Mortgage Mess Could Hit Banks, Housing

Remember the giddy days of the real estate bubble? Crooked lenders drew up mortgages without keeping track of them. Wall Street packaged them and foisted them off on naïve investors. The real estate bubble burst, and now there are massive foreclosures — but not adequate documentation for them. All 50 states are investigating the unscrupulous and slipshod record-keeping, major banks have suspended foreclosures, and lawyers are expected to file suits by the bushel. As a result, more bank woes and another housing dip may be inevitable.

So what is Washington doing? Trying to create another bubble — this one in the stock market. The logic seems to be that giddiness caused the calamity so more giddiness will straighten it out.

The Federal Reserve keeps short-term interest rates near zero, and it’s buying bonds to force long-term rates, which are already near record lows, even lower. The stock market is gleefully lapping up all the liquidity as banks’ trading desks borrow money for nothing and make almost risk-free bets, often on the stock market. We have seen three bubbles burst since the year 2000 — two in the stock market and one in real estate — but our leaders think we prefer financial asset inflation to product and service inflation.

The Fed’s theory is that interest rates are so low that people will buy stocks instead of bonds or savings instruments. If stocks go up, consumers will feel better and will spend. But the richest 1 percent of Americans control 40 percent of financial wealth (such as stocks and bonds); the top 5 percent control 68 percent; and the top 10 percent control 80 percent. The bottom 80 percent have only 9 percent of financial wealth.

Because stock ownership is so concentrated at the top, Del Mar’s Arthur Lipper III, an international investment banker who recently received a patent on his method for using royalties to invest in and finance companies, says propping up the stock market won’t improve the consumer mood. “It is somewhat similar to a liquor salesman providing free product sales to an already-inebriated group of partygoers,” says Lipper. And what about the timing of these liquidity snorts? “Surprise, surprise, right before an election.” (Boozing up the electorate is an old voting trick.)

Peter Q. Davis, retired chief executive officer of a San Diego bank and onetime mayoral candidate, thinks that a stronger stock market will initially lift the spirits of consumers and business executives. “Folks have 401(k)s and are concerned where their values for retirement went. With rising portfolios they are going to feel more confident and are going to spend and invest,” says Davis. But as the Fed creates floods of money, the value of the dollar goes down. “The big question is the rising debt and lowering of the value of the dollar. I worry the government may reach a tipping point similar to an individual who is borrowing far more than his income would justify. When others lose faith in the dollar, we will have trouble refinancing our debt, and then we’re on a slippery slope.”

Lipper worries that the Fed can’t afford to shell out more trillions of dollars to buy bonds. He also believes that “the stock market is being forced to unsustainable levels and a major correction is coming. The Obama administration has done wonders for Wall Street in the short term at the expense of the nation for the longer term. There is nothing like flooding the market with money to get stock prices up.” Long term, inflation is a worry.

More banking and housing misery is probably coming, and one reason is that people are getting smart about foreclosures. Taking advantage of mortgages’ legal limbo, those who owe more on their home than it is worth are not making their mortgage payments. “If you are upside down on your home and delinquent on your mortgage, why would you pay?” says Davis. “Just ride it out rent-free for as long as possible.”

So banks will get hit with lawsuits and the expense of state investigations at the same time people are not paying on their mortgages. Financial institutions won’t be able to rake in fees from foreclosures and will have to come up with the paperwork on foreclosures that had been massively rubber-stamped when the onslaught hit. Some claim that it should be only moderately difficult for banks to straighten out the paperwork, but “it is about as easy as unscrambling eggs,” says Davis.

“Bankers are now held in lower esteem than car dealers or lawyers, and I believe [bankers] will find this a bad situation,” says Davis. “I would sure not be buying bank stocks at present, as I believe there will be some costly shakeouts before this is behind us.” Not surprisingly, some bank stocks have been belted even though the rest of the besotted market continues to do well.

When the logjam of foreclosures in limbo finally breaks, these homes will hit the market and may “cause a real crash,” warns Davis.

Says Lipper, “The lawyers are going to have a long feast, and banks will take significant losses.” As legal and administrative costs pile up, “sooner or later, the banks will have to sell [bank-owned] homes at much lower prices. It is inevitable that residential property values will decline significantly, and that will put increased pressures on states and municipalities that depend on real estate as a tax base.”

Ouch! Several states and municipalities (such as San Diego) are already technically insolvent because of pension commitments they can’t fulfill. Tax receipts, already weak, will drop off more as valuations recede. A housing double-dip, billowing bank crisis, and insolvent political entities could push the overall economy back down again.

Alan Nevin, director of economic research at MarketPointe Realty Advisors, doesn’t take the gloomy view. He agrees that Wall Street shenanigans in selling mortgage-backed derivatives created a problem. “The foreclosures were legal, but they don’t know who has the title,” says Nevin. “It is one enormous headache.” However, “We know that the government — Fannie, Freddie, and FHA [Fannie Mae, Freddie Mac, and the Federal Housing Administration] own half of the foreclosed homes, so there is no question who has the right to foreclose.” Nonetheless, “Attorneys will use this as another business-generating technique.” But the problem should be gone in a few months. “They knew about these three years ago.”

Data from ForeclosureRadar.com show that San Diego County notices of default through September are down 16 percent from a year earlier. Trustee-sale filings, which set the date and time of an auction, are down 27 percent. Nevin expects housing resales in the county to stabilize at 2500 a month, although that’s down from 4000 in the halcyon days.