Published: November 06, 2009 06:27 pm      

States looking for cash, someone to blame

EDMOND — It appears that many state governments are angry at the fact that home foreclosures are wreaking havoc on their economies. They blame mortgage lenders for creating the problem. They also blame banks and other lenders because they are taking much too long to deal with loan modifications and other initiatives aimed at slowing the rate of foreclosure. So now, in an effort to take control, some states are weighing the possibility of suing mortgage lenders for fraud.

Think about that for a moment. State governments, who have wildly over-promised what they can support through their own funding, are contemplating suing mortgage lenders for fraud because they potentially lent money to people who couldn’t pay it back. This is one of those “you’re kidding?” moments.

If a lender is stupid enough, which many were, to make a loan that likely can’t be paid back, isn’t that sort of a bad business practice? To say that the lender did it for profit is a bit silly, since the business model — lending to people who were marginal borrowers — was doomed from the beginning. In fact, many of those lenders are now out of business.

But let’s run with this idea for a moment. Someone out there is responsible for creating a boom in economic activity through the promise of cheap home ownership. That boom created an unsustainable flow of capital and economic activity within states that they became accustomed to having. Now the spigot is turned off, so let’s blame the group that created this mania. To do this, you have to find the right group.

It can’t be the mortgage lender alone. Barring out and out fraud (which of course happened, and was always illegal), we are talking about the alluring promise of easy home ownership at a low price, getting in on the fastest game in town, and the real estate bubble directed at those who were at best marginal buyers and at worst non-qualified buyers. This, of course, came through the lenders, but it started a little further up the chain. You have to look at the Fed with its insanely low interest rate policy, which kept prices low. But that’s not the end of the line either.

For the end of the line, you have to look at the bucket of money that eventually purchased a big chunk of those mortgages backed by low income borrowers who are now in trouble. That would be me and you, through our agents Fannie Mae and Freddie Mac. In the 1990s we (government leaders) gave direction to those two government sponsored enterprises (GSEs) to make sure that a large percentage of the loans they purchased were those backed by low or modest income borrowers. So in this line of thinking, we want to believe that someone, somewhere, created all this mess in housing by making homes too affordable and persuading people to buy homes they couldn’t afford.

Unfortunately, the national foreclosure problem, according to a recent report from Deutsche Bank, “Drowning in Debt — A look at Underwater Homeowners,” probably will get worse. Currently, almost half of residential properties in default in the U.S. have not even entered the foreclosure process yet and the default and foreclosure numbers are almost certain to rise even if the economy recovers in the next year.

The U.S. has about 110 million households and 75 million of these, or 68 percent, own homes. Of the homeowners, 68 percent, or 51.6 million, have mortgages. Of these mortgages, 26 percent, or near 14 million, are estimated to have negative equity (mortgage is 105 percent or higher of home value) as of the end of the first quarter of 2009. Deutsche Bank is predicting that 48 percent, or 25 million mortgages, will have negative equity by the end of the first quarter of 2011. This is a potential 80 percent increase in foreclosures and defaults beyond millions that have yet to enter foreclosure but have already defaulted! It is doubtful the recent stress tests on banks have taken that into account.

Worse yet, normal middle class conforming loans (those that the average person with good credit gets) will see the highest increase in negative equity. Conforming loans are by far the biggest category of mortgages at 66 percent of the total. These loans will undergo the biggest increase in negative equity, or about 9 million mortgages! This is not a subprime crisis. That was just the beginning of the deleveraging of the greatest real estate and credit bubble in modern history. This is the ultimate conclusion and why the states and banks have good reason to worry.

So, are the states going to sue the federal government for fraud? I doubt it, but I can’t wait to see that show if it happens. As much as we’d all like to blame the government, I don’t think they’re totally responsible for this mess. This was a group effort. Credit Default Swaps (which were like made-up insurance contracts with no capital behind them) rating agencies who pandered to issuers, the Federal Reserve and Congress all had a big part. There are many others, including borrowers themselves. Clearly many states are suffering the consequence of the situation. I just think it’s a stretch to think they can sue someone over it. Thanks for reading.



NICK MASSEY is a financial adviser and owner of Householder Group Financial Advisors in Edmond. He is also a guest analyst on CNBC and Bloomberg. Massey can be reached at www.nickmassey.com. Securities offered through Securities Service Network Inc.