We have noticed in reading emails to editors in magazines and in various comments on sites and blogs that many people believe that the banks are currently hurting from the high rate of foreclosures in the US. And this leads to the natural perplexed question: “Then why don’t banks do general loan modifications, and resolve the problem? Isn’t that simple enough?”
This is good question but it follows from the assumption that the banks are hurt by foreclosures. The fact is they are NOT. Why? They sold most of their mortgages as mortgage backed securities years ago. The banks either sold their mortgages to Fannie Mae which turned them into bonds and sold them, or the banks set up their own REMICs (Real Estate Mortgage Investment Conduits) and turned the mortgage collateral into bonds and sold these themselves, or the banks sold their mortgages to another bank or investment firm that created a REMIC.
At this point the banks do NOT own the promissory notes and therefore will not foreclose on a house, and cannot foreclose on a house. Only the investors that bought the bonds can do.
The banks have now become servicers of the mortgages, gathering up payments which are reduced these days and sending these diminishing sums to a REMIC which divides up the take based upon the bond denominations of $10,000 or more per bond.
The banks can initiate foreclosure proceedings for a REMIC and investors through a kind of power of attorney. And the banks get a fee for the foreclosure and the subsequent fire sale of the home for an absurd price. But the banks do not make their primary profit in these activities – this would be in loans, the stock market, commodities, mergers and acquisitions, and international business and so on.
The recent news about robo-signing and false documentation expresses the banks’ cavalier attitude about foreclosures. They are just cramming things through because they just don’t care.
Banks are not wounded in the slightest bit by increasing foreclosures, they are making some money in fees but this is not essential to their financial health. And in fact, if prosecuting a foreclosure became a serious drain of time, energy and money, you will see banks bailing out of the activity altogether. And then perhaps auction companies will take over, and independent lawyers will begin representing the investors.
The problem in the foreclosure crisis is that we have 3 parties in the malaise – two of them are in financial straits and the other party, the banks, is not in financial pain, and has no interest in resolving the problem because it is not their problem – it is someone else’s issue and bad luck, not theirs.
Far too much focus now is on the banks and this focus clouds up the issues. It causes us to fire on the banks continuously, and it continually befuddles us that the banks will not simply do loan modifications to solve the problem. The real issue is who is hurt by this dilemma. When we see this clearly then the solution to the problem becomes self evident: Remove the banks from the equation and bring the investors and homeowners together to make a deal, a loan modification.
If the banks remain in the middle, foreclosures will accelerate, foreclosed properties will sell for declining prices, and then in general the values of all homes will plunge whether the owner is paying the mortgage note on time or not. What we do not want to come next is a Reverse Bubble where house prices collapse across the board. Neighborhoods in Chicago are now showing signs of blight as a result of massive foreclosures: This is the opposite of gentrification: Negative gentrification of de-gentrification.
Real estate is about 10% of the US GDP and the largest sector of banking activity. It is the number one reason that the US economy cannot reach lift speed and take off again. If we wait much longer we will have a new number one problem: Higher Treasury bond interest rates because our national credit rating will be downgraded by the world community. When this happens we will have to increase rates for government bonds to mollify the risk that nations will see in buying them. We will then have to apply a terrific tax increase that will certainly choke out any growth.
The simple solution is to stop focusing on the banks and focus on homeowners and investors. Here is where the solution is. Homeowners certainly have the right to question ownership their loans and delay any foreclosure sales until there is absolute proprietary proof – and if this takes years or decades, so be it. And investors certainly have the right to sue banks for losing documents and lying to them about the quality of the loans they bought, and whatever they can collect is just.
But the overall solution to the mess is to have a universal loan modification.
Then afterward regulators can survey the completely dysfunctional recording and documentation system for loan transfers and setting up REMICs, and set up new practices that are complete, transparent, verifiable and stringent.
Lastly, the mortgage backed security needs to be redefined and put under new rules and limitations, so that the feedback cycle between making a loan and selling the loan as bonds does not push banks to lower standards and over-loan, creating a real estate bubble that will eventually pop and deflate the world economy.