A Different Direction for the Foreclosure Mess?

I keep thinking of the mortgage foreclosure story and wondering, “Where will this go?” The problem is that this question is very hard to answer. One possible direction.

According to Realtytrac the number of actual repossessed properties in August was 95,000. They also have reported that in the second quarter the number of repos was 248,000. Call it a million over the last 12 months. "How many of these are now tainted" is a central question. But for me the more significant issue is, "Why were they were tainted".

From what I have read it would appear that this has been administratively blown up due to the volume of foreclosures. No one in the housing/mortgage story really wants to do a foreclosure. It is the most costly outcome. Not only does the lender lose principal and interest there is a big cost to close on a homeowner. So the lenders, lawyers, servicers and document houses all tried to push the process through a hole that is too small. Along the way they hired bozos to do the work and the cut every corner they could to close a file.

That sounds bad, but it does not worry me too much. A probable outcome would be that most of the closed deals are either properly documented or they deal with an original borrower who was so far underwater that the last thing he/she would want to do is restart the process with the old IOU’s. To be sure there is going to be a percent of deals that will result in some form of restitution to the original obligor. That will be a loss to all of the players. But it is not going to bring down the house.

There is a great deal of difference between a lender who is facing a loss and cuts corners to minimize the loss and fraud that occurs when the same tactics are used to make money. And that is what I fear has happened. Should that be the case we are looking at a very big hole developing in the mortgage space.

Assume there is a home that has a $250,000 mortgage and the loan is in default. Now assume that the owner of that mortgage wants to sell it. Assume further that the mortgage is bundled up with a bunch of other busted mortgages and sold at a deep discount from par. Say the price of the loan package is 40 cents on the dollar. Now finally assume that the property can be sold at an auction level price of $175,000.

If you add up all my assumptions you get a situation where the mortgage is purchased for $100k (250*.4) and the actual value of the assets securing the mortgage is worth $175k. That 75k for a “flip” is big money if there is a lot of them to be done. And as Realtytrac says it is a million or so a year.

If you’re reeling from all those “assume this” crap I was selling don’t be. What I describe is happening in very big numbers. Busted whole mortgage loans are being packaged and sold to investors to the tune of at least $10b a month. Some of the biggest players on Wall Street are in the game of arbing the sellers. Packages are regularly being put together and sold. Who are these sellers? A lot of the banks. The big ones have sold large amounts, the smaller banks have sold regional portfolios at distressed prices. But by far and away the biggest sellers that have created the “profit window” all reside in D.C. A big seller has been the FDIC. Fannie, Freddie and FHA have also been steady sellers.

I have no idea how much abuse there has been when secondary market purchasers of mortgages push through foreclosures and auction off homes to make a big profit. But the answer is it is not zero. What if only 10% of foreclosures were the result of some outfit or the other pushing to make some fast cash? What if they were doing it on the cheap. Say $10k a pop. Well that comes to a billion a year. And for that much money people will pull all matter of strings. They will buy lawyers and document processors who will gladly take the dough. When you have nine-figure money and a short time window of opportunity you press it as hard and fast as you can. That is how it works.

Two possible headlines we may see:

In an effort minimize losses Federal Agencies relied on improperly documented foreclosure procedures. 

Thousands may be affected. FHFA to issue apology.

Or it could look like this:

Federal Agencies Sold Loans to Scheisters

Improper payments made to foreclosure agents. Billions of profits at stake. Hundreds of thousands lining up for class action suit.

Congress suspends all foreclosures and new lending at Agencies. Mortgage market seizes up.

I have been amazed to see that more than 25% of all home sales of late have been the result of foreclosures. There are some folks who are burning the midnight oil to get all this done. And for a portion of them the profit motive, not a paycheck, is what is keeping them awake. I have seen bank REO sit on the market for years. And I have watched other parcels get priced deep in the hole and go very fast. In some of those cases the motivated seller is not taking a bigger loss. They are taking a fast profit.

If an investigation shows that even a small amount of foreclosures were done with a profit motive objective and those beneficiaries had “sweetheart” (AKA “Side deals”) with the servicers and closers to achieve their objectives there will be hell to pay. Something like this is likely to come. There is too much money involved. That brings abuse. Greed is in our nature. So is bending the rules.