sure they heard about it on Mars. It’s possible that Fannie is too optimistic about the cure rate of these loans. It’s possible that deep inside, they realize they are going to eat huge losses on all this stuff. But they were told in no uncertain terms to buy it out of the pools, take the FV write-down like a big kid, and start working out loans. Does anyone actually expect them to write a quarterly report that says “We think all this stuff will result in 100% losses in the next 90 days, but our regulators made us buy it anyway, so we’re reporting the worst possible credit loss ratio we can calculate, just to spite them”? On no planet, at no point in time, will that ever happen. You have to be willfully ignorant to think it would.

So there is, actually, a compelling story to be teased out of a couple of footnotes to a little table on page 55 of a 107-page quarterly report. It’s a story about political and market pressures and reactions; about the bottom-line impacts of workouts to investors like Fannie Mae; about the real-world effects on profitability numbers of things we see in fairly abstract forms, like those cliff-dives on the ABX and CDS charts or the dramatic ratings downgrades we post on regularly. There is a story that ties all of this together and shows how realized losses can be small compared to market losses, and how this ties into the debates over “mark to model” and other bad industry practices. There’s even possibly a story about how in certain unusual times, the old-fashioned GAAP rules fail to really tell investors what they need to know. These are fascinating and important subjects.

Eavis blew through all of those real issues to make a big deal about how Fannie projected losses in the 4-6 bps range for the year and might, actually, be at 7.5 bps as of Q3 if you calculate the number the way Eavis thinks you should. Think about this: he’s saying that it’s possible that credit losses on mortgage paper as of Q3 07 are worse than what was predicted at the end of 2006. OMG!!! No!! Really??? NEWS FLASH!! CALL THE POLICE!!!!! THE OBVIOUS!! IT IS BLINDING ME!!!

Sorry I let myself get out of control there, but come on. Anyone who has been reading USA Today on alternate weekends since February knows that losses are getting worse, and Fannie Mae did in fact explicitly report that losses were getting worse, even with the FV write-downs that were not realized losses backed out. What we are seeing is the whole problem with the “Another Enron” mentality: confusing the meaning of numbers with “accounting tricks,” and substituting some kind of gotcha for an honest attempt to understand the market mechanisms and economic reality that is creating those numbers. This mentality claims to be keeping companies honest, but it actually has the opposite effect, in my view, of inhibiting companies from presenting more detailed numbers, since the more you give people like Eavis the more they have to play gotcha with. And Eavis himself takes credit for his original article having lead to a 17% drop in Fannie Mae’s share price. I guess he’s proud of that. The other side of the Enron myth is the Famous Reporter Who Brought Down the Corporate Giant. It is worth not allowing oneself to get sucked into that sort of grandiose mythologizing.

I have to say I hate “blog triumphalism,” too. That’s the mindset too many internet writers have that us citizen journalists in our jammies are going to single-handedly bring down the Big Corrupt Media. I firmly believe in beating the press up a little when they do egregiously bad reporting, but that’s largely because I care about understanding what the real story is. And I hate being distracted by red herrings in my personal quest for understanding. Yesterday I spent over two hours rooting through SEC disclosures and listening to a 57-minute conference call trying to independently verify Eavis’s point; today I’ve spent a couple of hours writing this post. I am willing to believe that very few people have the time and the expertise to do what I just did. I therefore feel compelled to share my point of view with the rest of the world, in the interest of a worthwhile public discussion of financial and economic matters, which is the purpose of this blog. So I didn’t start out with the goal of catching Eavis being a lousy reporter; I started out with the goal of reading about Fannie Mae in a CNN Money article. But I believe that I did discover hyped, misleading, and ignorant reporting, and I believe it is fair to say so in public.

by Tanta on 11/15/2007 08:24:00 AM

So there was a pretty breathlessly hyped story on a blog about how the dismissal of a foreclosure filing meant that the entire MBS market is more or less toast. Then there was a tedious attempt by Tanta to sort through it and figure out what the real issue was and perhaps cool down some of the rhetoric. You know what had to happen next. Gretchen Morgenson got ahold of it.

Do read the whole piece. Perhaps I have gone temporarily blind, and there is somewhere in this article an acknowledgement that this story was "broken" on a blog. (Not mine, by the way: I Am Facing Foreclosure.com "broke" the story. I ignored it as long as I thought I could.) Query: is this where GM has been getting a lot of story juice lately? Could that be why some of her recent reporting, especially on Countrywide, is such a noxious mixture of fact and hype, information and innuendo?

All I know about journalistic practice tells me that if this story had originally been reported in the Podunk Inquirer, GM would have credited the ol' PI in her story. But you can fish in the blogs, it appears, without having to admit it. And without identifying the blog-source of your stories, you avoid having to confront the evaluation problem. There are great blogs and terrible blogs out there. There is carefully gleaned and analyzed information, and there is rumor, garbled gossip, and speculation masquerading as fact. There are people whose agenda and biases are perfectly clearly spelled out, and there are those who are talkin' a book or just shilling. If you want to seine the blogs for NYT material, you have to deal with this problem for yourself and for your readers. Identifying your sources is not simply professional courtesy, it's the beginning of the process of evaluating the source. Yes, I am not a professional reporter and this is a blog and I am lecturing the NYT on Journalism 101. I'm afraid to open the fridge to get milk in case there's a trout in there.

I said most of what I want to say about the issue yesterday. Let me just pause over this one tidbit in GM's article this morning:

When a loan goes into a securitization, the mortgage note is not sent to the trust. Instead it shows up as a data transfer with the physical note being kept at a separate document repository company. Such practices keep the process fast and cheap.

I rail endlessly about mortgage industry practices that are "fast and cheap" and that sacrifice risk management. You all have never heard me complaining about the practice of third-party document custody because it is one of the very few old-fashioned slow expensive risk management processes that the New Paradigm people have not yet managed to do away with. Document custodians are the Nerdiest Nerds there are, and their nerditude is in so many cases the only thing separating the current secondary market from a Wild West clown show. They are the thin red-tape line between us and chaos. I have never met anyone having anything to do with mortgage loans who has not at least once indulged in a major bitch-fest about dealing with some Iron-Fisted Custodian who won't just certify pools or mail notes around or change reports because some punk says to. They want appropriately-signed authorizations. They want Trust Receipts. They want originals, not copies; they want letters, not phone calls. They are, personally and institutionally, the kind of people who count the teaspoons after the dinner party guests leave.

And it costs money to use document custodians, who are, if you want to know, required to be financial institutions with a trust department that has direct authorization from its regulator to offer trust services. That does not make them perfect, but to call them "document repository companies" may give you all the impression that we're dealing with some fly-by-night Docs R Us outfit. I don't have exact numbers handy, but I would guess off the top of my head that after Fannie and Freddie, who are the custodians of most but not all of their own notes and mortgages, the single largest concentration of custody docs in this country is probably Wells Fargo. (I invite correction if I'm wrong about that.) Like anyone else who has ever certified pools, I've visited Wells's custodial operations center. I don't remember having to take my shoes off and put them in a basket before they let me in, but then again it was several years ago. At the time, Well's security was better than most airports'.

It has to be. Not only do they hold the documents collateralizing trillions of dollars of debt that belongs to someone else, but they do, in fact, hold those notes I was talking about yesterday that are endorsed in blank. Such a thing is rather more secure than a simple bearer bond, but not by much.

In the case of the DB foreclosure suit dismissal we looked at yesterday, there should have been a set of original notes and original recordable-form (but possibly not actually recorded) assignments of mortgage in the physical custody of a document custodian when DB went to file its FC action. It should therefore have been a matter of DB requesting the pertinent docs from the custodian, who would send them to DB's legal people in order to prepare the filing. Either this did not happen, or the custodian lost the docs, or DB lost the docs, or the docs were never there in the first place. If that last part is true, I want to know how a custodian certified those pools at issuance. If the custodian certified the pools on condition that some missing assignments get turned in later, then when and how did the custodian follow up on that? This is Deal, Big.

It is, mind you, possible that DB is acting as its own custodian. It's a bank, it has a trust department, it qualifies as a custodian. And if DB is acting as its own custodian, and certifying pools without having its hot little hands on the docs first, or it is misplacing those docs it had when it certified the pool to start with, then that, my friends, is a Story. It is a story that Deutsche Bank's regulators might be really really interested in. I know I am.

But this story will not get written by anyone who misunderstands what custodians are, how much they cost (real fee dollars), and how they are supposed to act like the Gatekeepers and SuperNerds of the whole process. In other words, they are supposed to be a check against "fast and cheap," not part of "fast and cheap."

by Tanta on 11/06/2007 11:10:00 AM

I know how disappointed everyone would be if I passed on an opportunity to publically describe Gretchen Morgenson as a tendentious writer with only a marginal grasp of her subject matter and what appears to be an insatiable desire to make uncontroversial facts sound sinister. So here we go again.

Obligatory declamation: I hate sloppy mortgage servicers, I think fee gouging is criminal, and nothing would make me happier than to see bankruptcy judges slapping some servicers around a little. Morgenson's article, "Borrowers Face Dubious Charges in Foreclosures," brings up one particular thing, payoff fees, that I have been bitching about for fifteen years and that I'd be happy to see outlawed. (News flash: those fees are charged by servicers to everyone who requests a payoff quote, including everyone who has ever refinanced a mortgage. This isn't just something that happens in bankruptcy or foreclosure. If there is a more normal course of business process than calculating what one is owed, which should therefore be a matter of general servicing fee compensation, I can't think of one. Total Ick.)

As usual, though, Morgenson's valid points are drowning in a sea of sensational swill:

Because there is little oversight of foreclosure practices and the fees that are charged, bankruptcy specialists fear that some consumers may be losing their homes unnecessarily or that mortgage servicers, who collect loan payments, are profiting from foreclosures.

The article presents exactly zero evidence, anecdotal or otherwise, that any of the foreclosures or bankruptcies in question were "unnecessary." There is certainly the implication here that servicers profit more from a foreclosure than from simply servicing a performing loan. That idea could use some evidence. It may be true that once a loan defaults, the servicer loses less by foreclosing (where its costs are reimbursed by the noteholder out of the liquidation proceeds) than by working the loan out; this is a big problem with the modification thing, in which servicers generally have to absorb the costs of the modification. But if the accusation here is that servicers drive borrowers into default in order to foreclose, I'd like to see some evidence for that. (Really, I would. That would be a serious indictment of the servicing industry.)

Bankruptcy specialists say lenders and loan servicers often do not comply with even the most basic legal requirements, like correctly computing the amount a borrower owes on a foreclosed loan or providing proof of holding the mortgage note in question.

Perhaps our attorney friends will tell me how it is that servicers have to prove that they are noteholders in a bankruptcy. I suspect that's news to all investors in mortgage bonds, who think they are the noteholders. Are we talking about sloppy filings, in which the servicer failed to include a copy of the note? Or are we really talking about servicers who cannot cough up an assignment of mortgage or deed of trust to show standing to foreclose? Is this predation by servicers who don't even have the right to collect on the debt, trying to worm their way into BK court, or botched paperwork?

In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

In one example, Ms. Porter found that a lender had filed a claim stating that the borrower owed more than $1 million. But after the loan history was scrutinized, the balance turned out to be $60,000. And a judge in Louisiana is considering an award for sanctions against Wells Fargo in a case in which the bank assessed improper fees and charges that added more than $24,000 to a borrower’s loan.

These are not impressive examples of servicer competence, and I don't object to public humiliation of any servicer who can make errors like that. But does anyone seriously think that these were attempts to "raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered"? (Keep reading to get to the details of the Wells Fargo case, and notice that the inappropriate charges were overwhelmingly fees or charges that would not be payable to Wells as servicer but would be passed through to the investor or someone else.)

But that's the thing: once again, Morgenson displays her profound ignorance of the industry she spends so much time writing about:

Loan servicing is extremely lucrative. Servicers, which collect payments from borrowers and pass them on to investors who own the loans, generally receive a percentage of income from a loan, often 0.25 percent on a prime mortgage and 0.50 percent on a subprime loan. Servicers typically generate profit margins of about 20 percent.

I have no idea where the 20 percent "profit margin" comes from or what it means in this context. I also do not know what "extremely lucrative" means in the context of a 25 bps servicing fee. But here's the kicker:

Now that big lenders are originating fewer mortgages, servicing revenues make up a greater percentage of earnings. Because servicers typically keep late fees and certain other charges assessed on delinquent or defaulted loans, “a borrower’s default can present a servicer with an opportunity for additional profit,” Ms. Porter said.

The amounts can be significant. Late fees accounted for 11.5 percent of servicing revenues in 2006 at Ocwen Financial, a big servicing company. At Countrywide, $285 million came from late fees last year, up 20 percent from 2005. Late fees accounted for 7.5 percent of Countrywide’s servicing revenue last year.

But these are not the only charges borrowers face. Others include $145 in something called “demand fees,” $137 in overnight delivery fees, fax fees of $50 and payoff statement charges of $60. Property inspection fees can be levied every month or so, and fees can be imposed every two months to cover assessments of a home’s worth.

When other sources of revenue go down, servicing revenue does, in fact, make up a larger percentage of total revenue even if servicing revenues are unchanged. Remember that you get that lordly 0.25-0.50% in servicing fees only as long as you have a loan to service. No new originations, no new servicing fees.

But of course, we are talking revenue here. For instance, those late fees are revenue: they aren't "income" until you back out the expenses of collecting on late loans and the carrying costs of the payments servicers have to advance to the noteholders on time regardless of whether they're collected or not. Do servicers actually make a profit, at the end of the day, on late fees? I suspect most do. Is it less than 100% of revenue? Yes. How much less? Pity Morgenson didn't ask.

You get no argument from me that junk fees like payoff fees, fax fees, demand fees, and unnecessary overnight charges are a horror. I am less convinced that doing away with periodic property inspections for a home in the foreclosure or bankruptcy process is such a great idea: you need to know that the home is still occupied and that it hasn't been vandalized. There's surely a reasonable argument that inspection costs should come out of general servicing revenue, not pass-through fees to the borrower. If you did that, of course, I'd guess that servicing fees would probably go up, so you'd pay it anyway. However, unless the servicer owns the inspection company and makes a big markup (which is possible, although no evidence is presented here), then it's "revenue" with a matched expense. Mortgage servicers can be amazingly dumb at times, but if they're beefing up income with that strategy, you can rest assured it won't last long.

Here's the part of the article based on actual data from a researcher:

In 96 percent of the claims Ms. Porter studied, the borrower and the lender disagreed on the amount of the mortgage debt. In about a quarter of the cases, borrowers thought they owed more than the creditors claimed, but in about 70 percent, the creditors asserted that the debt owed was greater than the amounts specified by borrowers.

The median difference between the amounts the creditor and the borrower submitted was $1,366; the average was $3,533, Ms. Porter said. In 30 percent of the cases in which creditors’ claims were higher, the discrepancy was greater than 5 percent of the homeowners’ figure.

Based on the study, mortgage creditors in the 1,733 cases put in claims for almost $6 million more than the loan debts listed by borrowers in the bankruptcy filings. The discrepancies are too big, Ms. Porter said, to be simple record-keeping errors.

Well, we don't know what the total amount of the loan debts listed is. Let's assume an average loan debt of $200,000. That gives us $346,600,000 in debts. A $6 million discrepancy is 1.7%. You have to assume that at least some of these are "discrepancies" because the borrowers simply have no idea how much back interest they owe (like all those folks who thought the accrual rate on their OA was 1.00%). There certainly seem to be some big outliers there, given a median of $1,366 and a mean of $3,533. I'm guessing that the one loan of $60,000 with a servicer balance of $1MM is probably throwing that off. End of the day, the discrepancy due to intentional servicer padding of fees has to be less than 1.0%.

Is that an impressive track record for the servicing industry? No. Are we relieved that bankruptcy judges are challenging these charges? Yes, we are: $1,366 might be small beer for a trillion-dollar servicer, but it's money no one needs to squeeze out of a bankrupt consumer. Does it support the contention that servicers are making up for a drop in origination income by loading up on inflated revenues that have no offsetting expenses? Not as far as I can see.

I realize that this will hurt the feelings of the conspiracy-minded, but I do believe that high rates of foreclosure and bankruptcy are money-losers for mortgage servicers, not profit centers. This is not a plea for sympathy for the servicing industry: I have wasted eleventy-jillion of your pixels on the subject of how the industry created this mess with ridiculous lending standards and dereliction of risk management duty. No one is happier than I am to see the little punks take it in the bottom line, and my enthusiasm for things like cram-downs and workouts--the cost of which is borne by the parties who got us into this mess--is an example of that.

It strikes me as quite plausible that some servicers are trying to make some lemonade by charging every fee they can think of. In a foreclosure of an upside down loan, of course, those fees come out of the investor's or insurer's pockets, not the consumer's. In a Chapter 13, these are fees borrowers are expected to repay, and with the cram-down prohibition, there's little incentive for servicers to control costs. So cram the damned things down.

The sad fact of the matter is that there are many businesses and industries that "profit off misfortune." There's money to be made in divorce lawyering, funeral parloring, and broken bone-setting, as well as default mortgage servicing. When profiting becomes profiteering, then yes, that should be punished to the fullest extent of the law. I suggest it also helps to create legal and regulatory structures that remove as many incentives for profiteering as possible in the first place. In order to do that, we have to understand how the business works. Nerdiness matters.

Are we to believe that payoff quote fees were OK until now? That late fees have never until the bust been a money-maker for servicers? That favorable bankruptcy treatment for mortage lenders was fine until 2007? That sloppy business practices have nothing to do with outsourcing, temping, mass layoffs, misguided technology projects, and any of the other myriad forces that corporate America has unleashed in its endless quest to enrich CEOs and keep you on hold for ten hours as you struggle to understand all that crap on your phone bill or locate your lost luggage? Mortgage servicing isn't any better or any worse than the rest of corporate America when it comes to half-assed business practices. It is, however, beginning to suffer the consequences of a huge boom, and I for one predict that we will get to see just how poorly managed a lot of these operations really were: there will be more than a few lost copies of promissory notes and misapplied payments. I'm sure it's too much to hope that everyone who bought shares of these outfits based on their impressive "cost management" will have to pay for it all.

Until justice does finally arrive, I guess we'll have to remember these words of wisdom:

No one likes to face ugly realities like financially ailing borrowers who are so strapped that nothing can save them. Not the lenders, not the Wall Street firms that sell the securities, not even the holders. But experienced investors know that a reliance on fantasy will only prolong the pain that is racking the huge and important mortgage market.

by Tanta on 10/22/2007 09:30:00 AM

Or "words," as the case may be. Take "Subprime crisis forces McMansions to take McBreather," a sad story of the housing horrors of Hinsdale, in which marketing time for properties in the $2MM range is now six to nine months, if you can believe that. (Note to reporters: that's hardly historically unusual for jumbo properties.) What I found amusing is how "subprime," the crisis thing announced in the headline, suddenly gets a set of scare-quotes half-way through the article:

Real-estate businesses are hurting. Uncertainty about the U.S. economy and tighter mortgage financing in the fallout from the "subprime" credit crunch have reduced buyers. . . .

Hanna said one way to view the U.S. property market was to picture it as "a pyramid, where subprime forms the base."

A credit crunch has tightened all mortgage lending because of probes of bankers, lenders and brokers amid the subprime crisis, limiting mid-tier borrowers from buying up.

"Now people at the bottom can't sell to move up a level and that also hurts people at the top of the pyramid," Hanna said.

Lenders are more reluctant to lend to people at the bottom of the market. But wealthier Americans with less-than-perfect credit -- some, for instance, with a hefty mortgage or two already -- are finding themselves in the same boat.

"Many of the people at the high end are CEO's and entrepreneurs who are used to getting what they want," said Bill McNamee, president of Pinnacle Home Mortgage, a mortgage broker focused on Chicago area high-end homes. "They don't like being told 'no,' but some will be forced to get used to it."

Nervousness after the summer's stock market volatility and fear of a recession have also played a role.

"High-end owners are staying put and adding on to their houses because they're afraid of what's happening in the economy," said Sandy Heinlein of Baird & Warner Real Estate in Inverness, a wealthy Chicago suburb.

Many owners are unwilling to risk buying a home for fear they may not be able to sell their existing one, she said.

Pat Turley, owner of Koenig & Strey GMAC Real Estate in the Chicago suburb of Glen Ellyn, said unrealistic expectations from both buyers and sellers have added to the slowdown.

"Some sellers have yet to accept they won't get the price they could have a year or two ago," Turley said. "And while it's a buyer's market, there is a limit to how low buyers can expect sellers to go."

A pyramid. Really? How big do these people think the subprime "starter home" purchase-money market is (or was, even at its height)? Perhaps those sudden queasy quotes around "subprime" involve an implicit recognition that the real "anomaly" in the market is the McMansion owners who perceive themselves as the top of the pyramid, but still want to sell and move up? Um, where are they going to go? Evanston? How wide does the top of a pyramid get?

And we think the problem is that "subprime" borrowers cannot "sell to move up a level"? Odd. I'm hearing that they cannot "sell to avoid foreclosure."

Some day this war is going to end, but until then, we are all subprime now.

by Tanta on 10/16/2007 12:46:00 PM

There has been a fair amount of reporting in the last two days on a survey of ARM borrowers commissioned by the AFL-CIO. As is often the case, what we learn seems to be more about the press's ignorance than anything else.

The clearest description of the results that I've found comes from the AFL-CIO's blog (surprised?):

The poll shows that of those homeowners whose ARMs had reset, 37 percent had interest rates at 8 percent or higher, above the current market rate for prime, fixed-rate loans, and 16 percent had interest rates at 10 percent or higher. After the reset, the average increase in monthly mortgage payments is approximately $291, a 10 percent cut in after-tax pay for a family earning $50,000 a year.

Two in three (64 percent) of those whose rate has reset do not recall their lender telling them how much more their payment would increase, and 32 percent don’t recall being told when their interest rate would increase. Twenty-three percent of all respondents say they had been late making a mortgage payment at least once in the past 12 months. That proportion jumps to 37 percent among those whose rate has increased.

The poll also found substantial support for government action to protect consumers. Fifty-one percent say they think the government should assist people with ARMs facing foreclosures, and 77 percent say the government should do more to regulate the mortgage industry.

Despite a general lack of understanding about their adjustable rate mortgages, 79 percent say they believe the information they received from their lenders was mainly accurate and truthful. Sixty percent say they got their ARMs from mortgage brokers, and 39 percent directly from banks. [Emphasis added]

Without seeing the actual survey question, I am at a loss to know what, precisely, we are to make of the fact that two thirds do not remember the lender disclosing how much the payment would rise. That implies that one third of the respondents seem to remember the lender disclosing an unknowable "fact." ARMs adjust on specified dates, and the rate (and hence payment) are adjusted to a specified formula (index plus margin, subject to caps), but since the index at adjustment is a future value, there is no "disclosure" of how much the payment will increase. If a third of respondents remember being told what their future payment would be (not, say, what it might be if the index value does not change, which is the standard disclosure), then we got some serious problems here, but I don't think it's the same problem that the press thinks it is.

It's also curious that 79% of people feel that the lender disclosed facts honestly, when it seems clear that a majority of borrowers aren't sure what the facts are. There are several possibilities here, one being that borrowers on the whole are likely to trust people who work in financial services and talk in numbers, whether that trust is misplaced or not. Another is that borrowers recognize that they were in fact given truthful information, they simply do not understand it. They don't even know what they're supposed to "know": you cannot, in fact, "know" what your future payment will be with an ARM. If you think you "know" that, you are confused. Similarly, if you don't remember being told when your ARM will adjust, you can actually look at your copy of the note you signed. Do people rely on memories of oral explanations because they do not know how to read these notes? Would they ever have known how to read these notes?

However, press reports don't seem to see the real problem here:

A study commissioned by the AFL-CIO shows that nearly half of homeowners with ARMs don't know how their loans will adjust, and three-quarters don't know how much their payments will increase if the loan does reset.

Nearly three quarters of homeowners (73%) with ARM's don't even know how much their monthly payment will increase the next time the rate goes up.

Not a single one of these sources explains how a person with an ARM might go about finding the information and the calculator necessary to determine what the adjusted payment might be if the index value available today is the one that will be used in a future adjustment.

Is that whole process over a lot of folks' heads? Sure it is. That's why offering ARMs in the mass market to people without much financial sophistication, who probably do really need to know what their payment will be in the future to budget around it, and therefore should be put in fixed rate loans, remains a thoroughly stupid idea. I, however, remain stunned that the press can report that "only" 73% of borrowers do not claim to know the unknowable as if that's the problem.

by Tanta on 9/30/2007 11:50:00 AM

I don't know how many posts I've written on Gretchen Morgenson's terrible reporting. I guess I'm going to have to start keeping score. "Can These Mortgages Be Saved?" Can this "reporter" be saved?

Her latest attempt to go after Countrywide, for sins real and imagined, contains the following "reportage":

But on the billions of dollars worth of mortgage loans that have been sold to investors in the last few years, it is not the banks or lenders like Countrywide that are hit with big losses when homes go into foreclosure. It is the sea of faceless investors who own pieces of these trusts. Also, under the trusts’ pooling and servicing agreements, Countrywide and other servicers typically recoup any costs they cover in the foreclosure process, such as legal and appraisal fees.

Borrower advocates fear that fees imposed during periods of delinquency and even foreclosure can offset losses that lenders and servicers incur. Few borrowers know, for example, that when they make only partial payments on their mortgages, servicers do not credit those payments against the principal or interest on their loan. Instead, the partial payments are deposited into a so-called suspense account. Servicers can dip into these funds and make use of them as interest-free loans, although the funds have to be accessible when the borrower becomes current on payments. In the meantime, borrowers — whether or not they know it — are still zapped with fees and charges for delinquent mortgage payments.

“The foreclosure process is a profit opportunity for servicers and lenders, but there is very little oversight of the fees imposed,” said Michael D. Calhoun, president of the Center for Responsible Lending. “There are a lot of folks trying to squeeze distressed borrowers.”

I cannnot, literally, think of a better way to stir up sympathy for Countrywide than printing crap like this.

1. Servicers recoup foreclosure expenses because servicers are servicers. Investors are investors. Investors buy the credit risk; they therefore cover foreclosure costs. This is a perfectly normal arrangement. If you think there's a problem with it, can you explain how being reimbursed for an out-of-pocket expense, like a fee paid to a lawyer or an appraiser, is "making a profit"? Are you saying there's a markup in there? Do you have evidence for that?

2. Servicers are not now and have never been required to accept partial payments. Mortgage loans are not free-form Option ARMs where the borrower gets to decide how much principal or interest to pay this month; all of them, even the real OAs, have "minimum payments." If a distressed borrower talks a servicer into accepting a period of partial payments, to be made up later, that is called a payment plan or forbearance arrangement or some other "workout," and it takes the servicer's consent.

3. Putting partial payments in "suspense" means they don't get posted to the customer's account. It does not mean that the money goes into the servicer's own account. Those funds go into custodial accounts to which servicers cannot "dip in." Servicers do receive float income on those accounts, but of course in most cases they are also obligated to advance the full payment to the investor, out of their own funds, until it is collected from the borrower. So advances do offset the float. This entire paragraph is such an egregious mismash that it's unbelievable.

4. Foreclosure is a profit opportunity? What does that mean? That mortgage loan servicing--which unfortunately does include having to foreclose loans when they default--is a profitable business? Well, yes. That's why people engage in it. Is the claim here that an unfair or excessive profit is being made off of foreclosures (but not off of performing loan servicing)? How? Specifically? The "examples" in these three paragraphs don't make any sense.

And I cannot begin to make sense of the "Connor" loan example. With the hashed-up timeline and limited information given it's impossible to figure out. All I can say is bang-up job of reporting.

Ms. Morgenson, if you want to keep up on your mission to portray Countrywide in the worst possible light, you are going to have to get an education from a reliable source at some point about how the mortgage industry works.