Foreclosure

So “housing is the problem,” as many pundits proclaims on saving the economy. I very much suspect that when they say housing, they actually mean the ever-deteriorating and at certain zip code massive foreclosures.

Admittedly plunging housing price can hurt in certain ways, but it is now also proved that there has been an asset bubble in the housing market, and its bust would reserve the inflated housing price back to somewhat normal state (although the fair price of the real estates, or any asset classes, is vague at best and nobody know for sure what it should be). At least, lower house prices may do some social good.

Why Foreclosure is the Sin

Closely linked to but different from the housing price, foreclosure is a case at the heart of the problem. This is how it feeds into the financial/economic crisis.

· Foreclosure and the resulting housing price deflation/excess supplies hits directly the construction companies, mortgage agents that have cropped up during the housing boom. The golden days are now over.

· Foreclosure generated a shockwave into the mortgage market, which has morphed over years into a long chain of regional banks, GSEs (Fannie and Freddie), securitizationers of CDOs/CLOs, SIVs, monoline insurers, and at the end of the chain a variety of institutional investors including major banks, mutual funds, hedge funds, sovereign funds, and pension funds – foreign and domestic. You may have heard the story that some Scandinavian workers lost their pension because some Californians got foreclosed upon. It’s a small, small world.

Fathom this: the U.S. mortgage market is sized $13 trillion, so that an additional 1% foreclosure generates $130 billion loss at par. In addition to the massive write-off we have already observed, financial institutions would have to fire-sell those troubled assets (deleverage) to meet capital adequacy requirement, if replenishment is not available. Those fire-sales drag down the market price and investor confidence. If the now controversial mark-to-market accounting rule (MTM) applies, it cascades into waves of book value losses. The result: drying-up of credit availability.

That said, holding back foreclosures would ease the balance sheets better than bolstering housing price could.

· Foreclosure, if not chosen, causes family grieves. As you can imagine, it is not pleasant to get foreclosed. I heard that some enforcement agents that come to help move out carry guns. Hired guns, literally. “Anna?”

The Many Faces of Foreclosure

Foreclosures are many-facet and various types deserve different attentions and treatments. So as to set the stage for a to-do list, I feel it is very much necessary to dissect the types of foreclosures.

The categorization starts with whether it is primary or secondary residence. There are well-grounded reasons to distinguish these two.

Foreclosure of Primary Housing

These are people who bought a first house as a home.

· Family A: the family faces foreclosure when they lose major source of income due to, for example, recent job loss – happening at a brutal rate of half a million net in each of the recent three months. They are unfortunate people, but not necessarily low-income ones – some belong to the proud jumbo type.

· Family B: the family has a stable income but fell victim to the fancy mortgage innovations (2/28, terser rate, ARM, HELOC, and whatnot), very possibly without a full knowledge of what they bought. When the rates reset, they suddenly found that they cannot afford it.

In short, they tripped over on predatory lending. Some online pieces exposed that mortgaging was so hot a profession that guys with criminal records got hired by imprudent mortgage peddlers. In certain areas where predatory lending became standard practices, why does that make a difference?

One more thing. I found it absurd when some talking heads blaming “people taking mortgages they couldn’t afford.” Few people would sign mortgage contracts when drunken.

Foreclosure of Secondary Housing

These are people who owned houses and borrowed to purchase a second house, a third house, and so on, many expecting to resell back into the trending-up for a capital gain.

· Family C: a well-off family that put down some extra cash for down payment and took mortgages and invested in extra houses. When housing market tumbled, they chose to foreclose it – “just take the house and forget the debt.” Credit score many get hurt, but according to some reports it is ironically a sensible choice against taking a $100,000 portfolio loss. Funny.

· Family D: this family is wild speculators. They took mortgages to buy a second house, possibly on a 2/28, and anticipated to take a short-term ride and cash in for a profit. Some guys allegedly loaded up to seven extra properties, fueling them with rent money. When the trend went south, the plan got smashed.

Types other than the above and combo types notwithstanding, I guess the four represent most of the home buyers. However, beware that I leave one crucial question unanswered: what is the portion of each, geographically? I doubt I would be able to obtain such info to make my parsing valuable.

Possible Solutions and Setbacks

Here’s what I think should do, with noticeable distinction between the primary- and the secondary-type: Do workout for the former, let go the latter. The reason is simple. The former has the incentive and will to keep their (only) homes, aka the quintessential part of the American dream, though some help is necessary.

The way to do it (the workout) is to reduce the installment payment level by extending the length of payment and reducing rate/refi. Both are getting done as of this moment today to a certain extent.

Besides the technical issues given the complicated value chain of mortgage slicing and dicing, there is a risk: the Type-A family may still not able to afford the worked-out arrangement or may re-default after a while. For them, the key is income/employment, and this is exactly the very challenging issue of the economic crisis.

The weird thing is: you take down the mortgage rate for those facing difficulties, a side benefit occurs for those don’t need help – their home purchase cost also fall, and it may not be what you aim to achieve.