Is the US Government About to Forgive Mortgage Debt? Let’s Crowdsource Our Way Through a Scenario or Two!

Note: This is a long post, so I have bifurcated it - placing part two with the heavy graphics and the financial stuff on by blog. The intro and legal theory suggested by readers is here in part one. I would suggest one read it in its entirety before dismissing any one part of it, though.

Is it possible for the US Government to choose to forgive mortgage
debt? Sounds outrageous? Read on for the legal theory behind this claim
and let me know what you think? I thought it was little esoteric as
well, but as I looked deeper… Well, I’ll let you be the judge.

A lot of attention accrued to Representative Grayson’s calling out of
foreclosure fraud, and for good reason. The story is absolutely
amazing, and kudos to a member of congress that defends his
constituency.

It’s not as if other entities have failed to take notice. ZeroHedge has its usual witty commentary regarding the possibility of foreclosure transactions potentially being unwound due to fraudulent foreclosure activity. The NYT
ran an article stating that Fitch will look into lowering the credit
rating of companies that participated in the submission of inappropriate
foreclosure paperwork, which apparently seems to include an awful lot
of companies. It goes on to state (as excerpted by Zerohedge):

Fitch Ratings said that Wednesday
it was asking mortgage companies about their internal processes for
executing foreclosure affidavits. If it finds the processes lacking,
Fitch will consider downgrading the company’s rating.

The agency also said if the
issue is widespread, the resulting delays and extra costs to
foreclose could increase losses related to residential mortgage-backed
securities.

Here’s the twist. A lawyer who happens to have
followed my writings over the years has suggested that most are missing
the big picture in focusing on fraudulent foreclosure documents. He
contends (and I’m paraphrasing here, these are not my words, per se) “that
since the U.S. has ownership interest in many (if not most) delinquent
and distressed mortgages, this fact will be counted as policy in
litigation. As a consequence it matters A LOT if you can
say that your client has a Fifth Amendment Due Process right (or third
party beneficiary Federal common law right) to a HAMP modification
which is in FACT a minimization of the risk of default (not that flaky
31% number) BECAUSE, among other things, the U.S. has no economic
incentive to foreclose”. Now, I am no lawyer and thus the legal
issues are beyond my domain, but I must admit I found the theory
interesting. So, I’ve decided to crowdsource this one in anticipation
that some of the more astute legal minds can shed some light on the
validity of the theory. I’ll supply the financial stuff in this post,
and I’ll rely on the legal eagles to peer review the theory.

This all stemmed from a chart and “what if”
scenario I post on the 23rd of September in which showed the increasing
decline in recoveries from gross charge-offs from banks.

As a matter of fact, things are so
bad that I believe banks will have a perverse incentive to actually
walk away. Now wouldn’t that be something??? Next, we take a look into
the home builder that makes more money doing distressed investing
than it does building and selling homes.

The legal argument from the BoomBustBlogger in question is as follows:

Things are
moving pretty fast now, especially since so many states are moving to
ban home foreclosures, and since your comments on the lack of economic
incentive to foreclose is coming to the fore. It’s becoming
a question of, Hey Uncle Sam, what is your policy?  This may result in
actions to quiet title, against the banks and the United States. The basis will be that in fact, the United States has forgiven home mortgage indebtedness. Your own observation of the economics of foreclosure is part of the mix. But the entire argument that the U.S., has in FACT (no matter what it CLAIMS) forgiven home mortgage indebtedness, is this:

Through its

1. ownership
stake in banks (creating Fifth Amendment Due Process rights to what is
in FACT–not the arbitrary 31%–minimization of the risk of housing loss:
see Huxtable v. Geithner Order on this (not the Order to Dismiss, sounds
like a settlement was reached since Huxtable filed no opposition); 2.
contracts with servicers (creating third party contract rights in
borrowers–see Marques v. Wells Fargo); 3. mortgage principal reduction; 4. adjustments to gross income for principal reduction; and 5. loss of economic incentive to foreclose,

the United States has in fact forgiven home mortgage indebtedness.

And here is more on the topic…

The
big divide in the United States District Courts, with regard to HAMP,
is the language of HAMP which seems to give the Government discretion as
to whether to modify or not.  Here is typical language from a court
decision saying there is no right to a modification:

“Notably, the statute provides that loans may be modified “where
appropriate” – a phrase that limits the Secretary’s obligation and
evinces a Congressional intent to afford discretion in the decision
whether to modify loans in certain circumstances.”

The way
to defeat this (as was done in Huxtable v. Geithner, before the case was
settled or abandoned) is to show FACTS which demonstrate that the
Government is actually enforcing a different policy.  In that case, it
doesn’t matter what the enabling language says, what decides the policy
is what the government is DOING.  What OTHER facts show that the
Government is pursuing this different policy?  That is where your
observation comes in.

One of
those facts is the factual conclusions the government ITSELF has come
to.  What has it really concluded in the secret, back rooms?

This is
why I was interested in your analysis of the returns on taking title to
defaulting properties (the link being the Government ownership stake in
these properties).  If the Government ITSELF has decided there is no
further economic incentive to foreclose, then its policy can ONLY be to
prevent foreclosures, because economics shows no facts in favor of going
forward with foreclosing and taking title.  Government policy must be
based on facts–if it is not, then the policy is simply prejudice, and
the courts will not uphold factless prejudice.  It’s a matter of
determining what policy the Government is pursuing, as a process of
eliminating all  those policy options for which there is no factual
basis.  Weeding out one prejudice after another.  One such prejudice, I
submit, is the idea that there is an economic incentive for the
Government NOT to grant HAMP modification.  If there is no economic
incentive to foreclose, then this supposed economic incentive is
revealed to be a prejudice, and unenforceable.  A right to HAMP
modification follows as a matter of elimination of other options.

That is
where you come in.  It would greatly help if, on your site, you would
give an estimate of the month/year on which the data clearly show that
the economic incentive to foreclose is ZERO.  Once it became clear that
the U.S. had no further economic incentive to foreclose, it would be
very clear that the U.S. has in FACT forgiven home mortgage debt.  That
is what zero incentive to foreclose, means.  It means that, in FACT, the
debt has been forgiven.

I get
the feeling that, privately, the U.S. is racing ahead based on this
knowledge.  I would not be at all surprised to see Obama simply ban home
foreclosures nationwide. 
But we are still in limbo, because there is still this notion that
robo-affidavits are the only problem with foreclosure documents, and
once that is “cleared up” it’s full speed ahead with foreclosures.

That
is certainly not the case, and people need to realize that that is not
the case.  Above all, their lawyers need more ammo, and the best ammo
would be a detailed examination of the rapidly declining economic
incentive to foreclose.

By the
way, if you assume that the Government already knows we are fast
approaching zero incentive to take title, what signs tell you that the
Government is already acting on the idea that there is zero incentive to
take title?  That is, what actions of the U.S. Government tell you that
it has in FACT forgiven home mortgage debt, that it has ALREADY written
it all off as a loss, and is now acting in the AFTERMATH of that
writeoff.  Because I think that’s where we are.  The United States is
ahead of ALL of us on this.  They know how bad.  What I’m asking you is,
where is evidence that they know there is nothing to be gained from
foreclosure, and have moved ahead and have IMPLEMENTED that conclusion?

So if you
could deal with that in some big public way, that would be best… That
would attract the attention of every lawyer, judge and investor in the
country–it would immediately resolve every legal question surrounding
home foreclosures, and it would provide an opportunity to get more of
the truth into court cases.  Even from the analysis you provided on
9/23, it is clear to me that it’s game over for home mortgages.  They
are simply not a part of the economy any more–they’re social policy and
the U.S. is dealing with them as social policy: but what IS the
Government’s new policy?  Well, what do the FACTS show it is?

Since you’re not a lawyer, you greatly underestimate the importance of this observation. When the United States has a stake in a matter, facts relating to that matter are imputed to it as United States POLICY.

Well, he’s right. I am not a lawyer. Actually
far from it, but it does appear he is on to some creative legal theory. I
invite any and all competent legal type to weigh in on this. There is
even more on this topic, which at first sounds a bit far fetched, but
actually congeals into a cogent argument as you read on…

It is a BIG mistake to read this as just a matter of cleaning up a few documents. These phony affidavits [as referenced above]
were part of an effort to hide bad debt on banks’ books. It is also
hiding something else, which is that the United States has forgiven home
mortgage indebtedness. Look:

1. ownership
stake in banks (creating Fifth Amendment Due Process rights to what is
in FACT–not the arbitrary 31%–minimization of the risk of housing
loss(on this prong, please see online the Huxtable v. Geithner Order
(not the Order to Dismiss–sounds like a settlement was reached since
Huxtable filed no opposition). The reasoning of Huxtable is sound and is
pretty generally accepted now. There IS a Fifth Amendment Due Process
right based on U.S. ownership of banks, and this Due Process right is a
right to a modification based on what is in FACT the minimization of
risk of default–this means that the 31% is simply the Government’s
assertion on this point–it is LITIGABLE;

2. contracts
with servicers (creating the same rights as above, but on a third party
beneficiary theory–see Marques v. Wells Fargo–online). The reasoning of
Judge Lorenz is also sound and is simply another basis for claiming a
factual minimization of the risk of default, rather than simply
accepting the Government’s 31%. Again, the 31% is going to be litigated.
People have to get used to that–it’s not off limits anymore;

3. mortgage principal reduction through HAMP;

4. adjustments to gross income for principal reduction through HAMP; and

5. loss of
economic incentive to foreclose (this is Reggie Middleton’s analysis on
his blog). The Middleton analysis is new (it’s at www.boombustblog.com, the September 23 story on housing prices). The return/chargeoff is rapidly hitting 0.

Litigants in
HAMP will certainly have the right to civil discovery as to what the
United States has concluded with respect to the economics of
foreclosure.

It will
probably turn out to be just what the facts show: that the policy is in
FACT to minimize the risk of default because there is no economic
incentive to foreclose.

Of course this
seems impossible, unacceptable, blah blah blah. But if the economic
facts bear it out, then the economic facts bear it out and you just have
to wrap your head around it. What will happen next/is happening now:

1. litigants
will sue to quiet title (among other causes of action such as fraud,
conspiracy, Civil Rights violations, etc., naming Tiny Tim, the IRS
commissioner and the United States, among others); and

2. the U.S. is
scrambling right now to decide what to do if people who have a gazillion
dollars and are sitting in a house which is soaring in value,
nevertheless decide to simply stop paying on their mortgages.

Of course, the
first instinct of Uncle Sam will be some sort of coercion. When that
fails in court, the next gambit will be to try to provide some incentive
to people to keep paying those damned mortgages. Who knows how this
will end?

In any event,
it’s Reggie Middleton’s analysis which broke the back of this. Indeed,
I’m sure his analysis was already made in the dark of night at the
Treasury Department.

The following charts of charge-off recoveries was sourced from the subscription document available to all Paying Subscribers (any who are interested in this extensive data set and analysis can subscribe here): Historical Bank Charge-offs and Recoveries 2Q10. There is also a more comprehensive mortgage, loss, demographic and credit template that was used in the original US (Don’t) Stress (US) tests, otherwise known as SCAP . We have taken the liberty to update the template on a periodic basis for the government, since it appears they are not forcing the banks to do so , and it is available here: SCAP Assumptions Updated_09082010 Web Version. This model shows a weakness in the Case Shiller method of following prices (which I will illustrate in graphic detail at 4:30 pm on Bloomberg TV and in my blog later on today) in that the CS doesn’t include investment properties (usually the first to go into foreclosure), new construction, and REOs. As a matter of fact, Case Shiller actually looked slightly rosy as of late  compared to the facts on the ground (see Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading!).

That’s been the
entire tendency of this mortgage mess: to separate out what is in FACT
the policy of the U.S., as opposed to what the U.S. SAYS its policy is.
If you believe the latter, you don’t get your day in court. But if you
assert the facts in court, then your house is free.

As this
unrolls, it will sink the dollar. This will entirely change rights in
housing in the United States. Among other things, it means that Lindsey
v. Normet minimum scrutiny for housing is out the window, because the
United States’ policy is a higher level of scrutiny for housing.

Of course, all of this prompted me to look a bit deeper into the
economics of foreclosure from the lender’s perspective in the near to
intermediate future. For those thatdon’t know, the US is the owner or at
least underwriter of risk for the biggest lenders in the country. We
outright own Fannie and Freddie, who process the bulk of conforming
mortgages, and we underwote  the risk of Bear Stearn’s rotting assets
directly as a condition of their sale to Jamie Dimon/JP Morgan as well
as partial ownership of Citi and AIG and the underwriting of untold risk
through Fannie and Freddie insurance programs. There is no telling how
much is underwritten indirectly. For a hint, see More Doom and Gloom: Homebuilders Making Better Money as Hedge Funds than Home Builders as well as Reggie Middleton’s Overview of the Public-Private Investment Program and I’m headed back to DC, with blogger’s opinions in hand! for examples of the government giving out 0%, non-recourse loans to buy failed assets.

This is the chart that originally sparked the conversation. It is a
rough chart that is annual and encompasses several loan categories.

So, I decided to dig back in and make the charts more granular in
both loan categories (concentrating on residential housing, as per the
legal theory above) and the time periods in question. As you can see,
the charge-offs on 1-4 family residential housing skyrocketed nearly
1,500% (yes, that is a lot) from the bursting of the bubble in '06.

Both recoveries have increased and the charge-offs decrease, giving
us an increase in recovery rates over the last two quarters though. Now,
before we get all giddy about the improvement in the credit situation
in residential real estate finance and blow out all of our provisions,
let’s take a more careful look at the chart. For one, although the
recoveries have increased very slightly, it is the drop in the
charge-offs that has served to boost the recovery rate. So, that leads
us to ask “What has changed so positively in the market to cause such a
drop in charge-offs?” Well, for one the Case Shiller Index has shown a
rise in prices. Of course, BoomBustBloggers don’t really go for that,
because the Case Shiller Index rise fails to capture many of the
elements that are causing aggregate housing values sold to fall on an
economic basis. See Why the Case Shiller Index, Although Showing Another Downturn Coming, is Overly Optimistic and Quite Misleading! then reference this chart below.

Those who are interested in reading the rest of this article can find it in its entirety on BoomBustBlog.com, here.

Comments

[MachoMan]

they already did take your money to keep people in their unearned mcmansions...  so, time to start fighting buddy.

[Voodoo Economics]

GAME ON!

OOH!!-RAH!!

[Bolweevil]

Who gets the sharp end Voodoo? Your neighbor who is a lemming and could or could not be conscious of their crappy foresight/moral hazard? (Insert despised authority or department here)? WallStreeters? Rioters (Greek, Spanish, Ecuadorian Cops) with whom you don't agree? The guy that rhymes with Hairy Spitholtz? 

[Voodoo Economics]

Solution: 

1) Anyone with a mortgage plus HELOC (total debt) payments that was more than 3x their actual (none of the "stated" bs) income at time of purchase and is getting foreclosed, they are to be exported to Afganistan.

        When they save enough $ for a real down payment 20+ percent, they can then apply to return to US soil.

2) Anyone who gave a mortgage to someone who met the conditions in 1 goes to Afganistan.

3) Anyone who worked for a company that got bailout funds goes to Afganistan.

4) Any politician that was on the Finance or Banking committees since 2001 goes to Afganistan (Front line combat position)

5) Any current or fomrer US military personnel who saw combat action gets a foreclosed home Free! Banks reset values to $0.00.

6) Anyone who was in any military position and subject to the UCMJ gets a foreclosed home for no more than 40% of mortgage + encumberances.

The economic HEAD (banking sector) will then be flushed, cleaned and rinsed!

Moral hazard averted!

[RockyRacoon]

Do keep us updated on your exploits.  Let us know how your first altercation turns out.

[Maos Dog]

So, I guess I should have went all-out and bought that 5,000 sq ft McMansion in Coral Springs, instead of a big piece of swampland in the everglades? Bummer...

[Skeebo]

Yeah... right up until their deadbeat neighbor down the block who had his 2 story 3,000  sqft home given to him drives home in his new Porsche while his kid is in the back seat crying on their way to the vet to put down the family dog and he's wondering how he's going to pay for his kid's braces, etc.

The ones that played by the rules and fight tooth and nail to get by are the most dangerous ones to be fucking with.

[Mariposa de Oro]

"The ones that played by the rules and fight tooth and nail to get by are the most dangerous ones to be fucking with."

Beware the wrath of a rule following man (or woman).

[max2205]

Next. Free rent for all yeah!!

[Millivanilli]

Then those MOTHER FUCKERS WILL RAISE MY RENT!  FUCKING MOTHER FUCKERS.

[NoVolumeMeltup]

The fuck, you say.

[Sudden Debt]

Like that will ever happen... It reeks of 100% pure communisme! Kennedy, Jhonson, Reagan,... would all turn in their graves!

[Chartist]

I have been saying for five years now that home ownership went from being the american dream to being the american mandate.

[Let them all fail]

Can someone please explain the zero economic incentive to foreclose?  Thanks.

[Edmon Plume]

See my below comment, a ways down the chain.  The incentive is there with the right houses.  Most of what we think of when we think of foreclosure is a big loan that the bank has to eat.  Yes, but not all.  Some loans are lucrative to foreclose on, and can make big money.

Not sure if this is what you are asking about.