You have to wonder about the ramifications of the mortgage foreclosure problems that have come to light in the last few weeks.
Last week it was widely reported that JP Morgan was suspending foreclosure on 56,000 mortgages due to improperly prepared documents.
This news comes after reports surfaced that GMAC was suspending foreclosure on an undisclosed number of mortgages a week earlier.
In the wake of two large players suspending foreclosure proceedings, doubtless other large financial institutions are now reviewing their own procedures. The probability of procedural flaws at other institutions can only be guessed at — but it certainly seems possible that other overwhelmed lenders, faced with a rising tide of foreclosure volume, may have resorted to similar procedural tactics to expedite their documentation process. Which should lead us to wonder on the foreclosure suspension front: Who’s next?
So far, most of the early coverage of foreclosure suspension has been positive. On Friday, The New York Times Dealbook ran a story citing several potential benefits of foreclosure suspension, among them that “Stricken neighborhoods across the country, for example, could benefit [from foreclosure suspension].”
The idea being this: that halting an upcoming wave of foreclosure might help to support housing prices and avert the wrenching effects of eviction for untold numbers of families. While the trauma of foreclosure on a personal level cannot be lightly dismissed, what are the potential consequences of a large scale mortgage foreclosure suspension?
Litigation exposure to the banks seems an obvious place to begin. So far, there has been little early coverage of the potential legal ramifications banks may face in light of these revelations — or the attendant financial risks that bank shareholders may bear as a consequence.
This much seems almost certain: When a firm with the deep pockets of J.P. Morgan essentially issues a mea culpa on tens of thousands of foreclosures, legions of trial lawyers must be champing at the bit to file suit against them — as well as any other financial institution they can paint with that same brush.
Think about it: How scary must things have been before JPM & GMAC attorneys managed to persuade senior management to abandon foreclosure processing? It seems likely that there would have been a fairly strong natural bias in favor of continuing foreclosures — liquidating assets in an attempt to stem the tide of mortgage losses — and yet decision makers were persuaded that abandoning the process was actually the lesser of evils.
In short, we may be looking at the next big wave of class action law suits against major financial institutions.
And if there are allegations of redlining or other types of discrimination, the ugliness will only increase. It has already been speculated by analysts that minority home owners were disproportionately targeted by banks with predatory lending practices.
If, for example, it comes to light that banks disproportionately foreclosed on economically disadvantage home owners, because those homeowners would have been less likely to have the resources necessary to prolong the foreclosure process, a new and unpleasant dimension is added to the mix.
Furthermore, with the possibility of a tidal wave of impending litigation and unpleasant PR looming ahead for the banks can an SEC investigation of the foreclosure process be far behind?
And of course there is the direct impact to bank balance sheets in the wake of a foreclosure suspension.
Financial institutions who suspend foreclosures are essentially forced to continue to hold non-performing loans on their books. Unable to exercise their legal rights to liquidate underlying assets, banks would appear to remain unable to cut their losses and take a onetime write down — instead continuing to accrue losses quarter after quarter as homeowners fail to make payments on bad mortgages. And, to add to the murkiness, it would seem likely that banks would be forced to continue to carry highly illiquid assets on their balance sheets, making accurate valuation of their portfolios more difficult.
It would also seem prudent to wonder about the implications to new lending. If banks aren’t able to liquidate bad mortgages through foreclosure, a pool of capital that could otherwise have been used to create new loans dries up.
Furthermore, from a risk management perspective, banks may be more hesitant to make new loans, even if the capital were available to do so, due to skepticism over their future ability to liquidate assets in the event that some of the new loans run into trouble down the road.
On the macroeconomic front, a healthy skepticism about the benefits of foreclosure suspension may remain the best default position. Optimism regarding the benefits of foreclosure suspension, of the type alluded to in the NYT Dealbook article, could prove unfounded. (Namely, the hope that limiting foreclosures may stabilize housing prices by preventing a glut of fresh supply from newly coming online in the housing market.)
Fundamentally, we are left with this question: If the volume of foreclosures remains too high to be processed by banks through their ordinary procedures, and the expedited procedures remain unworkable, where does that leave banks’ ability to exit bad loans? And what effect will those changes have to the overall structure of the housing and lending markets?
It is possible that large scale prevention of foreclosures may alter the supply of housing, manipulating pricing in the residential housing market, which could materially distort the ways in which buyers, sellers, and lenders come together. This may prevent markets from clearing as they ordinarily would — potentially prolonging the pain of the crisis. Furthermore, it seems difficult to speculate about the unintended second and third order effects of broadening suspensions at this time.
It seems reasonable to entertain concerns about the ultimate consequences of the suspension of a mechanism intended to lessen risk to lenders. Major changes to the rules of the road governing housing lending remain at best an unknown quantity with regard to their impact on the overall marketplace — especially the significant diminution of a corner stone of lending such as the mortgage foreclosure process.
Intervention in markets, even with the most altruistic of intentions, often creates a cascade of unintended consequences.
In short, the recent development of mortgage foreclosure suspension may add to the uncertainty surrounding the already shaky U.S. housing market.
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