Thursday, March 03, 2011

Foreclosures: Pro & Con

Last week brought a pleasant surprise to David Faber's CNBC program. Former Salomon Brothers Vice-Chairman and mortgage-backed securities pioneer Lew Ranieri gave his first live televised interview.

Ranieri is a seriously smart and sophisticated guy, so I hung around within range of a television after I'd finished what I was doing, just to listen to his entire set of comments.

His version of how the late 2000s mortgage lending bubble occurred is objective and credible. He gives weight to both so-called Wall Street houses for securitizing questionable mortgages, and to the GSEs for accepting them to back their own securities, too. He cited some numbers regarding GSE explosion of pass-throughs which were simply incredible.

To his credit, Ranieri personally apologized for not having screamed louder and longer as the bubble grew beyond any sustainable size. He identified poor underwriting standards and an over-reliance on FICO scores, rather than prior, more involved and often qualitative mortgage lending standards.

When the conversation turned to foreclosures, Ranieri cited a stunningly large supply of unsold or foreclosed housing. I don't recall the exact numbers, but I believe he said several months supply had been the historical norm, but today's supply was something like almost two years' worth, if not more.

Never the less, he came out against massive foreclosures. He said that foreclosures destroy neighborhoods and cause them to rapidly degenerate into ghettos. He also cited a lack of government programs to promote and assist local entrepreneurs in buying foreclosed properties, repairing/renovating them and putting them back up for sale at new, lower, market-clearing prices.

Separately, Joseph Mason, a professor of banking at Louisiana State University, wrote an editorial in the Wall Street Journal last week entitled Why Regulators Should Let Banks Foreclose.

 Mason  providing evidence that foreclosure delays don't help

"On Capitol Hill last week, federal banking regulators suggested that the government may soon reach a comprehensive settlement with banks on foreclosure procedures and servicing. In theory such a settlement could unlock housing markets and boost the economy. But recent statements by Comptroller of the Currency John Walsh and FDIC Chair Sheila Bair suggest that they remain focused on using the settlement to extend, rather than end, ongoing foreclosure delays.

Meanwhile, states including New Jersey and Hawaii are considering imposing their own moratoriums on foreclosure that, if they conflict with federal policy, may lead to protracted litigation. This approach is the wrong medicine for our ailing economy.

For borrowers, delaying foreclosure only provides false hope. Today, a borrower faces a foreclosure sale only after failing to make a payment for more than a year. There is no reason to believe a brief additional time-out will allow such borrowers to become current. To the contrary, data from the Mortgage Brokers Association indicate that loans reaching the foreclosure stage almost never avoid default, and that borrowers who become 90 days delinquent cure their default only about 1% of the time.

Similarly, recent research done for the National Bureau of Economic Research demonstrates that loan-modification programs have mixed effectiveness. Data suggest that many delinquent borrowers have the means to afford their mortgage payments, but are so deeply "under water" on their mortgages that they are simply no longer willing to pay. Others have insufficient income to afford any reasonable mortgage payment.

For those who do obtain modifications, roughly half become delinquent again within six months. Thus, while modification efforts are laudable, they are not the solution.

The unfortunate reality is that efforts to lengthen the foreclosure process will not substantially alter borrower outcomes. They will only extend a painful time for borrowers and the economy. During that time, uncertainty will prevent borrowers from moving on with their lives, including starting to pay rent and make purchases that would inject money into the economy.

For neighborhoods, every day without foreclosures means another day of deteriorating home values. A recent study of the Cleveland area published in Urban Affairs Review found that neighborhood home values are largely unaffected by foreclosures that take less than a year. But foreclosures that take longer than a year have a negative impact on home values as the effects of neglect and vandalism mount.

One of the root causes of the economic crisis was a deterioration of underwriting standards: We stopped focusing on whether people could afford the homes they were buying. Continuing to delay foreclosures reflects the same kind of wishful thinking. California's 90-day moratorium in 2009 did not improve the state's economic performance, and moratoriums in other states would only prove again that a delay can't turn an unaffordable mortgage into an affordable one.

Kicking the foreclosure problem down the road creates uncertainty that discourages investment—and delays our desperately needed economic recovery."

Mason seems to provide evidence contradicting Ranieri on foreclosures. Rather than worry about allowing them, Mason suggests getting them over quickly is the better alternative. And his end-game is Ranieri's, too- repurchase of foreclosed properties at lower, market-clearing prices.

Personally, I believe it's foolish to delay foreclosures, especially when it's governmentally-coerced. It unfairly penalizes some while allowing others to evade the proper consequences of their failure to fulfill financial contracts, as well as discriminating against all those who behaved properly and did not buy an unaffordable home, only to see such behavior rewarded.

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