by Calculated Risk on 12/01/2009 10:00:00 AM

We started the year looking for two key construction spending stories: a likely bottom for residential construction spending, and the collapse in private non-residential construction.

It appears residential construction spending may have bottomed, although any growth in spending will probably be sluggish until the large overhang of existing inventory is reduced.

And the collapse in non-residential construction spending continues, and there will be further declines as projects are completed.

Click on graph for larger image in new window.

The first graph shows private residential and nonresidential construction spending since 1993. Note: nominal dollars, not inflation adjusted.

Residential construction spending increased in October, and nonresidential spending continued to decline.

Private residential construction spending is now 63% below the peak of early 2006.

Private non-residential construction spending is 20.6% below the peak of last October.

The second graph shows the year-over-year change for private residential and nonresidential construction spending.

Nonresidential spending is off 20.6% on a year-over-year basis.

Residential construction spending is still off 23.6% from a year ago, although the negative YoY change will get smaller going forward.

Here is the report from the Census Bureau: October 2009 Construction at $910.8 Billion Annual Rate

by Calculated Risk on 12/01/2009 08:39:00 AM

UPDATE: Here is the document (pdf): Introduction of Home Affordable Foreclosure Alternatives – Short Sale and Deed-in-Lieu of Foreclosure

From Reuters: Treasury sets guidance to simplify "short sales" (ht Anthony)

Here are the basics of the Home Affordable Foreclosure Alternatives Program financial incentives for completing short sales or a deed-in-lieu transaction:

Borrowers would receive $1,500 from the government in relocation expenses.

Servicers receive $1,000 from the government.

Second liens holders can receive up to $3,000 of the sales proceeds for releasing their liens.

First lien investors can receive $1,000 from the government for signing off on payments to subordinate lien holders.

Borrowers must be fully released from any further liability.

by Calculated Risk on 12/01/2009 12:07:00 AM

Ok, one more post on Dubai before all the U.S. economic news this week ...

A couple of articles from the NY Times: Dubai Crisis Tests Laws of Islamic Financing

Shariah-compliant investments prohibit lenders from earning interest, and effectively place lenders and borrowers into a form of partnership. Yet there are no consistent rules about who gets repaid first if a company defaults on such debt, said Zaher Barakat, a professor of Islamic finance at Cass Business School in London.

And Andrew Ross Sorkin describes a recent trip to Dubai: A Financial Mirage in the Desert

One discussion was led by a British banker from Barclays who had moved to the region to create an entire Shariah-compliance team. He shared tips about various ways to create “structured products” that would pass muster with Muslim investors. (To me, the investments looked like bonds, walked like bonds and talked like bonds — but he never called them that.) Some of the bonds that Dubai World is in jeopardy of defaulting on, by the way, are Shariah-compliant sukuk. Just don’t call them bonds.

Oh great, more "structured products".

by Calculated Risk on 11/30/2009 08:58:00 PM

From The Times: Fear of creditor wipe-out as Dubai jettisons conglomerate

Dubai World, the state-owned conglomerate, was effectively abandoned to its fate by the Emirate's Government yesterday despite previous assumptions that Dubai would stand behind the company. That has raised the likelihood that lenders to Dubai World, which has liabilities of $60 billion, could lose billions of dollars.

Dubai World will be restructured and some of its assets ... are likely to be sold to pay down debt.

However, there is uncertainty over the robustness of creditor protection under Dubai law and lenders are understood to be concerned that they will get little or none of their money back.

Analysts at RBC Capital Markets said: “The bottom line is that creditors have almost no legal legs to stand on to maximise recovery values.”

This reminds me of a post by Rachel Ziemba in early 2008: Petrodollars: How to Spend It

Click on graph for larger image.

Rachel Ziemba writes:

2007 was the first year that spending growth outstripped revenues [growth] in the GCC and many other oil exporters. 2008 budget plans imply even higher current (especially wages and subsidies) and capital expenditures. Even countries that have traditionally saved more (Kuwait) are ramping up spending especially on capital projects and in some cases transfers to the population or pension funds. ... With megaprojects in the works in a variety of sectors including energy and other infrastructure, capital spending will likely continue to rise.

Further Ziemba argued - based on spending growth - that "many GCC countries might have very small current account surpluses" within 5 year, if oil prices hold steady.

And guess what? Oil prices fell - and spending continued to increase. And JA reminded me of this story earlier this month from Bloomberg: Qatar Bonds Gain After $28 Billion of Orders for Sale (ht JA)

Qatar’s bonds rose after the largest-ever sale of debt by an emerging-market government received $28 billion of orders, four times the amount issued.
...
“This is the largest debt deal from an emerging-market sovereign to date,” said Fabianna Del Canto, syndicate manager at Barclays Capital, a lead arranger for the sale, in London. “Qatar has firmly established itself as the premier borrower in the region.”
...
Qatar, the world’s biggest exporter of liquefied natural gas, will use the bond proceeds to provide “contingency funding” for state-owned companies, pay for infrastructure projects, and invest in the international oil and gas industry, according to the bond sale prospectus obtained by Bloomberg News.

Interesting. From lenders to borrowers ...

by Calculated Risk on 11/30/2009 06:01:00 PM

One year ago today, my friend and co-blogger Doris “Tanta” Dungey passed away.

This has been a very difficult couple of weeks for her family - Tanta's birthday was Nov 15th and she would have been 48. Cathy, Tanta's sister, asked me to pass along the gratitude of her family for all of your touching comments.

I first "met" Tanta in the comments to my posts in early 2005. She was clearly very knowledgeable about the mortgage industry - and extremely funny - and we shared concerns about the housing bubble and the eventual credit collapse. Tanta was a frequent participant in the comments all through 2005 and into 2006 - and then she disappeared for several months.

When Tanta eventually resurfaced, she revealed she had been seriously ill, and was no longer able to work (she was a mortgage banker). I approached her about writing for this blog, and at first she was hesitant - her health was her primary concern - but in December 2006 she finally agreed.

Tanta became well known for her brilliant posts (see the obituaries below), and she was also very witty and full of life. To understand the impact she had on readers, check out the comments to my post last year: Sad News: Tanta Passes Away

Sadly Tanta’s health declined in the summer of 2008, and she passed away last November. She left us many great posts and wonderful memories. Tanta was about getting the story right – and also having fun. I know this is a sad anniversary, but I think it is also a moment to once again celebrate her life.

Tanta Vive!

Click on photo for larger image in a new window. Here is more: In Memoriam: Doris "Tanta" Dungey Tanta playing guitar in 2002 (photo credit: family) From David Streitfeld in the NY Times: Doris Dungey, Prescient Finance Blogger, Dies at 47

For some reader remembrances, emails from Tanta and more, see Remembering Tanta Dance, Tanta, dance! (Photo credit: family) From Patricia Sullivan in the WaPo: Doris J. Dungey; Blogger Chronicled Mortgage Crisis

by Calculated Risk on 11/30/2009 03:55:00 PM

From CNBC: Dubai World to Restructure About $26 Billion of Debt

Dubai World said it would try to restructure about $26 billion of debt, far less than the nearly $60 billion in total liabilities that the Dubai government's investment arm had as of August.
...
"Creditors need to take part of the responsibility for their decision to lend to the companies," said Abdulrahman al-Saleh, director general of Dubai's Department of Finance.

Hmmm ... that statement could apply to mortgage lenders in the U.S. too.

by Calculated Risk on 11/30/2009 01:20:00 PM

Click on graph for larger image in new window.

Unfortunately the data for this index only goes back to 2002.

Note: Any reading below 100 shows contraction for this index. The index is a year-over-year index, so the headline index might be slow to recognize a pickup in business, but the underlying details suggests ongoing weakness.

From the National Restaurant Association (NRA): Restaurant Industry Outlook Improved Somewhat In October as Restaurant Performance Index Posted First Gain in Three Months

[T]he National Restaurant Association’s ... Restaurant Performance Index (RPI) ... stood at 98.0 in October, up 0.5 percent from its September level. However, the RPI still remained below 100 for the 24th consecutive month, which signifies contraction in the index of key industry indicators.

“Although restaurant operators continue to report soft same-store sales and customer traffic levels, they are somewhat more optimistic about improving conditions in the months ahead,” said Hudson Riehle, senior vice president of the Research and Knowledge Group for the Association. “Restaurant operators reported a positive six-month economic outlook for the fourth consecutive month, and the proportion planning for capital expenditures rose five percentage points.”
...
The Current Situation Index, which measures current trends in four industry indicators (same-store sales, traffic, labor and capital expenditures), stood at 96.5 in October – up 0.4 percent from September and its first improvement in three months. However, October still represented the 26th consecutive month below 100, which signifies contraction in the current situation indicators.

Restaurant operators reported negative same-store sales for the 17th consecutive month in October, with the overall results similar to the September performance. ...

Customer traffic also remained soft in October, with operators reporting net negative traffic for the 26th consecutive month. ...

Although sales and traffic levels remained soft, operators reported a modest uptick in capital spending activity.
emphasis added

by Calculated Risk on 11/30/2009 11:20:00 AM

From the U.S. Treasury: Obama Administration Kicks Off Mortgage Modification Conversion Drive

The U.S. Department of the Treasury and Department of Housing and Urban Development (HUD) today kick off a nationwide campaign to help borrowers who are currently in the trial phase of their modified mortgages under the Obama Administration's Home Affordable Modification Program (HAMP) convert to permanent modifications. ... Roughly 375,000 of the borrowers who have begun trial modifications since the start of the program are scheduled to convert to permanent modifications by the end of the year. Through the efforts being announced today, Treasury and HUD will implement new outreach tools and borrower resources to help convert as many trial modifications as possible to permanent ones.

"We are encouraged by the pace at which trial modifications are now being made to provide immediate savings to struggling homeowners," said the new Chief of Treasury's Homeownership Preservation Office (HPO), Phyllis Caldwell. "We now must refocus our efforts on the conversion phase to ensure that borrowers and servicers know what their responsibilities are in converting trial modifications to permanent ones." In her new role, Caldwell will lead HPO's conversion drive efforts.

The new push includes "operational metrics to hold servicers accountable for their performance, which will soon be reported publicly" and "Servicers failing to meet performance obligations ... will be subject to consequences which could include monetary penalties and sanctions".

With 375,000 borrowers eligible for permanent modifications by the end of the year, we would expect a minimum of 190,000 permanent modifictions through December - and a 50% conversion rate would be considered very poor. Many of these permanent modifications will probably fail over time too.

by Calculated Risk on 11/30/2009 09:46:00 AM

From MarketWatch: CNov. Chicago PMI rises to 56.1%, a 15-month high

The business activity index rose to 56.1% in November from 54.2% in October. ... The employment index rose to 41.9% from 38.3% ...

Readings above 50% indicate expansion, and below 50% indicate contraction, so this suggests business activity is increasing, but employment is still declining.

This index is for both manufacturing and service activity in the Chicago region. In general the Chicago area is considered representative of the mix of manufacturing and non-manufacturing business activity in the nation.

The national ISM manufacturing index will be released tomorrow, and the ISM non-manufacturing index on Thursday.

by Calculated Risk on 11/30/2009 08:39:00 AM

From The Times: Investors face huge losses as Dubai abandons debt company

The Government of Dubai said today that it will not stand behind its wholly-owned subsidiary Dubai World, prompting fears that the company’s creditors could lose billions of dollars.

Today's comment, from Abdulrahman al-Saleh, the director general of Dubai’s Department of Finance, effectively confirms that country does not have enough money to repay Dubai World’s $60 billion of liabilities. ...

From the Financial Times: Dubai official confirms no guarantee

From MarketWatch: Dubai World debt not backed by government:official

by Calculated Risk on 11/29/2009 10:55:00 PM

From the WSJ: Worries Grow Over Gulf Rift

The central bank said it "stands behind" U.A.E. banks and would make available funds to local institutions, including local subsidiaries of foreign banks.

But the statement pointedly didn't mention Dubai, disappointing many market observers.

And from the NY Times: Crisis Puts Focus on Dubai’s Complex Relationship With Abu Dhabi

Despite the announcement by the emirates’ central bank on Sunday that it would make more money available to local and foreign banks in Dubai, analysts say such imprecise promises — the bank did not say how much, or that it would back all the debt of Dubai or Dubai World — may not be enough to placate investors.

Many have been left wondering, again, if the Emirate’s debts are worse than most of the world suspects. Analysts estimate Dubai’s total debt at around $80 billion, but some here say it could well be closer to $120 billion, or more.

But looking at the stock markets, investors don't seem to be worried ...

In Asia, the Hang Seng is up over 3%, and Nikkei is up over 2%.

In the U.S, the S&P futures are up about 6 points (Dow futures up 50). Some sources:

Bloomberg Futures.

CNBC Futures

Best to all.

by Calculated Risk on 11/29/2009 07:13:00 PM

For some reason The Times has been removed from news stands in Dubai ...

From The Times: Central Bank of the United Arab Emirates takes hard line as Dubai counts soaring cost

... The rulers of Abu Dhabi are expected to make a statement before the markets open on whether they will bail out Dubai and which businesses and projects will be rescued.
...
Senior analysts in the region expect that projects regarded as folly will not be backed but operations and investments with a strong business model will be.
...
Today will mark the first key test of whether Dubai will default on its estimated $88 billion debt pile, when interest payments of about $138 million on a $2 billion bond issue by Jebel Ali Free Zone Authority, a unit of Dubai World, become due.

I think many people consider most of Dubai "folly".

by Calculated Risk on 11/29/2009 03:30:00 PM

The week will start with questions about Dubai, and a Treasury announcement on Monday about a plan to put pressure on lenders to complete modifications.

Click on graph for larger image in new window.

This graph is from the most recent Making Home Affordable Program Report for October.

To put the numbers in perspective: as of the end of June (five months is up for those borrowers) there were 143,276 trial modifications, and a 50% conversion rate would be about 70,000 permanent modifications. Of course a 50% conversion rate would be considered dismal. So I'd expect the number of permanent modifications to be well in excess of 100,000 for those early trials, and if some later trial modifications were converted, perhaps many more. The data will probably be released the week of December 7th.

The big news later in the week will be the November employment report. In between will be the ISM reports (manufacturing and service), auto sales (on Tuesday), construction spending, other employment reports and more. An interesting week!

And a summary ...

Chicago Fed Activity Index

From the Chicago Fed: Index shows economic activity leveled off in October

The index’s three-month moving average, CFNAI-MA3, decreased to –0.91 in October from –0.67 in September, declining for the first time in 2009. October’s CFNAI-MA3 suggests that growth in national economic activity remained below its historical trend.

Click on table for larger image in new window.

This graph shows the Chicago Fed National Activity Index (three month moving average) since 1967. According to the Chicago Fed the index should move "significantly into positive territory a few months after the official NBER date of the trough" - and that hasn't happened yet.

Existing Home Sales increased Sharply in October

Here is the NAR report: Existing-Home Sales Record Another Big Gain, Inventories Continue to Shrink

This graph shows existing home sales, on a Seasonally Adjusted Annual Rate (SAAR) basis since 1993.

Sales in Oct 2009 (6.10 million SAAR) were 10.1% higher than last month, and were 23% higher than Oct 2008 (4.94 million SAAR).

For graph on Not Seasonally Adjust (NSA) sales, inventory and months of supply, see: Existing Home Sales Graphs

New Home Sales increase in October

The Census Bureau reports New Home Sales in October were at a seasonally adjusted annual rate (SAAR) of 430 thousand. This is an increase from the revised rate of 405 thousand in September (revised from 402 thousand).

This graph shows New Home Sales vs. recessions for the last 45 years. New Home sales fell off a cliff, but are now 31% above the low in January. For inventory, NSA sales, and months of supply, see: New Home Sales in October

Case-Shiller House Prices increased in September

This graph shows the nominal seasonally adjusted Composite 10 and Composite 20 indices (the Composite 20 was started in January 2000).

The Composite 10 index is off 29.9% from the peak, and up about 0.4% in September.

The Composite 20 index is off 29.1% from the peak, and up 0.3% in September.

More on house prices: Case Shiller Home Price Graphs

Other Economic Stories ...

FDIC Q3 Banking Profile: 552 Problem Banks

First American CoreLogic Negative Equity Report for Q3

"Nearly 10.7 million, or 23 percent, of all residential properties with mortgages were in negative equity as of September, 2009. An additional 2.3 million mortgages were approaching negative equity, meaning they had less than five percent equity. Together negative equity and near negative equity mortgages account for nearly 28 percent of all residential properties with a mortgage nationwide."

From the American Trucking Association: ATA Truck Tonnage Index Dipped 0.2 Percent in October

From the U.S. Courts: Bankruptcy Filings Up 34 Percent over Last Fiscal Year

$430 Billion in CRE Losses?

Scott Reckard at the LA Times has an overview: Few mortgages have been permanently modified

Unofficial Problem Bank List Increases Significantly

Best wishes to all.

by Calculated Risk on 11/29/2009 01:33:00 PM

From the NRF: Black Friday Verdict: As Expected, Number of Shoppers Up, Average Spending Down

... a National Retail Federation survey conducted over the weekend confirms the expected: more people spent less. According to NRF’s Black Friday shopping survey, conducted by BIGresearch, 195 million shoppers visited stores and websites over Black Friday weekend, up from 172 million last year. However, the average spending over the weekend dropped to $343.31 per person from $372.57 a year ago. ...

“Shoppers proved this weekend that they were willing to open their wallets for a bargain, heading out to take advantage of great deals on less expensive items like toys, small appliances and winter clothes,” said Tracy Mullin, NRF President and CEO.
...
“During a more robust economy, people may be inclined to hit the “snooze” button on Black Friday, but high unemployment and a focus on price caused shoppers to visit stores early in anticipation of the best deals,” said Phil Rist, Executive Vice President, Strategic Initiatives, BIGresearch.

* NRF’s definition of “Black Friday weekend” includes Thursday, Friday, Saturday and projected spending for Sunday.

This is for "stores and websites" - not just brick and mortar.

by Calculated Risk on 11/29/2009 11:26:00 AM

Note: I'll have a Black Friday retail post in a few hours ...

From Bloomberg: U.A.E. Central Bank Stands Behind Lenders, Adds Funds

The United Arab Emirates’ central bank said it “stands behind” the country’s local and foreign banks, which face losses from Dubai World’s possible default, and offered them access to more money under a new facility.

And from the Financial Times: UAE central bank offers credit facility

“It’s a bit disappointing .... It’s obviously a welcome measure in itself but we want to see more from the central bank. We want to see that they will guarantee the capital position of any banks that have exposure and that they will ultimately be willing to buy out the debt,” one UAE analyst said on Sunday.
excerpted with permission

Apparently the hope is that a majority of the debt due on Dec 14th is held by banks in the UAE, and that by adding liquidity, the UAE Central Bank will make it easier for the bondholders to accept the deferral of payment. However this isn't just a liquidity crisis - this is a solvency crisis (the assets are almost certainly worth less than the liabilities) - and this does nothing to address the solvency issues.

by Calculated Risk on 11/29/2009 09:23:00 AM

From Alejandro Lazo at the LA Times: Falling rents aid homeowners in mortgage trouble

Southern California rents peaked at $1,501 in the third quarter of 2008 ... Since then, rents have fallen 4.9%, to an average of $1,427 in the third quarter of this year, according to a survey of larger apartment complexes by property research firm RealFacts. The drop came as the occupancy rate of the buildings ticked down 0.8% to 93.7%. The data don't include homes converted into rental units or smaller apartment buildings.
...
Job losses and competition from foreclosed homes have made concessions by large landlords common. Thomas Shelton, president of Western National Property Management in Irvine, said he was offering about a month of free rent for every 12-month lease signed.

Although falling rents and significant concessions are good news for renters, this will also lead to more apartment defaults, higher default rates for apartment CMBS, and more losses for small and regional banks.

And falling rents are already pushing down owners' equivalent rent (OER). Since OER is the largest component of CPI, this will apply downward pressure on CPI for some time. And lower rents will also put pressure on house prices, since renting is a competing product.

But renting is a relief to some:

Thomas DeLong walked away from the mortgage on his final home in September and began renting a house for about $1,400 a month, with utilities, in the high-desert area of Perris.

DeLong ... said renting was a relief after years of worry and a financial juggling act that came crashing down all around him.

by Calculated Risk on 11/28/2009 10:55:00 PM

From The Times: Abu Dhabi rides in to rescue Dubai from debt crisis

And from the Telegraph: Abu Dhabi will not race to Dubai's rescue

Actually both stories are pretty much the same. From The Times article:

An Abu Dhabi official said yesterday it would “pick and choose” how to assist its neighbour, a hint that the restructuring of Dubai’s debts may not be straightforward. “We will look at Dubai’s commitments and approach them on a case-by-case basis,” the official said. “It does not mean that Abu Dhabi will underwrite all their debts.”

Clearly Abu Dhabi will ride, but not race, to the rescue.

by Calculated Risk on 11/28/2009 06:52:00 PM

By request here is a graph of the number of banks on the unofficial problem bank list.

We started posting the Unofficial Problem Bank list in early August (credit: surferdude808). The FDIC's official problem bank list is comprised of banks with a CAMELS rating of 4 or 5, and the list is not made public (just the number of banks and assets every quarter). Note: Bank CAMELS ratings are not made public.

CAMELS is the FDIC rating system, and stands for Capital adequacy, Asset quality, Management, Earnings, Liquidity and Sensitivity to market risk. The scale is from 1 to 5, with 1 being the strongest.

As a substitute for the CAMELS ratings, surferdude808 is using publicly announced formal enforcement actions, and also media reports and company announcements that suggest to us an enforcement action is likely, to compile a list of possible problem banks in the public interest. Some of this data is released with a lag (the FDIC announced the October enforcement actions yesterday).

Click on graph for larger image in new window.

This graph shows the number of banks on the unofficial list. The number has grown by almost 40% since early August.

The two red dots are the number of banks on the official problem bank list as announced in the FDIC quarterly banking profile for Q2 and Q3. The dots are lagged one month because of the delay in announcing formal actions.

The unofficial count is close, but is slightly lower than the official count - probably mostly due to timing issues.

by Calculated Risk on 11/28/2009 03:42:00 PM

It sounds like the permanent mod numbers will be grim ...

From Peter Goodman at the NY Times: U.S. to Pressure Mortgage Firms for Loan Relief

The Obama administration on Monday plans to announce a campaign to pressure mortgage companies to reduce payments for many more troubled homeowners, as evidence mounts that a $75 billion taxpayer-financed effort aimed at stemming foreclosures is foundering.

“The banks are not doing a good enough job,” Michael S. Barr, Treasury’s assistant secretary for financial institutions, said in an interview Friday.
...
“I’ve been very frustrated by the pace of the program,” said Senator Jeff Merkley, an Oregon Democrat who sits on the Senate Banking Committee. “Very few people have emerged from the trial period.”
...
Capitol Hill aides in regular contact with senior Treasury officials say a consensus has emerged inside the department that the program has proved inadequate, necessitating a new approach. ...

"[A]t senior levels, where people are looking at this and thinking ‘Good God,’ there’s a sense that we need to think about doing something more.” said a Senate Democratic aide, who spoke on the condition he not be named for fear of angering the administration.
emphasis added

There is much more in the article. We will see the numbers in a couple of weeks.

by Calculated Risk on 11/28/2009 11:55:00 AM

CR Note: This is a guest post from albrt.

Thanksgiving Weekend Mortgage Litigation Roundup

CR forwarded me a couple of links recently, so I told him I’d write up a summary for your holiday weekend entertainment. I’m also including a little ubernerd bonus at the end.

Mortgage Cancelled Due to Unconscionable, Vexatious and Opprobrious Conduct

One case has been mentioned in the comments a few times, but for hat tip purposes I believe it was first sent in by Art Vandalay. The link is to a summary at Law.Com, which has a link to the decision. Note that this is a local trial court decision – the county trial courts in New York are called the Supreme Court, while the highest court is called the Court of Appeals.

The bottom line in this case is that the trial judge spent several months trying to encourage IndyMac to modify a mortgage that was in foreclosure. The borrowers made a number of different offers, including offering to have other family members cosign on the modified loan. IndyMac refused, and also submitted some questionable information to the court. The judge finally had enough and decided that the note and the mortgage should be “vacated, cancelled, released and discharged of record.”

This is a very unusual result in a foreclosure case. Not only did the judge refuse to enforce the mortgage by foreclosure, he actually wiped out the debt completely. The decision is entertaining, but it doesn’t highlight any legal principles that are likely to affect other mortgages other than the most fundamental of all legal maxims: “try not to piss off the judge.” It’s very hard to guess whether a decision like this will be upheld on appeal.

More Trouble with Paperwork in Massachusetts

The other case is from Massachusetts, which as you may recall has strict standards for recording mortgage documents. This link is also a Law.Com summary with a link to the recent decision in the case of MERS v. Agin. Hat tip Dogbert.

The first thing to notice about this case is that Mr. Agin is a bankruptcy trustee, not a borrower. The borrower declared Chapter 7 bankruptcy, which essentially means there is no workout plan, and everything will be liquidated except certain property that is exempt by law. A house (or a certain amount of equity in a house) can be exempt, but this is unlikely if there is a significant mortgage.

A Chapter 7 trustee has two major responsibilities: to make sure the debtor is not withholding assets, and to serve as a referee among the different creditors. Mr. Agin, perhaps with prompting from some of the other creditors, filed a motion asking the bankruptcy court to determine whether the mortgage was valid. The bankruptcy court decided the mortgage was not valid because the borrower’s name was not filled in on the notary acknowledgement. The federal district court upheld the decision.

As a result, the mortgage was eliminated but the debt was not. The mortgage lender became an unsecured creditor, just like a credit card lender. The house will be sold, but the proceeds will be split between all the creditors on a pro-rata basis instead of going to the mortgage lender first. I don’t see any obvious reason to expect this decision to be overturned on appeal.

For Ubernerds: A Note on Bona Fide Purchasers

Footnote 2 of the Agin case contains a mysterious reference to a legal doctrine that may be of interest to the ubernerds amongst us:

Section 544 allows the trustee to avoid a transfer of an interest in real property of the debtor to the extent a bona fide purchaser of the property may avoid the transfer “without regard to the knowledge of the trustee or of any creditor.”

The footnote doesn’t make much sense unless you understand the significance of being a bona fide purchaser without knowledge. This site has a pretty good definition:

bona fide purchaser n. commonly called BFP in legal and banking circles; one who has purchased an asset (including a promissory note, bond or other negotiable instrument) for stated value, innocent of any fact which would cast doubt on the right of the seller to have sold it in good faith. This is vital if the true owner shows up to claim title, since the BFP will be able to keep the asset, and the real owner will have to look to the fraudulent seller for recompense.

A “purchaser” includes anyone who has given value, which means it generally includes a secured lender as well as a buyer. A “holder in due course” is similar to a BFP, except that the term is generally limited to a purchaser of a negotiable financial instrument. Purchasers of debt instruments are not just worried about whether the person who sold the instrument was the “real owner” – they are also worried about whether the borrower will try to avoid repaying the loan by accusing the original lender of fraud or something similar. BFP status protects against both of these things.

Like most everything in the law, the BFP concept is hedged with all sorts of qualifications, mostly having to do with reasonableness – a bona fide purchaser should not be able to ignore things that a reasonable person should have known. The most obvious example is that a BFP cannot ordinarily ignore a document that was properly recorded in the local land records.

In Agin, the issue was whether the missing name on the acknowledgement was enough to make the mortgage void. An ordinary person who purchased the debtor’s house might not have been able to avoid the mortgage if the purchaser should reasonably have known from the records that the mortgage existed. But the bankruptcy statute allowed the trustee to be treated as a BFP of the debtor’s house regardless of what he knew or should have known, so all he had to do is show that the mortgage document had a material defect.

So an ordinary BFP doesn’t get quite as much protection as the bankruptcy trustee in Agin, but lenders and investors do consider BFP status important. There are many things to be said for and against giving special treatment to BFPs, but the point I’d like to make today is that the bona fide purchaser concept creates decidedly mixed incentives for due diligence. A buyer or lender wants to discover everything that a reasonable person should discover, but does not particularly want to discover any problems that could be avoided by a BFP without knowledge.

The BFP concept played a significant role in the Wall Street securitization process. As Judge Long noted in footnote 29 of the Ibanez ruling:

The Ibanez Private Placement Memorandum is quite explicit regarding the separateness of “Originators” and “Servicers” and the reasons for that separateness. See Private Placement Memorandum at 84 (explaining the “information barrier policies” intended to protect the trust’s status as a holder in due course of the notes and insulate it from claims of fraud, misrepresentation, etc. in the making of the loans).

In other words, as many of you suspected all along, “hoocoodanode?” was officially part of the plan for creating mortgage backed securities. Systematic and willful ignorance was incentivized. If Wall Street created a system where each bogus mortgage passed through the hands of a couple of intermediaries who had no ability to do any due diligence on the quality of the loan, then the end buyer of the loan would, legally speaking, be in a better position to collect than the original lender by virtue of BFP status. Did the mortgage broker tell the borrower the loan was fixed rate when it really wasn’t? Oh well, no way the mortgage pool trustee could have known about that after the loan passed through the hands of an originating lender, an unrelated depositor and a legally separate issuer.

Whether for better or for worse, this system is pretty clearly not playing out as intended. BFP status does nothing to protect lenders from broke borrowers and half price houses, both of which were foreseen by knowledgeable people who were not willfully ignorant of details about loan origination. And even the limited protection of BFP status may not be available in cases that are actively litigated, since it won’t be hard to prove that everyone in the industry knew brokers were filling in the blanks on stated income loans with whatever numbers were needed to make the applications go through.

So I guess this is just one more reason why all the Fed’s ponies and all the Treasury’s men are not going to be able to put Humpty Dumpty back together again.


CR Note: This is a guest post from albrt.