Reuters has a new article, Insight: A new wave of U.S. mortgage trouble threatens, which is simultaneously informative and frustrating. It is informative in that it provides some good detail but it is frustrating in that it depicts a long-standing problem aided and abetted by regulators as new.
When the mortgage mess was a hotter topic than it has been of late, we would write from time to time about the second mortgage time bomb sitting at the major banks, particularly Bank of America. Unlike first mortgages, which were in the overwhelming majority of cases securitized and sold to investors, banks in the overwhelming majority of cases kept second liens (which in pretty much all cases were home equity lines of credit, or HELOCs) on their books).
This arrangement led to tons, and I mean tons, of abuses, which regulators chose to ignore or worse, actively promoted. Second liens, as the name implies, have second priority to first liens. In a bankruptcy or resturcturing, they are to be wiped out entirely before the first lien is touched (“impaired” as they say).
But the banks that had HELOCs on their books were often the servicer of the related first liens. And even though they had a contractual obligation to service those first liens in the interest of the investors, they’d predictably watch out for their own bottom line instead. For instance, if a borrower was deeply underwater, it would make sense to at least partially write down the second. If the borrower was delinquent, the servicer should write off the second and restructure (aka modify) the first mortgage. But instead you’d see banks use their blocking position as second lien holder to obstruct mortgage modifications. Worse, Bill Frey of Greenwich Financial documented that Bank of America had modified subprime mortgages securitized by Countrywide (as in reduced their value) without touching the seconds, a clear abuse (notice that this issue was raised in the BofA mortgage settlement, and bank crony judge Barbara Kapnik looks almost certain to sweep it under the rug).
Regulators played a direct hand in this chicanery. If the regulators had forced the banks to write down HELOCs, banks would have much less incentive to try to wring blood out of the turnip of underwater borrowers (particularly if the regulators had made clear they took a dim view of that sort of thing). But the authorities were far more concerned about preserving the appearance of solvency of the TBTF players.
Another dubious practice that regulators enabled was extend and pretend on HELOCs. Unlike first mortgages, where fixed payments are stipulated, HELOCs didn’t require borrowers to engage in principal amortization until typically ten years after the loan was first made (a minority of loans set the limit at five years). This is not unlike credit cards in the pre-crisis era, where banks were permitted to set the minimum payment so low as to pay interest only (banks are now required to set minimum payments high enough to that the balance would be paid off in 60 months).
If that isn’t bad enough, the banks went one step further. Banks were engaging in negative amortization, as in not even requiring borrowers to pay all the interest charges, which meant they were adding unpaid interest to principal in order to keep the mortgages looking current so as to avoid writing them down. As we wrote in 2011:
The bone of contention is that mortgage servicers, which also happen to units within the biggest US banks, have not been playing nicely at all with stressed borrowers out of an interest in preserving the value of their parent banks’ second liens. And the reason for that is that writing down second liens to anything within hailing distance of reality, given how badly underwater a lot of borrowers in the US are, would blow a very big hole in the equity of major banks and force a revival of the TARP…
Anecdotally, it appears that banks use a very aggressive carrot and stick to keep seconds current. They threaten borrowers with aggressive debt collection on seconds. And on home equity lines, which are the overwhelming majority of second liens (see this spreadsheet courtesy Josh Rosner for details of the results from the five biggest servicers, click to enlarge), negative amortization is kosher.
For data junkies, 1 is Citi, 2 is JPM, 3 is BofA, 4 is Wells and 5 is GMAC
So what does a bank do? On day 89, before the HELOC is about to go delinquent, it tells the borrower to pay anything on it. A trivial payment is treated as keeping the HELOC current. So this explains Eisenger’s question: it’s easy for the Wells of this world to pretend that these second loans are doing fine if you will go through all sorts of hoops to make them look current, including if needed by lending them the money to make part of their interest payment. So even though a lot of commentators argue that it’s hard to argue that banks should write down their seconds if borrowers are current, what “current” really means deserves a lot more scrutiny than it has gotten.
And as Matt Stoller wrote in early 2012:
Over the past three years, the big four servicers have been keeping hundreds of billions of dollars of second mortgages on their books (mostly in the form of Home Equity Lines of Credit, or HELOCs). Many of these mortgages would seem effectively worthless, because a home equity line of credit or second mortgage on top of an already deeply underwater first mortgage has no value. You can’t use it to foreclose, because you’d get nothing out of the foreclosure – all of that would go to the first mortgage holder (usually some investor in a pension fund somewhere). It has only “hostage value”, or the ability to stop a modification or write-down from happening. The best way to clean up this situation is to have the regulators (FDIC, OCC, Federal Reserve) simply tell the banks that they must write down their second mortgages on collateral that has been impaired. That way, the incentive problem goes away. By forcing the bank to recognize the loss now, the bank will no longer stop a modification on a first mortgage. And in fact, the regulators pretty much agreed that this is what their examiners should do, when they issued new rules earlier this year on accounting for second liens.
Only, the regulators haven’t done it, because the banks claim their seconds are performing. Bank of America says that these loans are worth 93 cents on the dollar. Several of the other banks don’t break out their loss reserves for seconds, so it’s hard to tell, but I think it’s clear they aren’t reserving enough. We can tell that because the Federal Reserve itself is dramatically overvaluing these seconds. In a stress test, the Fed said in its worst case scenario that the banks would lose only “$56 billion”. These are low numbers. According to their most recent investor report, Wells Fargo alone has $35 billion of second liens behind first mortgages that are underwater.
So now, after years of denial by banks and enabling by regulators, the second lien chickens are finally coming home to roost. Homeowner advocate Lisa Epstein gives an idea of how bad this looks from the borrower side:
People who’ve owned their homes for decades, never paid a bill late in their life, and got one of these HELOCs in the early to mid 2000s are starting to get seismic shocks in their monthly statements. Monthly bills going from $200 to $1,200 is met with incredulity and confidence that a mortgage servicer mistake has been made until it is clear that they’ve received a rude reminder of something most families have forgotten or never fully realized. Some have been paying interest only for 10 years and a $25,000 balloon is coming due. For most, the only option is to sell if not underwater or to default and try to negotiate a reduction and deal with the IRS 1099 issue if the Mortgage Forgiveness Act expires without extension in a few weeks, risking foreclosure. And, then there’s the question about what to do with the first mortgage if there is one.
But the Reuters piece, while doing a good job of trying to get a handle on the magnitude of this problem, peculiarly plays down they way regulators have given the banks a wink and an nod all these years:
U.S. borrowers are increasingly missing payments on home equity lines of credit they took out during the housing bubble, a trend that could deal another blow to the country’s biggest banks….
More than $221 billion of these loans at the largest banks will hit this mark over the next four years, about 40 percent of the home equity lines of credit now outstanding….The number of borrowers missing payments around the 10-year point can double in their eleventh year, data from consumer credit agency Equifax shows. When the loans go bad, banks can lose an eye-popping 90 cents on the dollar, because a home equity line of credit is usually the second mortgage a borrower has…
The number of borrowers missing payments around the 10-year point can double in their eleventh year, data from consumer credit agency Equifax shows. When the loans go bad, banks can lose an eye-popping 90 cents on the dollar, because a home equity line of credit is usually the second mortgage a borrower has…
For home equity lines of credit made in 2003, missed payments have already started jumping.
Borrowers are delinquent on about 5.6 percent of loans made in 2003 that have hit their 10-year mark, Equifax data show, a figure that the agency estimates could rise to around 6 percent this year. That’s a big jump from 2012, when delinquencies for loans from 2003 were closer to 3 percent.
This scenario will be increasingly common in the coming years: in 2014, borrowers on $29 billion of these loans at the biggest banks will see their monthly payment jump, followed by $53 billion in 2015, $66 billion in 2016, and $73 billion in 2017.
The Reuters story also says that the Office of the Comptroller of the Currency was “warning” about HELOCs in early 2012. Ahem, they were recognized as a big undeplayed risk in the infamous bank stress tests of 2009. And if the OCC was so concerned, why did it then (as now) natter about the need for more data? Why didn’t it just demand it?
Regulators were clearly hoping that the housing market would recover enough to reduce the size of this looming time bomb. But the much-touted housing recovery has been almost entirely due to price appreciation in foreclosed properties. Josh Rosner ascertained that the year-to year median sales price increase in owner-occupied homes was a mere 1%.
Investor appetite for homes has been cooling, in part due to concerns about QE taper, in part due to one of the hoped-for exit strategies, that of turning a portfolio into a REIT and taking it public, looks to be pretty much dead. And reports of bad maintenance and tenant abuses by the kingpin investor in rentals, Blackstone, could also put a pall over the category, even for more responsible operators. So even a bit more uptick in supply due to HELOC-shock sales, short sales, and foreclosures, could put another dent in the faltering housing recovery.
The math of payment shock means the Reuters story is the harbinger of more accounts. I only hope some of them focus on how banks and regulators made matters vastly worse for borrowers through their efforts to save their own hides.
Yves here. While I agree with the general thrust of Ilargi’s argument, some small caveats are in order. First, the idea of progress, which is the foundation of the internalized belief in rising incomes and improving living standards, is a child of the Industrial Revolution. And that is despite the fact that the first generation, in fact, nearly two generations of the Industrial Revolution brought worse living standards for ordinary people in England (see here for details).
Second, we’ve had considerable periods even in the modern era where living standards have stagnated and people didn’t have good reason to be optimistic about the future. Consider the 1920s in England and Europe through the reconstruction after World War II. The UK didn’t get fully off WWII rationing for well more than a decade after the war ended. The US didn’t get whacked by the post Great War malaise, but the period from 1929 to 1945 was no party, and the later half of the 19th century had America going from the Civil War into the Long Depression. So the idea of more or less continuous improvement in living standards is an artifact of the 1980s and 1990s (and a lesser degree the first few years of the new century, although I’d argue that was projecting previous experience onto deteriorating fundamentals) projected backwards (the 1970s were an economically lousy, anxious decade, until you compare it to our current malaise).
By Raúl Ilargi Meijer, editor-in-chief of The Automatic Earth, Cross posted from Automatic Earth
What worries me most about the world today, in the last weeks before Christmas and New Year’s Day 2014, is that all the plans we make for our futures and more importantly our children’s futures are DOA. This is because nobody has a clue what the future will bring, and that’s more than just some general statement. Is the future going to be like the past or present? We really don’t know. But we do exclusively plan for such a future. And that’s not for a lack of warning signs.
One might argue that in the western world over the past 50 years or so, we’ve not only gotten what we hoped and planned for, but we’ve even been to a large extent pleasantly surprised. In a narrow, personal, material sense, at least, we’ve mostly gotten wealthier. And we think this, in one shape or another, will go on into infinity and beyond. With some ups and downs, but still.
While that may be understandable and relatively easy to explain, given the way our brains are structured, it should also provide food for thought. But because of that same structure it very rarely does.
The only future we allow ourselves to think about and plan for is one in which our economies will grow and our lives will be better (i.e. materially richer) than they are now, and our children’s will be even better than ours. If that doesn’t come to be, we will be lost. Completely lost. And so will our children.
The ability of the common (wo)man to think about the consequences of a future that doesn’t include perpetual growth and perpetually improving lives (whatever that may mean), is taken away from her/him on a daily basis by ruling politicians and “successful” businessmen and experts, as well as the media that convey their messages. It’s all the same one-dimensional message all the time, even though we may allow for a distinction between on the one hand proposals, and their authors, that are false flags, in that their true goal is not what is pretended, and on the other hand ones that mean well but accomplish the same goals, just unintended.
This all leads to a nearly complete disconnect from reality, and that is going to hurt us even more that reality itself.
We extrapolate the things we prefer to focus on in today’s world, with our brains geared for optimism, into our expectations for the future. But what we prefer to focus on is, by definition, just an illusion, or at best a partial reality. We don’t KNOW that there will be continuing economic growth, or continuing sufficient energy supplies, or continuing plenty food. Still, it’s all we plan for. Not every single individual, of course, but by far most of us.
The last generation in the western world old enough to live through WWII fully aware, i.e. the last who knew true hardship – as a group -, is now 75 or older. Everyone younger than 70 or so have lived their entire lives through a time of optimism, growth and prosperity. That this could now be over is therefore something the vast majority of them either fail to recognize or refuse to.
They stick to their acquired possessions and wealth, which they view wholly as entitlements, and fail to see even the risk that they can continue to do so only by preying on their children, their children’s children, and the weaker members of the societies they live in. That notion may be tough to understand, even tougher to process mentally, and for that reason provoke a lot of resistance and denial, no doubt about it, but that doesn’t make it less true. The more wealth you want to retire with, the less your children and grandchildren will have to retire with, and even to live on prior to retirement. That is because there is a solid chance that the pie is simply no longer getting bigger.
As societies we must find a way to deal with these issues as best we can, or our societies will implode. If trends from the immediate past continue, then, when the entire baby boomer generation has retired, 10-15 years from now, income and wealth disparities between generations will have become so extreme that younger people will simply no longer accept the situation.
That is what should arguably be the number one theme in all of our planning and deliberations. It is not; indeed, there is nobody at all who talks about it in anything resembling a realistic sense. Every single proposal to deal with our weakened economies, whether they address housing markets, budget deficits, overall federal and personal debt, or pensions systems, is geared towards the same idea: a return to growth. It doesn’t seem to matter how real or likely it is, we all simply accept it as a given: there will be growth. It is as close to a religion as most of us get.
And while it may be true that in finance and politics the arsonists are running the fire station and the lunatics the asylum, we too are arsonists and loonies as long as we have eyes for growth only. That doesn’t mean we should let Jamie Dimon and his ilk continue what they do with impunity, it means that dealing with them will not solve the bigger issue: our own illusions and expectations.
We allow the decisions for our future to be made by those people who have the present system to thank for their leading positions in our societies, and we should really not expect them to bite the hand that has fed them their positions. But that does mean that we, and our children, are not being prepared for the future; we’re only being prepared, through media and education systems, for a sequel of the past, or at best the present. That might work if the future were just an extrapolation of the past, but not if it’s substantially different.
If there is less wealth to go around, much less wealth, in the future, what do we do? How do we, and how do our children, organize our societies, our private lives, and our dealings with other societies? Whom amongst us is prepared to deal with a situation like that? Whom amongst our children is today being educated to deal with it? The answer to either question is never absolute zero, but it certainly does approach it.
Obviously, you may argue that we don’t know either that the future will be so different from the past. But that is only as true as the fact that neither can we be sure that it will not. So why do we base our entire projections of the future on just one side of the coin, the idea that we will have more of the same – and then some more -, without giving any thought to what will be needed when more of the same will not be available? That looks a lot like the “everything on red” behavioral pattern of a gambling addict. But who amongst us is ready to admit they’re gambling with their children’s future?
I see the future as completely different than a mere continuation from the 20th century past and the 21st century present. I even see the latter as very different from the former, since all we’ve really done in the new millennium is seek ways to hide our debts instead of restructuring them. You can throw a few thousand people out of their homes, but if you label the by far biggest debtors, the banks, as too big to fail, and hence untouchable, nothing significant is restructured. But that doesn’t mean it’s going to go away by itself, the by far biggest debt in the history of mankind. At some point it must hit us in the form of a massive steamroller of dissolving and disappearing credit. In a world that can’t function without it.
And if we refuse to consider even the possibility that the debt will crush us under its immense weight, and profoundly change our societies when it does, then we will be left unprepared. And lost. That should perhaps scare us into action, not denial. Denial simply doesn’t seem very useful. Is there a risk that business as usual will no longer be available? Yes, and that risk is considerable. But we plan our futures as if it’s non-existent. That is a huge gamble. Not to mention the worst possible kind of risk assessment.
The best, or most, that people seem to be able to think of doing, even if they feel queasy about their economic prospects, is to stuff as much manna as they can into their pockets. That is the sort of approach that may have worked in the past, but it offers no guarantees for the future. It’s just another gamble.
We love to tell ourselves how smart we are. It’s time we walk that talk.
Lambert here: Anomalies that you see are a consequence of bringing the new site design live. So don’t worry. At least not about that.
I’m turning off comments on this page so people don’t waste their time telling us about stuff that will be fixed as all the pieces come together; we promise there will be a feedback page later.
So stay tuned, head for the kitchen to make so popcorn preparatory to passing it, or whatever….
UPDATE And I forgot to add, if anomalies persist, sure to clear your brower’s cache. If that doesn’t work, try quitting and restarting your browser. And if that doesn’t work, maybe you found a bug!