According to RealtyTrac, home repossessions will rise in 2011 from the record one million homes that were repossessed in 2010. There are five million homeowners who are at least two months behind on their mortgages, primarily due to job losses and declining home prices, which pushes more borrowers underwater.
One in 45 households received a foreclosure filing in 2010, for a record high 2.9 million homes. RealtyTrac projects three million foreclosures in 2011, with 1.2 million repossessions. This hidden inventory is on top of the 700,000 homes on the books of banks within the $53.2 billion in Other Real Estate Owned (OREO). It will likely take three years to clean up these unwanted homes and some banks are abandoning OREO properties. This environment will reduce property appraisals, which will eventually filter through to lower home prices.
Foreclosure Players: The Home Owner, The Bank, The Investor
When a homeowner buys a home and takes out a mortgage, he is usually unaware of whether or not the bank holds the mortgage as an investment or has the mortgage pooled into a mortgage-backed security that is sold to an investor. Before the housing crisis began, many mortgages were sliced and diced into mortgage derivative structures sold in the private market, as well as to Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC). Since Fannie and Freddie became government-owned through conservatorship, these GSEs have securitized roughly 90% of mortgage securities, as the private market fell off the map.
This tangled web is one of the major problems in trying to unravel how to help homeowners stay in their homes, and to accurately perform a foreclosure procedure when there is no hope of their doing so.
The Home Owner – May have bought a home he could not afford with a mortgage that he could not understand. As home values plunged, owners owed more than what the home was worth. Defaults resulted when mortgage payments increased because of higher mortgage rate adjustments, or because the homeowner lost his job, or felt screwed by the bank.
The Bank – May have exaggerated how easy it would be for the homeowner to afford adjustable mortgages. Most mortgages were packaged by the bank, entered into the securitization process, and were sold by Wall Street to investors around the world, who thought the mortgage securities were “AAA” rated -- and, in the case of Fannie and Freddie, were backed by the U.S. government, which was not true.
The Investor – The main reason to securitize and sell mortgage structures to investors is to spread the risk of default to a broader group. The problem was the false ratings and assumed U.S. backing of Fannie- and Freddie-backed securities. As a result, instead of investors taking a hit, tax payers have, through the conservatorship and guarantee assumption of Fannie and Freddie, which cost about $150 billion through 2010.
Now state attorneys general are meeting with mortgage securities investors, who want to shield themselves from losses that may result in settlements relative to the foreclosure dilemma. The so-called “too big to fail” banks are in the middle of this, as they risk having to buy back the mortgage securities they sold to investors. I see no problem with this as long as it’s done at a current market price, not at the original price. That’s what makes a market. The investor bought betting on gains, but market conditions have changed due to default and foreclosures, so the investor should simply sell the bonds back to the bank at a current market price, where the investor takes the loss. That’s the free-market solution.
At the end of 2007, the mortgage market totaled about $15 trillion, by some estimates. Of these, FDIC data shows only $2.25 billion were held as investments on the books of our nation’s banks at the end of 2007. At the end of Q3 2010, this asset class was down $364.9 billion or 16.3%. It’s hard to evaluate why mortgages had this huge decline, other than defaults and foreclosures, or packaging loans to Fannie Mae or Freddie Mac. They all did not go into OREO, which rose 338.2% to a record $53.2 billion. This stress in the banking system is a factor in making the foreclosure process even more difficult for the bank.
The bigger problem is how many mortgages are sliced and diced into Notional Amount of Derivatives, which grew 43.5% to $236.4 trillion at the end of Q3 2010. You can’t put Humpty Dumpty mortgages back together again as investors fight over whether they own the front door or even the kitchen sink of the underlying collateral known as the home.
I do not have a solution, and neither does our government, the legal folks sorting through the mess, or the financial market place.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.