The signs are back. I remember seeing these during prior downturns in San Diego during the early 1990s, the early 1980s, the 1970s, and the early 1960s.
I saw the same sign on the 5 south on-ramp from Sorrento Valley. I wondered if one of those real estate investor seeks apprentice 20k month type signs.
barnaby33, I took this photo at the corner of Sorrento Valley Road and Sorrento Valley Blvd. That is very close to where you saw the sign (a hundred yards or so). For those that don't know - this area is commercial - so I don't know where the house is located.
It's slightly different this time, zephyr, since mortgages these days are all made with enforceable due-on-sale clauses. Anybody who takes this offer without the participation and consent of the lender is likely to find he or she doesn't have clear title to the property. And there aren't many lenders willing to do "no qualifying" assumptions, so I doubt anyone was going to tell the bank.
I'm waiting for installment sales to come back, personally. Then we'll know The End Is Near.
Installment sales are also known as land contracts or contracts-for-deed. They have always been more common in certain parts of the country; it depends on state and local RE law and custom. I have no idea how CA law works in this regard, since my experience with this issue is all in flyover country.
In a contract-for-deed, the seller accepts a small down payment (more like earnest money) from the borrower, followed by installment payments toward the contract sales price over a term of 1-3 years. At the end of the contract, the buyer pays off the remaining balance, usually by securing bank financing, and the seller hands over a warranty deed. Since title doesnt change hands until the end of the contract, the buyer walks away with nothing if he or she defaults. On the other hand, if the property depreciates during the contract period, the otherwise qualified buyer may not be able to secure enough permanent financing to cover the balance due on the contract. Contract-for-deed is a risky game to play in a declining market.
My parents actually sold my late grandparents home on a contract-for-deed just a few years ago. It was an elderly 750 square foot house on nearly 3 acres, including 2 acres of mature orchard. Too expensive/too many zoning issues for a tear-down, too little house for the kind of buyer who wants that much back yard. The only offer they got equal to the appraised value included a contract, so they took it and it worked out quite well. Of course, they owned the property free and clear and were smart enough to have the buyer pre-qualified by their own bank.
When you start seeing contracts-for-deed on normal properties, you may well have the signs of a desperate seller or an unqualified buyer or both. And if you see sellers offering quit-claim rather than warranty deed at the end of the contract, you have the signs of a nasty scamthe buyer generally ends up with title to the property encumbered by the sellers unpaid mortgage. As with these informal assumptions, the combination of all those sleazy RE investors who want to get out from under a mess and all those hopelessly naïve buyers who dont have an adequate down payment is going to cause a fair amount of tragedy before this is all over.
donna, I live in Orange County, but I'm in San Diego fairly often.
Tanta, in California there is somthing similar called a "subject to" deal. Basically the buyer and seller are hiding the sale from the lender because of the "Due-on-Sale" clause. The buyer takes title to the house, but I don't think the title is recorded (to hide from the lender). If the new buyer quits making payments, the ex-owner has to start making the payments, and it can become a real mess.
These deals are usually popular when interest rates are rising, and the old loan has a good fixed interest rate. I think the dynamics are different now. These types of deals don't work when the seller wants out, but owes more than the house is worth!
The only way out of this bad situation is for the government to outlaw foreclosures until things settle down. I know of two congressmen who are working on this right now, but they will have to wait until after November to make their ideas public.
Two thirds of Americans are home owners, and the government will NOT sit idly by while they lose their homes.
A government bailout is the only solution, so don't worry, it is on the way.
If forecloseure is outlawed, what is to prevent me from stopping my monthly payments to the bank? Seems like I could continue to live here without paying and without penalty... Sounds like an idea designed to get votes but will never become law.
rtalcott, thanks! That was a surprise. Traffic may be up a little - however I probably got a bigger bump from Barry Ritholtz mentioning my blog was mentioned in Barron's, than from the actual mention!
Jacob, the negative economic consequences of outlawing foreclosures would far outweigh any benefit. However I do think Congress should repeal the new bankruptcy law. Some homeowners are going to lose their homes, and then find they still owe money on their house (and then have to make payments for years). That seems like one rung above debtors prison - at least they can still work to pay off their mortgage debts on their lost home. (note: I believe many lower income homeowners don't fall under this provision of the new law).
I think people should be able to start over clean - and that would put more responsibility on the lenders.
The only way out of this bad situation is for the government to outlaw foreclosures until things settle down. I know of two congressmen who are working on this right now, but they will have to wait until after November to make their ideas public.
Second tanta's comment - add 'complete BS' & 'troll bait'.
I lived in the rural midwest during the ag crisis when bankruptcies, foreclosures & forced auctions were more common than church bake sales.
The whole country from rocky mountains to gulf of mexico was 'for sale'... and the senate hardly peeped. Willie Nelson & John Mellencamp were the only ones who even noticed.
Gov't going to do nothing this time too.
Hell, gov't doesn't even KNOW there is a problem yet let alone secretly planning some crazy 'Area 51 solution' like that... maybe the bankers will be flown around in black belicopters protected by soldiers in blue helmets.
Maybe it will all happen... as soon as Mulder & Scully get appointed to the next open seats on the FOMC.
"I can't even imagine what the interest rate would be on an uncollateralized 30-year home loan."
Possibly not all that high. To supply American consumers with the funds to keep overbuilt export industries operating, Asian governments either will buy them directly or will induce others to buy them through ultra-low-interest-rate policies. And hedge funds will sell credit default swaps (insurance) on them, making huge short-term profits for their managers to take their 20% cut on.
Eventually the massive corruption in China will lead to another revolution there, the present Chinese leadership and their cronies will flee to the US as the Shah of Iran did in '70s, and China will fall into the hands of demagogues who will exploit the US debt defaults for political gain.
Jm, somebody has seriously mislead you about what a credit default swap is.
AZ_Cowboys excellent point is that home mortgages have low interest rates because they are collateralizedif the borrower defaults the lender can take the house through foreclosure. If you made it impossible for lenders to foreclose, mortgages would in effect become uncollateralized, and as Jim points out, borrowers at no risk for losing their homes would default in droveswhy make your mortgage payment if you cant lose your house?
If the idea behind outlawing foreclosures is that the loan actually remains collateralized because the government makes the lender wholeas if congress is going to pass some law that suddenly puts free FHA insurance on every mortgage loan in the countryyou still have a little problem with the moral hazard you just put in front of the homeowner (leaving aside the question of how the government would fund an insurance pool of that magnitude without having collected any mortgage insurance premiums from anybody and without being able to liquidate the collateral). What would happen is that the federal government would suddenly be forgiving about $10 trillion in home mortgage debtwed all default, the lenders would all demand reimbursement from the government, and the government would have to borrow the money to pay the reimbursement, and there is no one on planet Earth with that kind of money to invest who would lend it to them. You think Asian central banks would buy $10 trillion in worthless paper? After all the Fannie and Freddie debt issues theyve been holding just became worthless, since Fannie and Freddie no longer have a business, since the government just liquidated all their assets? After the US economy just collapsed, because the financial sector is in ruins?
Credit Default Swaps are not forms of primary mortgage insurance or even credit enhancement for mortgage securities. They are issued to reduce institutional exposure to commercial credit risk. Heres an oversimplified example:
Megabank A buys $10MM worth of corporate bonds from Megacompany B. Megabank As total return on the investment is potentially impaired by the risk that Megacompany B will default on its bond issue, or will look like its going to do so and get downgraded, and the downgrade will hurt the price of the bonds. So Megabank A goes to Investment Bank C and buys a CDS worth a nominal $10MM priced at, say, 200 bps (2%) with a maturity the same as the original corporate bonds. Megabank A is protected from default by Megacompany B, since if Megacompany B defaults on the bond, Investment Bank C has to make Megabank A whole for the original $10MM (it takes the impaired asset off the counterpartys books, which is why its a swap). If Megacompany B never defaults, Megabank As total yield on the original investment is reduced by 2% and Investment Bank C makes 2%.
The CDS is now a derivative (an asset whose value is derived from changes in value of an underlying asset) that can be traded like the original bond. If things are lookin good for Megacompany A, the CDS will be worth more and if not it will be worth less. Hedge Fund D can always come in and buy a discounted CDS from Investment Bank C, because Hedge Funds are (of course) geniuses at buying high-yield high-risk low-disclosure junk and making beaucoup-jillions of dollars off the trade. But I digress.
If Megacompany B happens to be, say, General Motors, which makes most of its profits off its mortgage lending business, since that car-manufacture thing hasnt worked out so well, and if Megabank A happens to be, say, Citicorp, which has a booming mortgage lending business and giant mortgage portfolio, and if Investment Bank C happens to be Goldman Sachs, which owns more mortgage-backed securities than you can shake a stick at, and if some lunatic in Congress put through a bill that instantly erased the value of mortgage lending, everybody would collapse together and the price change in the CDS would simply disappear in the conflagration of Hedge Fund D. Bond market traders wouldnt care because theyd be burning their Telerates for fuel while they foraged in the woods for food. And you tell me that Asian Central Bankers would decide they could prevent this by buying American mortgage loans at low rates of interest?
You could use my GM-Citi-GS example to say that CDSs have something to do with mortgage credit risk, but, well, everything has something to do with mortgage credit risk these days. Thats the problem that is not going to be solved by outlawing foreclosure.
One way to avoid mass foreclosures is for govt to confiscated the houses for public housing.
But that does appear to be less appealing than letting a bunch of folks on both sides the transaction take their medicine. The creditors can write off their loss on taxes and the debtors get to pay taxes on their 'gain' from debt forgiveness.
If things get real bad, the creditors may let the former tenants live in the houses for rent or even reduced rent to keep the property up. Risky but happened during the Great Depression according to my father who lived through it.
I've seen figures thrown about that 20%+ of the transactions recently are 'investment' plus a simular figure for 'second/vacation/ homes. So it looks to me that if mass foreclosures happened, then the majority of owner occupied houses will remain with the owners because the investment and second houses will be sacrificed first. So figure from a political calculation that there is not enough of a threat to force action.
You're right, Captain. The rise or fall in the value of the CDS would more or less mirror the rise or fall in the value of the underlying corporate debt.
The probem is that the rise or fall in the snark level of a post is in inverse proportion to the level of proofreading it gets. My mother told me I would get into trouble some day by being a wiseass, but I didn't listen . . .
It seems to me, and this may be naive and not well thought out..., but with so many people with ARMs and interest-only mortgages getting ready to reset on top of a declining...ok..."Crashing"...housing market, wouldn't it be prudent of the lending institutions that made these ARM and Interest-only loans to recognize that their borrowers are going bust in an ever-growing wave and offer those borrowers fixed rates at very low fees to stem their losses? They can't profit from housing declining in value with no buyers and defaulting borrowers either. Seems to me they should consider offering the fixed rates to their borrowers for both their sakes.
The rise or fall in the snark level of a post is in inverse proportion to the level of proofreading it gets.
Tanta's Law?
:::::
wouldn't it be prudent of the lending institutions that made these [] loans to recognize that their borrowers are going bust in an ever-growing wave and offer those borrowers fixed rates at very low fees to stem their losses?
Or at least string them along until things stabilize???
Not if the originators bundled & sold the loans on the open market as MBS... then it's some other fools problem.
The question then is whether the buyers of the MBS have the economic muscle to underwrite the bad loans themselves. My guess is many don't.
However for those loans that are still held by a bank or thrift or a large institution... and assuming the institutions are solvent & have sufficient reserves, then one would think they would be slow to foreclose. Find a way to keep money coming in somehow and push the problem out... roll it over into some other instrument somehow.
Reminds me of another 'tantaism'... "A rolling loan gathers no loss."
May not be possible.
In the ag crisis of the 80s when farms were going under left & right... banks absolutely didn't want the farms back because they sold at forced auction for a half or less of the loan amount.
But two things forced their hand... one was the Feds required banks to keep a certain reserve level PLUS many states wanted to keep banks & thrifts out of farming (a justified fear of corporate 'share cropping').
So to get cash to meet reserves and to comply with state laws forcing banks to divest from landlording... we got forced auctions. Wave after wave of them - each with lower selling prices than the one before.
In my home town land that was fought over at $2000/acre (top of bubble) was barely selling at forced auction for $400/acre a couple years later.
This is prime Midwestern farm land - produces 180-200 bu/acre corn like clock work... even in this 'drought year' will produce 160 bu/acre or more.
I don't think we'll repeat that insanity in suburbia - I hope the banks & thrifts & regulators are smarter now. Are they?
Tanta, your succinct description of what constitutes a genuine credit default swap is excellent. But I'm sure I read some months ago that there were major problems in the CDS market after Delphi's bankruptcy announcement due to the fact that the total notional value of the CDSs in the market was in the vicinity of ten times the amount of Delphi bonds outstanding, implying that there is a parallel universe of derivative instruments that some are calling CDSs, but in fact are not underpinned by actual bondholdings, and are essentially the same as naked puts and calls traded on the options exchanges. I've gotten the distinct impression that hedge funds are creating those instruments as well as trading them. And if such instruments are not at present being offered by hedge funds as default insurance for mortgage-backed securities, is there anything to prevent that in the future?
That of course is irrelevant to the other issue you address -- that the government couldn't simply outlaw foreclosure. I agree almost completely with your analysis of why it wouldn't work. But since Asian governments' only alternative to buying whatever debt instruments we generate is to allow the collapse of their overgrown export industries, I do believe they would provide a market for uncollateralized mortgage-backed securities, if it came to that.
dryfly, thanks for mentioning Tanta's dictum that, "A rolling loan gathers no loss." Everyone trying to puzzle out how this may all develop should keep in mind that that is especially true in Asia, and it is Asian funding of US borrowing, both directly through bond purchases and indirectly through near-zero interest rates supporting the "yen carry trade" that make so much of today's insanity possible.
Having thought about this, I could imagine a way the gov't COULD 'outlaw' foreclosure... they could do it coupled with another round of 'bankruptcy reform'.
Think of it as a sort of financial market equivalent of 'debtor's prison'.
You don't lose the home via foreclosure BUT the debts aren't forgiven either and you aren't allowed to stop making payments - the courts step in and force a 'mediation'.
You live in the house like before, make court mandated payments on the mortgage or possibly have wages garnished like child-support... maybe not the original mortgage payment amount but something to keep paying down the balance.
The 'owner' is required to provide up-keep & maintenance on the property as before or those 'damages' can be added to the bill by the judge. Plus you continue to pay property taxes, assessments, etc.
And you can't sell the property UNLESS the balance is paid off to the mortgage holder in the process... either by saving up to pay it down & buy your freedom or there is a gain sufficient to clear you.
If the garnishment isn't sufficient to cover the interest (neg amortization)... well then work harder, save more or the tally grows just like in the old days of the company town.
Onerous? You bet. But I can see congress doing something like this to correct for 'flipper abuse' before a foreclosure holiday is enacted.
:::::::::::::
Personally I don't think anything will happen other than hand wrining... but if Jacob (above) wants to throw out baseless conjecture... I can match his ante & raise it.
I am thinking along the same lines -- that if there's any relief on foreclosures it will be accompanied by onerous repayment provisions, such that even if mortgages become more poorly collateralized than they already are by virtue of unsustainability in home prices, there will still be some basis for mortgage-backed security sellers to argue they'll eventually be repaid (at least enough to provide the foreign central banks with justification for continued buying).
Central Banks Favor U.S. Agency Debt Over Treasuries (Bloomberg)
"Central banks are diversifying their assets at a faster rate. They bought about $14 billion in agency debt on average every month this year, up from $12 billion in 2005. The banks now hold $535 billion in agency securities, Fed data show."
I've gotten the distinct impression that hedge funds are creating those instruments as well as trading them. And if such instruments are not at present being offered by hedge funds as default insurance for mortgage-backed securities, is there anything to prevent that in the future?
Let me say I'm sure you're right that the hedge funds are creating these things, which is to say I don't know where to draw the line between "Investment Bank" and "Hedge Fund" any more than the regulators do. And since new derivatives seem to be invented every week, and since there doesn't seem to be any limit to the number of derivations from a single piece of credit risk (could you design an instrument to hedge the risk of holding a CDS? Sure.) you can't really depend on everybody to use clear-cut terminology.
There are actually some "synthetic securitizations" of mortgage portfolios out there that can properly be called credit default swaps. The big mortgage insurers--PMI, AIG--do them, to my knowledge, not hedge funds, and so I think of them as a special case. But this only makes sense if the lender wants to hold the mortgages on its balance sheet. Maybe I'm missing something, but I can't think why anyone would buy a CDS on an MBS--how much excess risk is there? And how much excess yield could you give up for more insurance? Why buy impairment protection for something that liquid?
My comment was responding to the idea that CDS could keep mortgage interest rates low with less collateral. I can see how a CDS could "replace" collateral, but I don't see how you can keep the interest rates down.
We are coming to a change of party in charge, be it in 2006, 2008 or a wee bit later.
The struggle to win and the struggle to keep onto power by the various players will result in not much new. Winning and not losing will occupy the parties attention. A few forclosures will not matter. I hang out at a few pogressive/liberal blogs and foreclosures are not on the radar screen. The Iraq War, Jobs, Civil Rights, National Debt are.
There are other possiblities other than foreclosure holiday. Say tax credits, or tax advantaged securites holding past due mortages, or job programs or tax credits for hiring the unemployed or massive federal infrastrucure projects that need significant labor.
Wrap your mind around the rolling loan gathers no loss concept and you can come up with lots of ways of pushing out doomsday without foreclosure or the forbidding of foreclosure.
It would be complicated to be sure but the current debt instruments and the option type securities that exist today are complicated.
Lets assume a Mortgage Backed Security with a pool of mortgages. Currently, the security survives a payoff, or a mortage default covered by insurance-the proceeds get paid out. Assume that some agency pays the Mortgage Backed Security something for a toubled mortgage, then there is no real difference. Maybe the agency assumes responbility for payments. There are lots of possblities. Maybe a new law that substitutes a 30 year goverment bond in the principal amount of the mortgage. I'd think it would only be an accounting entry.
The idea is that there are lots of creative ways of dealing with this other than a foreclosure holiday.
Once more unto the breach...
The signs are back. I remember seeing these during prior downturns in San Diego during the early 1990s, the early 1980s, the 1970s, and the early 1960s.
It's not different this time.
Here we go again...
I saw the same sign on the 5 south on-ramp from Sorrento Valley. I wondered if one of those real estate investor seeks apprentice 20k month type signs.
barnaby33, I took this photo at the corner of Sorrento Valley Road and Sorrento Valley Blvd. That is very close to where you saw the sign (a hundred yards or so). For those that don't know - this area is commercial - so I don't know where the house is located.
Best Wishes.
It's slightly different this time, zephyr, since mortgages these days are all made with enforceable due-on-sale clauses. Anybody who takes this offer without the participation and consent of the lender is likely to find he or she doesn't have clear title to the property. And there aren't many lenders willing to do "no qualifying" assumptions, so I doubt anyone was going to tell the bank.
I'm waiting for installment sales to come back, personally. Then we'll know The End Is Near.
This is probably one step before Jingle Mail.
I followed the link to Jingle Mail at MSN.com and found additional links to the following headlines:
* It's a pause, not a recession
* Turn a profit on rising rents
* Why real estate belongs in your portfolio
* The worst-case scenario is not about us
Funny, eh?
Tanta:
Can you go into a little more detail about installment sales and what they involve?
CR - Great site! Thanks for all your hard work on keeping us readers informed on the coming trends.
You're in San Diego and didn't let us know? Hmmmph. ;^)
Lost wages:
Installment sales are also known as land contracts or contracts-for-deed. They have always been more common in certain parts of the country; it depends on state and local RE law and custom. I have no idea how CA law works in this regard, since my experience with this issue is all in flyover country.
In a contract-for-deed, the seller accepts a small down payment (more like earnest money) from the borrower, followed by installment payments toward the contract sales price over a term of 1-3 years. At the end of the contract, the buyer pays off the remaining balance, usually by securing bank financing, and the seller hands over a warranty deed. Since title doesnt change hands until the end of the contract, the buyer walks away with nothing if he or she defaults. On the other hand, if the property depreciates during the contract period, the otherwise qualified buyer may not be able to secure enough permanent financing to cover the balance due on the contract. Contract-for-deed is a risky game to play in a declining market.
My parents actually sold my late grandparents home on a contract-for-deed just a few years ago. It was an elderly 750 square foot house on nearly 3 acres, including 2 acres of mature orchard. Too expensive/too many zoning issues for a tear-down, too little house for the kind of buyer who wants that much back yard. The only offer they got equal to the appraised value included a contract, so they took it and it worked out quite well. Of course, they owned the property free and clear and were smart enough to have the buyer pre-qualified by their own bank.
When you start seeing contracts-for-deed on normal properties, you may well have the signs of a desperate seller or an unqualified buyer or both. And if you see sellers offering quit-claim rather than warranty deed at the end of the contract, you have the signs of a nasty scamthe buyer generally ends up with title to the property encumbered by the sellers unpaid mortgage. As with these informal assumptions, the combination of all those sleazy RE investors who want to get out from under a mess and all those hopelessly naïve buyers who dont have an adequate down payment is going to cause a fair amount of tragedy before this is all over.
I see those bandit signs all over the place here in west central florida.
Owners of converted apartments seem particularly eager to unload them.
donna, I live in Orange County, but I'm in San Diego fairly often.
Tanta, in California there is somthing similar called a "subject to" deal. Basically the buyer and seller are hiding the sale from the lender because of the "Due-on-Sale" clause. The buyer takes title to the house, but I don't think the title is recorded (to hide from the lender). If the new buyer quits making payments, the ex-owner has to start making the payments, and it can become a real mess.
These deals are usually popular when interest rates are rising, and the old loan has a good fixed interest rate. I think the dynamics are different now. These types of deals don't work when the seller wants out, but owes more than the house is worth!
Best Wishes.
Congratulations on beng mentioned in today's barons....
Are you seeing more traffic today?
rt
The only way out of this bad situation is for the government to outlaw foreclosures until things settle down. I know of two congressmen who are working on this right now, but they will have to wait until after November to make their ideas public.
Two thirds of Americans are home owners, and the government will NOT sit idly by while they lose their homes.
A government bailout is the only solution, so don't worry, it is on the way.
Outlaw foreclosures? That should work out well. I can't even imagine what the interest rate would be on an uncollateralized 30-year home loan.
If forecloseure is outlawed, what is to prevent me from stopping my monthly payments to the bank? Seems like I could continue to live here without paying and without penalty... Sounds like an idea designed to get votes but will never become law.
rtalcott, thanks! That was a surprise. Traffic may be up a little - however I probably got a bigger bump from Barry Ritholtz
mentioning my blog was mentioned in Barron's, than from the actual mention!
Jacob, the negative economic consequences of outlawing foreclosures would far outweigh any benefit. However I do think Congress should repeal the new bankruptcy law. Some homeowners are going to lose their homes, and then find they still owe money on their house (and then have to make payments for years). That seems like one rung above debtors prison - at least they can still work to pay off their mortgage debts on their lost home. (note: I believe many lower income homeowners don't fall under this provision of the new law).
I think people should be able to start over clean - and that would put more responsibility on the lenders.
Best Wishes.
Jacob, that's the single most ridiculous thing I have read on the Internet since Ted Stevens tried to explain how it works. Thanks for the laugh.
The only way out of this bad situation is for the government to outlaw foreclosures until things settle down. I know of two congressmen who are working on this right now, but they will have to wait until after November to make their ideas public.
Second tanta's comment - add 'complete BS' & 'troll bait'.
I lived in the rural midwest during the ag crisis when bankruptcies, foreclosures & forced auctions were more common than church bake sales.
The whole country from rocky mountains to gulf of mexico was 'for sale'... and the senate hardly peeped. Willie Nelson & John Mellencamp were the only ones who even noticed.
Gov't going to do nothing this time too.
Hell, gov't doesn't even KNOW there is a problem yet let alone secretly planning some crazy 'Area 51 solution' like that... maybe the bankers will be flown around in black belicopters protected by soldiers in blue helmets.
Maybe it will all happen... as soon as Mulder & Scully get appointed to the next open seats on the FOMC.
Sheesh.
"I can't even imagine what the interest rate would be on an uncollateralized 30-year home loan."
Possibly not all that high. To supply American consumers with the funds to keep overbuilt export industries operating, Asian governments either will buy them directly or will induce others to buy them through ultra-low-interest-rate policies. And hedge funds will sell credit default swaps (insurance) on them, making huge short-term profits for their managers to take their 20% cut on.
Eventually the massive corruption in China will lead to another revolution there, the present Chinese leadership and their cronies will flee to the US as the Shah of Iran did in '70s, and China will fall into the hands of demagogues who will exploit the US debt defaults for political gain.
Jm, somebody has seriously mislead you about what a credit default swap is.
AZ_Cowboys excellent point is that home mortgages have low interest rates because they are collateralizedif the borrower defaults the lender can take the house through foreclosure. If you made it impossible for lenders to foreclose, mortgages would in effect become uncollateralized, and as Jim points out, borrowers at no risk for losing their homes would default in droveswhy make your mortgage payment if you cant lose your house?
If the idea behind outlawing foreclosures is that the loan actually remains collateralized because the government makes the lender wholeas if congress is going to pass some law that suddenly puts free FHA insurance on every mortgage loan in the countryyou still have a little problem with the moral hazard you just put in front of the homeowner (leaving aside the question of how the government would fund an insurance pool of that magnitude without having collected any mortgage insurance premiums from anybody and without being able to liquidate the collateral). What would happen is that the federal government would suddenly be forgiving about $10 trillion in home mortgage debtwed all default, the lenders would all demand reimbursement from the government, and the government would have to borrow the money to pay the reimbursement, and there is no one on planet Earth with that kind of money to invest who would lend it to them. You think Asian central banks would buy $10 trillion in worthless paper? After all the Fannie and Freddie debt issues theyve been holding just became worthless, since Fannie and Freddie no longer have a business, since the government just liquidated all their assets? After the US economy just collapsed, because the financial sector is in ruins?
Credit Default Swaps are not forms of primary mortgage insurance or even credit enhancement for mortgage securities. They are issued to reduce institutional exposure to commercial credit risk. Heres an oversimplified example:
Megabank A buys $10MM worth of corporate bonds from Megacompany B. Megabank As total return on the investment is potentially impaired by the risk that Megacompany B will default on its bond issue, or will look like its going to do so and get downgraded, and the downgrade will hurt the price of the bonds. So Megabank A goes to Investment Bank C and buys a CDS worth a nominal $10MM priced at, say, 200 bps (2%) with a maturity the same as the original corporate bonds. Megabank A is protected from default by Megacompany B, since if Megacompany B defaults on the bond, Investment Bank C has to make Megabank A whole for the original $10MM (it takes the impaired asset off the counterpartys books, which is why its a swap). If Megacompany B never defaults, Megabank As total yield on the original investment is reduced by 2% and Investment Bank C makes 2%.
Continued below:
The CDS is now a derivative (an asset whose value is derived from changes in value of an underlying asset) that can be traded like the original bond. If things are lookin good for Megacompany A, the CDS will be worth more and if not it will be worth less. Hedge Fund D can always come in and buy a discounted CDS from Investment Bank C, because Hedge Funds are (of course) geniuses at buying high-yield high-risk low-disclosure junk and making beaucoup-jillions of dollars off the trade. But I digress.
If Megacompany B happens to be, say, General Motors, which makes most of its profits off its mortgage lending business, since that car-manufacture thing hasnt worked out so well, and if Megabank A happens to be, say, Citicorp, which has a booming mortgage lending business and giant mortgage portfolio, and if Investment Bank C happens to be Goldman Sachs, which owns more mortgage-backed securities than you can shake a stick at, and if some lunatic in Congress put through a bill that instantly erased the value of mortgage lending, everybody would collapse together and the price change in the CDS would simply disappear in the conflagration of Hedge Fund D. Bond market traders wouldnt care because theyd be burning their Telerates for fuel while they foraged in the woods for food. And you tell me that Asian Central Bankers would decide they could prevent this by buying American mortgage loans at low rates of interest?
You could use my GM-Citi-GS example to say that CDSs have something to do with mortgage credit risk, but, well, everything has something to do with mortgage credit risk these days. Thats the problem that is not going to be solved by outlawing foreclosure.
Dryfly, the Truth is Out There.
Dryfly, the Truth is Out There.
Thanks Scully. I knew you could help.
Great explanation, Tanta. Thanks.
But I think the following from the second part of your post:
"If things are lookin good for Megacompany A..."
Should instead read:
"If things are lookin good for Megacompany B..."
??
I just want to be sure I understand that the value of the CDS hinges on the fortunes of the company issuing the bonds.
One way to avoid mass foreclosures is for govt to confiscated the houses for public housing.
But that does appear to be less appealing than letting a bunch of folks on both sides the transaction take their medicine. The creditors can write off their loss on taxes and the debtors get to pay taxes on their 'gain' from debt forgiveness.
If things get real bad, the creditors may let the former tenants live in the houses for rent or even reduced rent to keep the property up. Risky but happened during the Great Depression according to my father who lived through it.
I've seen figures thrown about that 20%+ of the transactions recently are 'investment' plus a simular figure for 'second/vacation/ homes. So it looks to me that if mass foreclosures happened, then the majority of owner occupied houses will remain with the owners because the investment and second houses will be sacrificed first. So figure from a political calculation that there is not enough of a threat to force action.
You're right, Captain. The rise or fall in the value of the CDS would more or less mirror the rise or fall in the value of the underlying corporate debt.
The probem is that the rise or fall in the snark level of a post is in inverse proportion to the level of proofreading it gets. My mother told me I would get into trouble some day by being a wiseass, but I didn't listen . . .
It seems to me, and this may be naive and not well thought out..., but with so many people with ARMs and interest-only mortgages getting ready to reset on top of a declining...ok..."Crashing"...housing market, wouldn't it be prudent of the lending institutions that made these ARM and Interest-only loans to recognize that their borrowers are going bust in an ever-growing wave and offer those borrowers fixed rates at very low fees to stem their losses? They can't profit from housing declining in value with no buyers and defaulting borrowers either. Seems to me they should consider offering the fixed rates to their borrowers for both their sakes.
The rise or fall in the snark level of a post is in inverse proportion to the level of proofreading it gets.
Tanta's Law?
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wouldn't it be prudent of the lending institutions that made these [] loans to recognize that their borrowers are going bust in an ever-growing wave and offer those borrowers fixed rates at very low fees to stem their losses?
Or at least string them along until things stabilize???
Not if the originators bundled & sold the loans on the open market as MBS... then it's some other fools problem.
The question then is whether the buyers of the MBS have the economic muscle to underwrite the bad loans themselves. My guess is many don't.
However for those loans that are still held by a bank or thrift or a large institution... and assuming the institutions are solvent & have sufficient reserves, then one would think they would be slow to foreclose. Find a way to keep money coming in somehow and push the problem out... roll it over into some other instrument somehow.
Reminds me of another 'tantaism'... "A rolling loan gathers no loss."
May not be possible.
In the ag crisis of the 80s when farms were going under left & right... banks absolutely didn't want the farms back because they sold at forced auction for a half or less of the loan amount.
But two things forced their hand... one was the Feds required banks to keep a certain reserve level PLUS many states wanted to keep banks & thrifts out of farming (a justified fear of corporate 'share cropping').
So to get cash to meet reserves and to comply with state laws forcing banks to divest from landlording... we got forced auctions. Wave after wave of them - each with lower selling prices than the one before.
In my home town land that was fought over at $2000/acre (top of bubble) was barely selling at forced auction for $400/acre a couple years later.
This is prime Midwestern farm land - produces 180-200 bu/acre corn like clock work... even in this 'drought year' will produce 160 bu/acre or more.
I don't think we'll repeat that insanity in suburbia - I hope the banks & thrifts & regulators are smarter now. Are they?
Tanta, your succinct description of what constitutes a genuine credit default swap is excellent. But I'm sure I read some months ago that there were major problems in the CDS market after Delphi's bankruptcy announcement due to the fact that the total notional value of the CDSs in the market was in the vicinity of ten times the amount of Delphi bonds outstanding, implying that there is a parallel universe of derivative instruments that some are calling CDSs, but in fact are not underpinned by actual bondholdings, and are essentially the same as naked puts and calls traded on the options exchanges. I've gotten the distinct impression that hedge funds are creating those instruments as well as trading them. And if such instruments are not at present being offered by hedge funds as default insurance for mortgage-backed securities, is there anything to prevent that in the future?
That of course is irrelevant to the other issue you address -- that the government couldn't simply outlaw foreclosure. I agree almost completely with your analysis of why it wouldn't work. But since Asian governments' only alternative to buying whatever debt instruments we generate is to allow the collapse of their overgrown export industries, I do believe they would provide a market for uncollateralized mortgage-backed securities, if it came to that.
dryfly, thanks for mentioning Tanta's dictum that, "A rolling loan gathers no loss." Everyone trying to puzzle out how this may all develop should keep in mind that that is especially true in Asia, and it is Asian funding of US borrowing, both directly through bond purchases and indirectly through near-zero interest rates supporting the "yen carry trade" that make so much of today's insanity possible.
One last thought on 'outlawing foreclosure'...
Having thought about this, I could imagine a way the gov't COULD 'outlaw' foreclosure... they could do it coupled with another round of 'bankruptcy reform'.
Think of it as a sort of financial market equivalent of 'debtor's prison'.
You don't lose the home via foreclosure BUT the debts aren't forgiven either and you aren't allowed to stop making payments - the courts step in and force a 'mediation'.
You live in the house like before, make court mandated payments on the mortgage or possibly have wages garnished like child-support... maybe not the original mortgage payment amount but something to keep paying down the balance.
The 'owner' is required to provide up-keep & maintenance on the property as before or those 'damages' can be added to the bill by the judge. Plus you continue to pay property taxes, assessments, etc.
And you can't sell the property UNLESS the balance is paid off to the mortgage holder in the process... either by saving up to pay it down & buy your freedom or there is a gain sufficient to clear you.
If the garnishment isn't sufficient to cover the interest (neg amortization)... well then work harder, save more or the tally grows just like in the old days of the company town.
Onerous? You bet. But I can see congress doing something like this to correct for 'flipper abuse' before a foreclosure holiday is enacted.
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Personally I don't think anything will happen other than hand wrining... but if Jacob (above) wants to throw out baseless conjecture... I can match his ante & raise it.
dryfly,
I am thinking along the same lines -- that if there's any relief on foreclosures it will be accompanied by onerous repayment provisions, such that even if mortgages become more poorly collateralized than they already are by virtue of unsustainability in home prices, there will still be some basis for mortgage-backed security sellers to argue they'll eventually be repaid (at least enough to provide the foreign central banks with justification for continued buying).
Central Banks Favor U.S. Agency Debt Over Treasuries (Bloomberg)
"Central banks are diversifying their assets at a faster rate. They bought about $14 billion in agency debt on average every month this year, up from $12 billion in 2005. The banks now hold $535 billion in agency securities, Fed data show."
jm said:
I've gotten the distinct impression that hedge funds are creating those instruments as well as trading them. And if such instruments are not at present being offered by hedge funds as default insurance for mortgage-backed securities, is there anything to prevent that in the future?
Let me say I'm sure you're right that the hedge funds are creating these things, which is to say I don't know where to draw the line between "Investment Bank" and "Hedge Fund" any more than the regulators do. And since new derivatives seem to be invented every week, and since there doesn't seem to be any limit to the number of derivations from a single piece of credit risk (could you design an instrument to hedge the risk of holding a CDS? Sure.) you can't really depend on everybody to use clear-cut terminology.
There are actually some "synthetic securitizations" of mortgage portfolios out there that can properly be called credit default swaps. The big mortgage insurers--PMI, AIG--do them, to my knowledge, not hedge funds, and so I think of them as a special case. But this only makes sense if the lender wants to hold the mortgages on its balance sheet. Maybe I'm missing something, but I can't think why anyone would buy a CDS on an MBS--how much excess risk is there? And how much excess yield could you give up for more insurance? Why buy impairment protection for something that liquid?
My comment was responding to the idea that CDS could keep mortgage interest rates low with less collateral. I can see how a CDS could "replace" collateral, but I don't see how you can keep the interest rates down.
Damn, it's so much fun to talk to you guys.
We are coming to a change of party in charge, be it in 2006, 2008 or a wee bit later.
The struggle to win and the struggle to keep onto power by the various players will result in not much new. Winning and not losing will occupy the parties attention. A few forclosures will not matter. I hang out at a few pogressive/liberal blogs and foreclosures are not on the radar screen. The Iraq War, Jobs, Civil Rights, National Debt are.
There are other possiblities other than foreclosure holiday. Say tax credits, or tax advantaged securites holding past due mortages, or job programs or tax credits for hiring the unemployed or massive federal infrastrucure projects that need significant labor.
Wrap your mind around the rolling loan gathers no loss concept and you can come up with lots of ways of pushing out doomsday without foreclosure or the forbidding of foreclosure.
It would be complicated to be sure but the current debt instruments and the option type securities that exist today are complicated.
Lets assume a Mortgage Backed Security with a pool of mortgages. Currently, the security survives a payoff, or a mortage default covered by insurance-the proceeds get paid out. Assume that some agency pays the Mortgage Backed Security something for a toubled mortgage, then there is no real difference. Maybe the agency assumes responbility for payments. There are lots of possblities. Maybe a new law that substitutes a 30 year goverment bond in the principal amount of the mortgage. I'd think it would only be an accounting entry.
The idea is that there are lots of creative ways of dealing with this other than a foreclosure holiday.