The US foreclosure crisis continues with the “robo-signing” scandal already costing US banks $US50 billion in market value. Six finance providers, including giants Bank of America, Wells Fargo, GMAC Mortgage, JP Morgan Chase, PNC Financial Services Group Inc. and Litton Loan Servicing, are currently reviewing their foreclosure processes with BOA halting foreclosures across all American states. The moves came after it was revealed that the banks had been employing “robo-signers” (who included “hamburger flippers” and people who weren’t able to explain what “personal property” was) to sign-off on foreclosures without verification of the banks’ actual right to foreclose.
This is a very, very big problem and it’s not a good thing for the US housing market.
The ability for a lender to foreclose is critical part of the mortgage process — without the ability to sell the underlying security, the borrowing becomes effectively an unsecured personal loan. The problem for US lenders is that through a chain of securitisations the lending process became so convoluted, as CNBC explained, “many suspect that the reason banks were falsifying their knowledge about the possession of loan documents is that the banks do not actually have the documents and don’t know where to find them. This could permanently impair their ability to foreclose on some properties”.
Therefore, not only did banks lend money to people who didn’t deserve it (by way of liar-loans and adjustable rate mortgages), but they didn’t even bother to even keep tabs on required legal documentation. While in most cases the banks have a moral right to foreclose (if the owner has failed to make necessary mortgage repayments), they may not have the proper assignment documentation required to legally foreclose on the property. This doesn’t excuse the borrower, who due to bad luck, poor management or outright dishonesty, is unable to pay contractual amounts owed to their lender, but it means that the lender is (temporarily) powerless to reclaim the security and sell it to recover some or all of the borrowed funds.
When banks aren’t able to foreclose, this means that they need to charge a far higher interest rate to future borrowers to mitigate their increased risk — or even worse, they can stop lending altogether. Given most house purchases are funded largely through debt, this will have an ever greater negative effect on house prices in the United States.
Peter Schiff, the head of Euro Pacific Capital and one of the few who correctly predicted the housing collapse and global financial crisis in 2006, told Tech Ticker that halting foreclosures would be disastrous for the US economy:
The longer you keep somebody in a house and that person has no equity in that house and knows that its only a matter of time before they have to leave, that person is not going to maintain that property … and real estate, despite what realtors will tell you is a depreciating asset, you have to spend money every year to maintain it … so if we delay the foreclosure process by a couple of years, by the time the banks get the properties they’ve lost that much more value.
Schiff then warned of the perils of owning a home, advice that applies equally in Australia’s fanatical home owning market:
Owning a home is expensive, it’s so much easier to rent because you know what your rent is — it’s fixed, you can’t have a big expense. If the roof leaks, you call the landlord, he fixes it. A lot of people, they have no savings, they’re living paycheck-to-paycheck — how can they be home owners? They shouldn’t be home owners. You have to have a lot of money to be a home owner. You need to be able to afford that ten or twenty thousand dollar expenditure if something goes wrong.
The US housing market appreciated after the 2002 recession largely on the back of easy credit policies of the Federal Reserve — capital was therefore misallocated into “bidding up” the price of housing rather than being invested in productive means.
Not altogether different to what has happened in Australia over the past decade, where a period of historically low interest rates (and government subsidies) has made housing look far more affordable than it really is. Many Australians who shouldn’t have bought a home have done so using mostly borrowed money. Many investors have purchased a second or third property not because of the return achieved, but because they can reduce their tax bill courtesy of property losses.
The US has shown what happens when the price of an asset diverges from its value. Capital is poorly allocated and lenders and equity holders lose large sums. The foreclosure debacle is merely symptom of what happens when an asset market loses all semblance of rationality.