PIMCO, which was one of the firms spearheading the putback push against BofA, has put together a useful and rather objective analysis though Executive Vice President, Global Structured Finance Specialist, Rod Dubitsky, titled "Foreclosure Flaws Trigger New Round of Uncertainty." While not surprisingly the baseline case presented by PIMCO is a moderate one, as the asset manager claims the most likely impact is "moderate" it does acknowledge that there is a possibility for substantial complications (although Fannie's recent bail out of BofA pretty much takes cares of that). The two main adverse consequences are "corrupted title" - a topic beaten to death previously, and, more importantly, "Tax issues relating to RMBS issuance entities" on which PIMCO says "Some have argued that assigning the note for the
mortgage loan so long after closing would run afoul of REMIC rules,
which could subject RMBS deals to adverse tax consequences." Of course, as an escalation of these developments would bring the entire $8 trillion RMBS structured finance industry to a halt, we are fairly confident that as more and more settlements are instituted, that the whole fraudclosure issue will be very soon completely forgotten.
Foreclosure Flaws Trigger New Round of Uncertainty
Rod S. Dubitsky
In early October a contested foreclosure action on a tiny house in
rural Maine lit the fuse of a blast that has reverberated throughout
the markets, spreading renewed fear of a second downturn in the housing
market and potential gridlock in the mortgage market. Specifically, the
contested foreclosure action led to a deposition of an employee of GMAC
Mortgage (a subsidiary of Ally Bank, fka GMAC Bank), which appeared to
reveal that GMAC was cutting corners while executing the foreclosure
process. The deposition led GMAC to freeze the foreclosure process, and
other servicers quickly followed GMAC into the servicer confessional
and likewise froze foreclosures. Further, the 50 state attorneys
general launched an investigation.
Though many servicers are in the
process of fixing the flawed procedures, and the long-term market
impact of these revelations is uncertain, in our base case scenario we
see moderate risks to housing prices and to residential mortgage-backed
securities (RMBS) investments. Though the story is months old and
several issues have been clarified since the story initially emerged,
much uncertainty remains and many additional challenges have been
raised with the foreclosure process as well as with the securitization
process in general.
A Brief History of “Robogate”
Though there are several complicated threads to
the story, the primary flawed processes employed by mortgage servicers
can be easily summarized: 1) employees of the servicers were attesting
to facts in affidavits that in fact they often didn’t have explicit
knowledge of and 2) contrary to requirements, the affidavits in many
cases weren’t signed in front of a notary. (We note that this should
not imply there are no other broken servicer processes.) As an
affidavit is a sworn statement of fact that needs to be witnessed,
these two shortcuts rendered the affidavits defective. No witness and
no real knowledge of the facts being attested means an affidavit is not
acceptable to the foreclosure court. The media dubbed this trend of
rapid, automated signing of affidavits “robo-signing” and the ensuing
uproar “robogate.”
The secondary thread of the story that seems to
be growing in importance is potential flaws associated with the
mortgage documents and the process of transferring the documents during
the securitization process. The upshot of the latest stories is that
flaws in the transfer of mortgage documents associated with the
securitization could increase the complexity of the foreclosure process
and, in the extreme scenario, jeopardize the economic interest of the
trust in the associated mortgage. Though the document flaws (as
distinct from the affidavit flaws) currently appear to be limited, we
are watching this thread closely to see if the issues are more
pervasive.
Though some of the earlier moratoria have been
lifted, it’s not entirely clear that the servicers’ processes have
improved enough to satisfy the attorneys general and foreclosure
judges. Further, for some servicers who have not imposed a moratorium
and have indicated that their procedures were correct, in some cases
evidence has emerged that calls into question the procedures of even
these “compliant” servicers.
The attorneys general, who have yet to conclude
their review, are rightly concerned over the possibility that
streamlined foreclosure processes either 1) resulted in some
foreclosures that shouldn’t have occurred (though we expect this is
rare) or 2) didn’t give borrowers an adequate chance to resolve their
mortgage payment difficulties (e.g., via a loan modification or other
resolution). However, we don’t believe the attorneys general want to
see permanent gridlock in the
REO (Real Estate Owned – i.e., foreclosed homes) housing market; after
all, many voters buy foreclosed homes and most voters don’t like seeing
empty homes blighting their neighborhoods and failing to contribute
property taxes.
Most Likely Overall Impact Is Moderate
At this point it doesn’t appear the legal right
to foreclose will be severely impaired across a large number of
mortgages, nor will the ability to foreclose likely be subject to
massive or terminal delays. Rather, thus far it appears that servicers
will ultimately be able to execute foreclosures on the overwhelming
majority of mortgages. Most of the problems and flawed procedures, in
short, appear to be fixable, and in our base case scenario we see the
long-term impact on housing prices and RMBS as likely to be moderate.
That said, robogate and its fallout do have
several implications for investors. First, the servicers will be
affected by 1) higher costs (in both the short term, as the backlog is
cleared, and the long term, as staffing needs to be stepped up) and 2)
potential legal liability, as the various infractions may result in
legal action on the part of borrowers or the attorneys general. Second,
potential gridlock in the housing market and further delays in
resolving the housing overhang do pose the risk of an adverse impact on
home prices in the longer term, though the short-term effect could be
positive as distressed supply is pulled from and kept off the market.
Third, RMBS investors will likely be affected as delayed liquidations
result in longer duration and higher losses (due to greater costs,
resulting from the longer timelines). On the other hand, credit IO RMBS
will likely benefit, as the IO (interest only) period will last longer,
thereby increasing the value of the interest component of their cash
flows (a credit IO is a bond that is impaired to the degree that no
principal is expected to be received and the only value is remaining
interest payments). Fourth, we note the foreclosure delay’s impact will
depend on the bond structure, since structural nuances vary across and
within deals.
The final implication for investors is very
difficult to quantify: If borrowers know they have a reasonable basis
to legally contest the foreclosure, the recent revelations may embolden
many more borrowers to do so. Even borrowers who know they can’t afford
the home may choose to contest foreclosure if it increases the free
rent period or if they have hope of improving their financial situation
during the prolonged delay. Borrowers may cite an array of reasons to
contest foreclosure: affidavit irregularities, lost notes, improper
standing to foreclose, misapplied payments, incorrect ARM calculations,
excessive delinquency-related expenses (late fees, inspections, force
placed insurance), failure to offer a loan modification (which is
required in some jurisdictions), or problems associated with the
origination of the loan. In most cases, we believe delay will be the
worst outcome from an investor’s perspective. We believe most
title/note mortgage assignment issues appear to be fixable (at some
time and expense), and more to the point, while some borrowers will
challenge and successfully avoid foreclosure, most borrowers who
challenge are likely only delaying the inevitable (as most such
borrowers simply can’t afford the home). Nevertheless, it’s another
area of uncertainty.
And on a positive note, we have no doubt that
some borrowers were rushed to foreclosure when in fact they may have
had a legitimate ability to pay, and to the extent the foreclosure
timeout can save additional borrowers, that is clearly a good thing.
In PIMCO Advisory, we’re accounting for the
impact of foreclosure freezes on RMBS prices by running delays ranging
from three to 12 months across base case and stress scenarios; the
values of the bonds generally don’t change more than a few points in
the more extreme scenarios. In addition to longer foreclosure
timelines, we are assuming higher loss severity because servicers will
need to advance more delinquent interest while the foreclosure is
pending. One element that is difficult to quantify is whether servicers
will incur substantially more fees that may in turn be passed along to
RMBS investors, thereby adding to loss severity. Though some expenses
will likely be borne by investors, at this point we’re not assuming
much additional loss severity other than that strictly from the
extended timelines.
Further, it’s not clear at this point whether the
delay should only be applied to current foreclosures or whether
foreclosure timelines will become permanently longer as servicers and
courthouses now take longer to process each foreclosure. We are
currently applying our lags to the existing foreclosure and REO
pipeline, while leaving our process for current loans unchanged.
Assuming servicers increase staff to clear the backlog and adequately
fix their procedures, we believe it’s reasonable to assume that
foreclosure timelines will revert to pre-robogate levels (which already
reflected lengthened timelines).
Less Likely but More Dire Consequences Are Possible
Following the foreclosure moratorium, market
participants raised two issues that would theoretically have far more
dire consequences for RMBS investors in particular and the mortgage
market in general. Thus far, the likelihood of either of these
worst-case scenarios appears remote, but they are worth considering.
- Corrupted title:
Some have speculated that the legal transfer of the mortgages to the
trust has been so flawed that investors in RMBS face the risk that they
don’t even have good title (i.e., ownership) of the mortgages. As a
result, servicers potentially would have no legal standing to
foreclose. A mortgage that doesn’t allow the holder to foreclose and
take title to the property and doesn’t permit the lender to enforce the
borrower’s obligation to pay is worth no more than kindlin’ wood, as
the saying goes. Thus far – despite a couple of sensational stories –
we don’t believe “kindlin’ wood” mortgages are widespread. Yes, there
was the story of the eight-year foreclosure and the foreclosure on the
homeowner who didn’t have a mortgage, but stories don’t equal
statistics. Not that we should dismiss all these stories just yet,
either; after all, mortgage origination horror stories turned out to be
the rule rather than the exception. If new information reveals far more
severe impairment in the note (obligation to pay) or the mortgage (the
lien on the property), things could get a whole lot worse for RMBS
investors (as well as other mortgage holders and guarantors, such as
Fannie and Freddie), but at this point the more extreme outcomes don’t
appear to be in the cards. However, the situation is fluid and we
continue to consult with attorneys and are actively evaluating the risk
of material impairment in the ownership of mortgages.
Relatedly,
some have questioned the role of MERS (Mortgage Electronic Registration
Systems), an electronic registry in whose name more than half of all
mortgages are registered. MERS was established to streamline the
process of mortgage assignments by having the mortgage assigned in
MERS’ name so that any time an ownership interest was transferred,
sellers could avoid the costly county recording process. Some are
arguing that MERS doesn’t have standing to foreclose (and indeed some
states have ruled thusly) and therefore foreclosures in its name are
invalid. Though this may pose a risk, our understanding is that the
cure for the MERS problem is simply to assign the mortgage to an entity
that does have legal standing to foreclose (e.g., the RMBS trustee).
Therefore, we believe that the MERS issue may result in further delays
to the foreclosure process, but not permanent foreclosure freezes or
impairments. - Tax issues relating to RMBS issuance entities:
RMBS are generally issued by an entity called a Real Estate Mortgage
Investment Conduit (REMIC) that is exempt from federal taxes at the
entity level provided it satisfies certain requirements. Broadly
speaking, REMIC rules provide that a REMIC has three months to acquire
its initial assets and two years to substitute a new mortgage loan for
a defective one. Some have argued that assigning the note for the
mortgage loan so long after closing would run afoul of REMIC rules,
which could subject RMBS deals to adverse tax consequences. However,
nothing that we have seen so far would validate this concern, and
opinions published by securitization attorneys recently give very
little credence to the REMIC tax risks. (For example, see SNR Denton’s
“Commentary on Transfers of Mortgage Loans to RMBS Securitization
Trusts,” October 18, 2010, www.snrdenton.com.)
I generally agree with yoru statement, all the tricks the FED did to print hosuing dollars are done now, now people have to bring real money, and that means wages. However I disagree with statement "businesses competing with foreign wages CANNOT pay higher wages to American workers". Businesses overpay their CEOs and upper management all the time (boards are made up of cronies, not directors working in best interest of stockowners) and big US businesses are generally making high profits and have record cash reserves. So businesses CAN afford to pay workers high wages, but rather, they simply WON'T because they do not have to (no laws, unions etc to force them) and the WON'T because unlike the waste of over-priced salaries at high-end of coroporate ladders, business are not so stupid and wasteful and low-end and they keep low and middle workers wages as low as they can or they outsource.
But just so you know in real world there is an alternative ( not one you will ever see in US due to our politics and people assumptions like yours) look at Germany. They are an exporting machine. Their companies are very competitive in world market AND their worker wages and benefits are much higher than US. They have higher horuly salaries, their workers get 6 weeks vacation from get go, etc.. Also, they are fairly heavily regulated, their companies are held to high safety standards, high worker fairness standards, and tough environmental standards and also their companies do a lot with expensive alternative energy.
So in my mind there are at least two ways to for a countries companies to be competitve on world market, China or Germany, the only option is NOT China and depressed wages and weak currency.
Again and again, I see smart people assuming we must just do a China to compete, low wages, weak currency, trash the environment, peel back regulations that keep workers safe and keep work place fair. Its like Germany's example does not enter our consciousness. No way we can have a strong social safety net, treat enviroment well, have a strong currency, pay workers well, regulate businesses to ensure fairness and still compete, pay not attention to Germany.
It may not be easy for US to replicate what is working for Germany, primarily simply because most in US media and culture has it so we don't even know it that at least one coutnry is already proven it is possible, but it is crazy not to at least look at what they are doing and see if maybe we could strive for something closer to them. Germany competes and grows and German workers benefit. Germans model is very good for the common wealth, and yet, all we can fixate on is China.
We see same phenomen in business. There are some companies that are very successful and treat their workers much better than average, while other companies see their only way to success is to treat low end workers as badly as possible and to overcompensate upper management. See simply Costco vs. Sam's club.
Stop self-limiting, we can be a globally competitive country and have a solid middle class and have clean air and water, safe workplaces. But we won't if we let crony upper management of US companies decide everything in their interest, because clearly, sh%^ting on workers and over-compensating themselves and their friends, corrupting our government for their purposes is what they will keep doing unless we fight for something better.
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