In Housing Smoke and Mirrors (3)[i] it was suggested that there were some anomalies, in the general pattern of improving mortgage delinquencies, that deserved closer scrutiny.
In particular, the Mortgage Vintages from 2005 and 2009 were identified as being the sources of systemic risk; and also the smoking guns of potential malpractice and fraud. It is these vintages that are the greatest threat to the housing market recovery; and therefore the mortgage securities market by default. The year 2005 was the peak of the Housing Bubble; and 2009 was the trough of the Crash. At such extreme inflection points, it is logical to assume that financial institutions and individuals are getting creative with their operations and accounting practices. A forensic investigator would immediately start an investigation at these stress points. Sure enough, the trend-lines in defaults support this forensic assumption; however no-one in authority is willing or able to pull back the curtain.
In Housing Smoke and Mirrors (3), it was also suggested that the Federal Government is desperately trying to increase its involvement in the mortgage market; in the hope of heading off the next emerging crisis, from the 2005 and 2009 sour Vintages.
Investigation of the crime scene, in relation to the 2005 and 2009 Vintages, has started to focus on the issue of what are known as “Zombie Homes”. A “Zombie Home” is one which the mortgage service company has initiated foreclosure on, in the knowledge of the bank lender; but without taking legal ownership of the title. The obligation to maintain the property therefore still remains with the title holder, even though they have stopped paying on their mortgage debt. Clearly the title holder cannot maintain the property, so it falls into disrepair. The mortgage servicer still makes interest payments to the bank lender however. The servicer is able to do this out of a pool of liquidity, created by a portfolio of other mortgages that are still making payments. The bank therefore still has an asset; and the servicer still collects a fee. In addition, since the properties never get to market, the existing housing inventory remains tight and prices are supported. The process, by which the servicer uses other income streams from unrelated properties, is the source of the contagion that was observed during the “Credit Crunch” of 2008. So far this dangerous practice still continues; which is hard to understand.
It is this legerdemain that we suspect is strongly associated with the problem 2005 and 2009 Vintages. In Housing Smoke and Mirrors (3), we stated that:
Clearly, the 2005 and 2009 Vintages present the systemic risk that is still challenging the housing market. Underwriting and fraud issues related to these two vintages are clearly still out there (perhaps off balance sheets); and represent a potent threat that has still not been addressed. The 2005 and 2009 Vintages are the smoking guns at a crime scene, which has remained un-investigated.
It is here in the “Zombie Homes” that we suspect that some of the great frauds, that have so far gone uninvestigated, are to be found. These are the bad eggs that are currently hatching; and causing the counter-trend worsening delinquency pattern in the chart. America is a big place, so the physical manifestation of this issue, in dilapidated homes and run-down neighbourhoods, has been hidden at the national level. As it festers and grows, at the neighbourhood level, it will however become a visible issue; that will cause a national outcry, especially if house prices in general begin to fall.
There are signs that the slow wheels of Federal Government are turning into gear on this issue. It is also possible that the Government has until now been colluding with the banks to address this issue in a manner that stays out of the courts. In Housing Smoke and Mirrors (3), it was noted that banks are increasing proprietary foreclosures, in a way that is forcing the borrowers to seek Federal support. First the bank modifies the mortgage. Next the borrower still becomes delinquent, so that he is forced to seek a Federal modification programme. The banks are therefore shifting the risk directly back to the Taxpayer, paying back TARP and redeeming Government share-holdings as they go. As the risk is transferred back to the Government, the banks tighten their own lending standards; so that borrowers who have been shifted to Federal programmes can never qualify for a private mortgage again. The banks are effectively exiting the riskier part of the mortgage business; and the Federal Government is entering in their place. The banks are driving this process; and the Federal Government seems to be accommodating them. There are however signs that this cosy ecosystem is about to be shaken up. The Office of the Special Investigator General of the Troubled asset Relief Programme (SIGTARP) is hinting at a “change” that the banks do not wish to believe in.
The latest SIGTARP report[ii] was as scathing as it is possible to be of the banks and the Federal Agencies involved, without causing national hearings on the issue. The bottom line is that SIGTARP believes that TARP saved the banks but failed the borrowers. In its most damning indictment of the Treasury, SIGTARP reported that as of March 31st 2013 Treasury had spent less than 2 percent ($7.3 billion) of TARP funds on homeowner relief programs including HAMP and the Hardest Hit Funds while spending 75 percent to rescue financial institutions. According to the report:
“Treasury pulled out all the stops for the largest financial institutions, and it must do the same for homeowners.”
In March, Treasury had been blowing its trumpet on TARP, when it said that:
“Thanks to TARP….struggling homeowners have seen relief, and credit is more available to consumers and small businesses”.
SIGTARP scornfully dismissed this claim with the counter-comment that:
“Lost in this statement is the unfortunate reality that this improvement is only a fraction of what TARP could and should have done, and in many ways still can do.”
TARP has therefore failed the US Economy; and hence the Taxpayers who funded it. Heads will roll; and Tim Geithner is lucky that his head has moved somewhere else. SIGTARP also indirectly noted the sleight of hand, occurring in proprietary mortgage modifications, which has had the impact of increasing the repeat defaults egregiously; at levels now above 40%.
On the issue of Too Big To Fail (TBTF), SIGTARP opined that the banks have no incentive to address the issue; and that the pre-crisis status quo is currently prevailing. In relation to “Living Wills”, which have been prescribed as a resolution to the TBTF issue, SIGTARP states that in a crisis there will be no time to execute such documents. SIGTARP recommends that “Living Wills” should be more pro-active; so that they actually form part of the banks’ mandatory reporting requirements. In this way, all on and off-balance sheet risks and counter-party exposures can be identified and managed by a regulator in real-time. Clearly the Federal Reserve and the FDIC are going to have a fist-fight over who gets to be the real-time “Trustee” of these “Living Wills”.
The only good news for the banks from SIGTARP was that it avoided opining on the subject of “Zombie Homes”. This is presumably a place that it is not in the interest of Government to go to at this time; however it has this ace up its sleeve to be played on the slackers in the banking system.
There was also a signal that Treasury itself is quickly moving to catch up with the new agenda; and cover its tracks in the process. The latest Financial Stability Oversight Council Report[iii] signalled that Treasury was quietly trying to address the issue of dubious practice by mortgage service companies that was allowing the “Zombie Homes” to have life after death.
“The Council recommends that FHFA, HUD, CFPB, and other agencies as necessary develop comprehensive mortgage servicing standards that require consistent and transparent processes for consumers and promote efficient alternatives to foreclosure as appropriate. In addition the Council recommends continued efforts to implement compensation structures that align the incentives of mortgage servicing with those of borrowers and other participants in the mortgage markets[iv].”
Reading this nuanced report, one gets the sense that it’s game over for the mortgage servicers, the banks and the “Zombie Homes”; however it also seems that Treasury wishes to bury this issue quietly before the potential fraud and malpractice gets uncovered. If this issue is not handled with care, it is going to blow up with nasty market and economic consequences.
The latest SIGTARP report signals that the Federal Government and the Federal Reserve are just about to apply the big stick to the banks. They are also about to apply an even bigger financial stick to the mortgage and housing markets. If the banks are lucky, they will have transferred a lot of the risk to the Taxpayer before the stick is applied. If they are unlucky, this big stick will come during another housing crisis, in which there are no Taxpayer funded bailouts for them. The problem is that the banks are now in a hurry to get away from Government and the Fed. As a consequence, they have cranked up the foreclosure process; and in doing so, they have accelerated the upward slope of the 2005 and 2009 Vintage default profiles to become systemic threats. The banks are therefore driving the next crisis closer faster, just as the Federal Government and the Fed are trying to postpone it. Government and the Fed need to jump in quickly, before some of the banks have the great idea of going the other way and getting the “Big Short” on again.
The lawmakers are doing their best to keep the bubble inflated. In the most recent lobbying efforts, at the Housing Ways and Means Committee[v], industry insiders put forward the case to continue the provision of fiscal incentives to housing; through the application of interest and tax deductions. With a surprisingly stronger budget picture, combined with a visibly slowing economy, these invitations to treat are likely to be well received.