Economic Drag of Mortgage Deficiencies Long Tail

Published by clickbroker.blogspot.com.

You can get whipsawed by the politicians, economists and media predictions of the housing bottom and recovery. Most of the government’s foreclosure prevention programs have unquestionably failed. But the GSE 30-year mortgage security spread over 10-year treasuries is hovering at a record low 63 basis points. And investors are outbidding owner-occupiers for choice foreclosures.

Will the Federal Reserve actually end its Fannie (FNM) and Freddie (FRE) securities purchases as promised? We have already experienced the Fed’s twisted promise of liquidity to Bear Stearns which was reminiscent of former President Bill Clinton’s “it depends on what the definition of 'is' is.”

Banks are getting hit from both sides. Private mortgage insurers are refusing claims based on warranty breaches and mortgage securitization trusts (MBS and CDO) and forcing buybacks for the same reason. Bank of America (BAC), JP Morgan (JPM), and Wells Fargo (WFC) could be liable for the majority of a projected $20B in buyback demands. How does Countrywide and WaMu look now?

While Ambac (ABK) and MBIA (MBI) are staking their lives on pushing mortgages back to originators, the banks are taking their time to “study” each potential fraudulent mortgage. I guess the armies of auditors on both sides are part of a new full employment program.

Economists in the popular press are touting an economic surge from consumers freed by foreclosure. It’s cheaper to rent and consume than pay the mortgage on an underwater house. The press would lead you to believe the walk away movement is in full swing. Forget about trying to negotiate a short sale with a stubborn bank.

Banks might not be the long term victims; they might actually become more of a devil than the press can conceive. First, banks will evaluate the homeowner’s ability to pay and require cash from the short-sale seller at closing. Second, in states such as Florida banks have 20 years or longer to recover mortgage deficiencies in foreclosures from borrowers.

While banks will likely make cost/recovery judgments in pursuing deficiencies themselves, an active secondary market will develop. The walkaways will quickly learn that old debts never die. The few might secure a release from the bank with some cash in a short sale, but most will be haunted by their foreclosures as soon as they reach their personal economic recovery.

The delusion of fresh start economics becomes clear. What’s not clear yet is whether deficiency judgments will change purchasers’ view of the risk profile of buying a house. With Fannie and Freddie the largest pursuers of buybacks, mortgage originators are surely adopting a new sense of underwriting diligence. Putting these factors together, a major housing recovery is unlikely for as the Fed says “an extended period of time.”

Disclosures: Author is long ABK, BAC, MBI and WFC.

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