We need to understand that government intervention in the mortgage market, not the banks, caused this mess. Goes back to WWII and the New Deal. So really if you want to blame anyone, start with FDR and the Democratic Congress of the 1930s and work forward.
The U.S. banking industry is entering a new period of crisis where operating costs are rising dramatically due to foreclosures and defaults. We are less than one-fourth of the way through the foreclosure process. Laurie Goodman of Amherst Securities predicts that 1 in 5 mortgages could go into foreclosure without radical action.
JR: This will definitely create uncertainty to go along with all of the uncertainty we have already about taxes, financial rule making, cap-and-trade, currency policy and the rest. That's important because while monetary policy may have caused the Great Depression, regime uncertainty is what kept it going so long and we're in that mode again.
Home buyers looking to buy out of foreclosures will step back from the market. Mortgagors considering strategic default will see less risk in doing so, thus leading to more defaults. Potential buyers of servicing rights will back off. Ditto for bulk purchasers of non-performing residential portfolios. Forecasting bank earnings and therefore stock prices and the market as a whole just got much more difficult. Throw in the lawyers and the politicians and it's a perfect storm of uncertainty, gridlock and wealth destruction. Just what we don't need right now.
LL: Should there be a national foreclosure moretorium?
CW: No. Moratoriums do not change the reality facing the banks, only makes it worse via delay. Banks should be aggressively refinancing performing borrowers and short-selling or renting to marginal borrowers. The President needs to start to make this a priority.
JR: No. The situation is definitely a mess, but one way to make it more of a mess is to impose top down government solutions which will just be one more step on the ideological road to redefining housing as a human rights entitlement and nationalizing the entire process from origination to servicing to foreclosure. The banks made this mess but they also have the strongest incentive to fix it so let them do so without government intervention. We have enough government interference already.
LL: This is halting the foreclosure market. Buyers are on hold, how will this effect the housing recovery?
CW: The Obama Administration is making the problem worse. If you were a title insurer, would you be writing new risk on mortgages today? In this environment? No. But the irony is that before we are done, the states will be enacting mortgage moratoria and the federal government will be powerless to stop it — as in the 1930s.
JR: What recovery? We are nowhere near the bottom. We will not hit bottom until markets clear. That will not happen until we reimpose some mark-to-market discipline and shut down more banks and let private buyers price the portfolios at market levels. None of that is happening and a moratorium on foreclosure just delays the process further and therefore prolongs the Depression.
LL: You both called the Tsunami two weeks ago in this column. Is it arriving faster or right on schedule?
JR: Good question. It's a slow-mo Tsunami. That's scarier because instead of sudden damage and a quick recovery you get to stare at the coming cataclysm for a long time and, like deer frozen in the headlights, the politicians and bankers don't know how to react.
Maybe volcano is a better metaphor; it builds pressure over long periods of time and sends off signals but still erupts suddenly and violently causing massive damage and catching many unaware. The point is, we are nowhere near the bottom on home prices, commercial real estate prices, currency collapses, etc. and the worst is yet to come over the course of 2011 and 2012.
CW: No, like all tsunami, it builds slowly and with terrible predictability.
LL: How much more damage could a moratorium have on the economy?
JR: Plenty. To put it differently, the principal losses on the mortgages are already baked in the pie and have been since 2006 because the entire structure was overleveraged, nonsustainable and bound to fall. Once that devleveraging process begins, there's no stopping it until every misallocated dollar of malinvestment has been destroyed.
The issue is how long does this take and are there collateral costs? Policy, in general, can prolong the process but at very high cost. Some of the unnecessary (as opposed to necessary) costs of the mortgage foreclosure moratorium are (a) encourage and subsidize more defaults, (b) bleed the mortgage servicers dry, (c) impose damage claims from class action lawyers on top of the base costs of foreclosure.
LL: How much more damage could a moratorium have on the banks?
CW: In a way the moratorium is good because it will accelerate the problems at Bank of America , Wells Fargo , JP Morgan and the GSEs. It will force the government to embrace restructuring, which will probably involve a good bank/bad bank model a la the RTC in the 1980s. Bond holders will be haircut and equity will be wiped out. But this is the start of a true solution. There is no free lunch Lori.
JR: In general, negative cash flow in servicers, greater loan losses (foreclosures do not get better with age) and more strategic defaults (because this will seem like a progressively more attractive option to borrowers on the knife edge).
LL: Could this create a double dip?
CW: Already has.
JR: Well, in my view everything since 2007 has been one continuous Depression so I don't really think about double-dips. Market rallies in 2009 were to be expected after you print $1Trillion and hand it out on street corners. But what's your second act? Another $1Trillion hot off the press? I don't think so.
LL: The whole housing contract system looks like it has broken down. Are the tentaciles reaching further out now?
CW: Well, not the housing contract system is fine for borrowers and lenders. The concept of a “good sale” of a mortgage is in shambles, this the private MBS market is probably going to be dead for a generation. This is bad for Wall Street, but good for America because the model of community banks funding mortgages is far more stable. We are going back to a model where lenders finance mortgages where they can see the collateral. This will turn houses back into a form of forced savings and not speculative vehicles.
JR: As Dick Cheney would say, Big Time. From the immediate impact on bank earnings, this will spread out to effect home builders, construction jobs, non-durable goods, municipal finance (because of eroding grand lists), etc. etc.
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A Senior Talent Producer at CNBC, and author of "Thriving in the New Economy:Lessons from Today's Top Business Minds."