Two big pieces of news today on the foreclosure front:

1. Michigan Supreme Court Reverses Ruling on MERS’ Right to Foreclose

2. Nevada Grand Jury Indicts Two in Alleged Robo-Signing Scheme

Before I share my thoughts on each of these cases, let’s start with some background:

When the whole robo-signing scandal first erupted, we predicted that in the end it would do little more than cause delays. This prediction angered many who believed that just because the lender used certain practices that have been called into question, the lender should be unable to foreclose. Two practices in particular have been the rallying cry for those that believe they should be able to stop making their payments, yet stay in “their” house forever without risk of foreclosure.

Robo-signing, is a practice where an employee signs computer generated documents, typically foreclosure related affidavits, without personal knowledge of the facts being attested to. When you consider the millions of foreclosure actions the banks have to process, and our reliance on computers these days, this practice should not have been a surprise to anyone… it makes sense. But the law often doesn’t keep up with common sense, and the banks are now paying for having gotten ahead of the law. In the end it is hard for us to see how a court of “justice” would deem it fair that one party, the lender (typically taxpayers these days) should lose everything, over whether or not a person who signed a document personally verified all the facts. There are those that will say the facts were wrong, but that doesn’t pass the common sense test… does anyone really believe that everyone being foreclosed on has actually been making their payments? Sure real mistakes occasionally happen, but those happen with or without robo-signing.

Another place the law hasn’t kept up with common mortgage banking practices is the requirement to record an assignment when the loan is transferred from one lender, or more specifically “beneficiary”, to another. The particular problem is that with mortgage securitization its a bit unclear who the beneficiary is, as the role of lender  is now split between the underlying investor, and the servicer who collects the payments. To simplify things, and to lower the costs of transferring loans between investors – a market that at the time was quite liquid -  the banks created their own system for tracking these loans called Mortgage Electronic Registration Systems or MERS. Like using robo-signers, it was a common sense solution, but one that some certainly argue the law does not support.

Since the day these two issues have come to light many have come to believe that these practices would lead to a huge windfall for homeowners by at least forcing the banks to negotiate, or at best leading to the loan being wiped out completely – a free house.

While we absolutely believe lenders should be held accountable for their role in the credit bubble that has left millions of homeowners underwater, these two issues are just a side-show, a distraction, and its keeping us from getting to the main event – dealing with the trillions of dollars in negative equity that continues to strangle homeowners, the housing market, and the economy itself.

The Michigan Ruling on MERS

Yesterday the Michigan Supreme court reversed a surprising appeals court ruling, reestablishing MERS authorization to foreclose in Michigan, and ending the chaos the earlier ruling created by leaving the status of thousands of earlier foreclosures in question. Given our position above it should be obvious this was the outcome we expected. It’s also what we’ve seen elsewhere. There have been a handful of wins to date against MERS, but all that we are aware of have been by lower courts, some of which one might argue were delivered by “activist judges” who were more focused on slapping banks for their behavior then on the proper application of the law. As these cases slowly work their way through to the top, we believe that mortgages and foreclosures in which MERS was involved will be allowed to stand, as was the case in Michigan yesterday. That said, please understand that we do think MERS should be better regulated, providing more transparency to homeowners on who currently holds the mortgage and note on their property, and establishing clear requirements on the transfer of both.

The Nevada Robo-Signing Indictments

A Nevada grand jury has handed up criminal indictments against two Lender Processing Services employees for filing foreclosure documents without proper legal review. Again, we believe lenders should be held accountable for their actions, and in those cases where mistakes of fact have been made their should be consequences. As foreclosure data providers we do see mistakes, like transposed parcel numbers, that lead to the wrong property being foreclosed on. We’ve never seen these foreclosures not immediately overturned as soon as the mistake was brought to light. Certainly the lender should make those who are a victim of such a mistake whole. No question. But should it really be a criminal offense for the person that signed the document to not have personally verified all those facts? We think that’s ridiculous. We are well past the days where your banker knew you personally, drove by your house before making the loan, and saw you each month when you brought your payment in. That’s all computerized now, and so are the foreclosure affidavits, the records of payments, mortgage assignments, etc. We’ll learn more about this case in the days ahead, but unless the acts of the Lender Processing Services employees that were indicted were far more devious then signing documents spit out by the computer without verifying facts, then these indictments seem completely misguided and vindictive to me.

That’s our two cents, we’d love to hear your thoughts.

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This morning a headline in my inbox caught my eye: Homeownership Rate Drops to 13 Year Low. Seems the Census Bureau has tallied the homeownership rate to be 65.9 percent, down from nearly 70 percent at the peak of the bubble. Despite the drop, I believe this stat significantly over-estimates the real rate of homeownership today. With another 9.6 percent of homeowners with a mortgage currently not making their payments, I’d argue that its time to realize the real rate of homeownership is getting close to being in the high 50′s – which is closer to a 50 year low. Sure the policies of extend and pretend will keep the Census Bureau from reporting this reality for months or even years to come, but we all need to be thinking about the implications now.

For example, should the government and banks really be in the rental business? House representative Gary Miller (R-CA), introduced a bill with bipartisan support to authorize FDIC insured banks as well as Fannie and Freddie into entering 5 year lease agreements on REO properties rather than sell them. He says “Something must be done to reduce the inventory of available homes and stop the further decline in home prices,” so he obviously hasn’t spoken with Realtors or investors in the area he represents or he’d realize that inventories throughout California are low and that homebuyers and investors are having a hard time finding decent properties to buy. Plus unlike banks, investors fix properties up by hiring local contractors, use local property managers, and spend their income locally, all of which create much needed jobs. His bill, if it passes, is likely to hurt the CA economy more than it will help… at least in the near term.

Rather than massive government intervention, like Miller’s bill, I believe the better answer is to deal with the decline in homeownership by re-igniting real estate investing. In an environment of zero interest rate policy ,with baby boomers nearing retirement, this change in homeownership rate may provide just the opportunity boomers need to get decent returns on their retirement savings. The only problem with this vision is that it’s bad for banks and Wall St who can’t afford to have investors move assets out from under their management. As such, expect more policies that help banks and GSE’s keep homes off the market, further frustrating both homebuyers and investors.

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Nearly a year ago I opined that banks were engaged in a game of Foreclosure Roulette — a game by which they randomly foreclosed on a few homeowners, while delaying most foreclosures for longer and longer periods of time. The primary aim of the bank’s random foreclosures being that they can’t let word get out that you can stop making mortgage payments and live in your home for free for years on end, as is increasingly the case. Otherwise, millions of underwater, but paying, homeowners might also stop making payments, spelling disaster for the banks.

At first glance current foreclosure sales do seem completely random. Vacant homes sit for months or even years waiting to be foreclosed on, while a family working hard to short sale their home has the rug pulled out from under them. But looking for patterns by focusing on the borrower or even the property assumes lenders care about people, and neighborhoods. That’s not the role of financial institutions. These are corporations, and their focus is on profit and loss. By focusing on where the losses really are, clearer patterns begin to emerge and we now see that this game of chance isn’t completely random. Like in Vegas, the odds are stacked in favor of the house — not your house, the banks.

First lets look at time to foreclose based on the size of the potential loss. We did this by analyzing 153,956 foreclosure sales on first mortgages from January 2008 through July 2011 for which we had all the necessary data. This includes properties that were sold back to the bank and became REO, as well as properties purchased by investors on the courthouse steps at foreclosure auction. We divided all the loans into two groups: those with balances over $417,000 (the conforming loan limit) and those below. Specifically we were wondering if banks took longer to foreclose on larger loans, where there tend to be larger losses, than on smaller loans. The answer is clear: yes, the size of the potential loss absolutely matters. Not only that, but time to foreclose doesn’t diverge until the government intervened in the foreclosure market in early 2009, with, for example, changes to the Federal Accounting Standards Board rules on mark-to-market.

In July 2011, the average loan balance on foreclosures with a loan balance greater than $417,000 (the red line) was $616,000, and the average current market value was $404,000, resulting in an average loss of more than $250,000 per loan after sales costs.

Compare that to loans with a balance less than or equal to $417,000 (the blue line). On those loans the average loss was closer to $115,000 on an average loan balance of $274,000 and with an average current market value of $176,000.

The truth is that the larger the loan balance you have, the more upside down you are in the home, and the bigger the loss for the lender, the better your chances are of not being foreclosed on for a very long time.

Next lets look at the time to foreclose based on the number of outstanding loans. Some have suggested that many servicers have a conflict of interest in that they service first mortgages on properties on which they directly hold the second mortgage in their own portfolio. In fact, Representative Bradley Miller D-NC, introduced a bill, H.R. 4953, to specifically eliminate this conflict of interest; saying at the time “Their stance does seem largely driven by accounting concerns — they are trying to maintain the fiction that the mortgages are worth the value they are carrying them at on their books.” It turns out that there is a dramatic difference in the amount of time it takes servicers to foreclose on first mortgages when there is also a second mortgage on the property, as shown below.

The blue line indicates the average time to foreclose for properties that only had one loan; and the red line indicates the average time to foreclose for properties that had two loans. While there is a notification requirement when foreclosing on a property with a junior lien (a second mortgage for example), this is easily accomplished within the standard foreclosure timeframe, and first mortgage holders have no other duties to protect second mortgage holders, so there is really no other reasonable explanation that we can think of for this significant difference in timing outside of the conflict of interest issue that some have suggested. Note that like time to foreclose by loan balance above, the lines don’t start to diverge until early 2009, when mark-to-market rules were loosened.

The basic idea behind mark-to-market accounting rules is that if an asset that you have on your books drops in value, you should recognize that loss on your books and write down the value of the asset on your books. When Treasury Secretary Paulson announced TARP in September 2008, he made it clear that he didn’t think banks should have to write down these assets to or be forced to sell them at what he believed were distressed prices. After that announcement, considerable pressure was put on the supposedly independent Federal Accounting Standards Board (which writes the accounting rules these companies must follow) to ease the rules that require companies to mark assets to current market values. It occurred to me at the time that it was a ridiculous notion as properties weren’t selling at distressed prices, they had instead returned to normal prices after being artificially inflated in a major credit bubble. Regardless, I think there is little doubt that the changes to these rules were necessary in order for the banks to pass the stress tests that were undertaken shortly after this accounting change was pushed through.

So while we still think foreclosure roulette is the bank’s game of choice, we now also believe that the number of chambers in their gun, and your likelihood of being quickly foreclosed on, is directly tied to the size of the potential loss that the bank might face. Perversely, this means those who took the biggest loans, on the nicest houses, with the largest lines of credit to buy lots of shiny new toys will also get the most free rent when they strategically default.

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Over the past month we noticed that Bank of America has been resuming foreclosures on loans originated by Countrywide. As you may recall in October BofA voluntarily imposed a foreclosure moratorium following the robo-signing scandal. We actually expected an increase in activity as lenders began to catch up after these delays and were instead surprised to see foreclosure activity drop in April.

Even more surprising is just how old some of the foreclosures being resumed are.

In Contra Costa alone there are 123 homes now scheduled for trustee sale, with loans originated by Countrywide, where the foreclosure process began in 2008.  That is 3 years of missed payments, interest and fees. In just this one county that totals $71.5 Million in original loans with balances now nearly $19 Million higher.

Although all of these 123 properties have active sale dates many are still being postponed. In fact the largest loan, where the total debt now exceeds the original loan amount by more than 1 Million dollars, has been postponing since January, and was just postponed again until June.

We remain as convinced as ever that these delays are simply part of the current game of Foreclosure Roulette. Hopefully someday soon lenders stop playing games and begin really dealing with the looming shadow of delinquent and underwater borrowers. Whether through loan modifications, short sales, or even foreclosure it’s time to move forward.

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There’s been a lot of news lately about the idea of killing the mortgage interest deduction. While I think this deduction has far too much public support for it to face the axe anytime soon, I personally believe that support is misplaced.

My core issue is that the mortgage interest deduction is not an incentive for home ownership, but rather an incentive for home indebtedness. As million of americans with a mortgage are finding out right now, they only “own” their home if they make their payments. If home ownership is the goal, wouldn’t it be better to incentivize homeowners to pay off those mortgages?

There’s no doubt in my mind that eliminating or limiting the mortgage interest deduction, even if only for those with incomes over $250,000 as Obama’s budget proposes, would hurt more than it would help right now. Even using conservative numbers one could argue that prices would have to drop 20 percent or more to make up for the loss of the deduction. With millions of homeowners underwater, that’s the last thing this market needs right now.

The funny part is that if we did eliminate the mortgage interest deduction and prices fell 20 percent, new buyers would need a smaller mortgage, and we’d all pay less in property taxes. So does this deduction really help homeowners? Or does it primarily benefit lenders and tax collectors? I believe it’s the later.

Unfortunately there is no easy way from here to there. Eliminate the deduction today and most of us would have an increased income tax burden and an immediate loss of equity as prices dropped to reflect the new cost of homeownership without the deduction. But make no mistake, the only real benefits that homeowners have received over the years is paying more for a house than they otherwise would have, resulting in a larger mortgage to pay off, and a great property tax burden. There is zero doubt in my mind that this deduction has done far more to enrich banks, bloat government and undermine true, debt free, homeownership, than it has to benefit those it supposedly supports.

Maybe its time we all got a little smarter about this debate. Instead of blindly supporting the mortgage interest deduction, maybe it’s time to ask if there is a better way to support homeownership. Specifically one’s that encourages actual home ownership rather than home indebtedness.

I’d love to hear your thoughts.

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Yesterday the Massachusetts Supreme Court ruled on a case that we believe is important and relevant to the foreclosure crisis, the robo-gate scandal and the housing market in the year to come.

Unlike the robo-signing of affidavits that became an issue last year in judicial foreclosure states, this case dealt with whether or not two lenders had the right to foreclose on two homeowners at all. The homeowners claimed that the lenders did not have the right to foreclose because the underlying mortgages had never been properly assigned to the foreclosing bank. This is likely a frequent issue as securitization and other practices in the mortgage industry have made it common for mortgages to trade hands multiple times over the life of the loan. While there have been a number of lower court rulings throughout the nation on this and related issues, this was the first time, to our knowledge, that a State Supreme Court has ruled, thus giving us a settled opinion that cannot be appealed and on which further cases will rely – at least in Massachusetts.

Bottom line, the court found that the lenders had NOT properly assigned the mortgages and that the foreclosures were therefore invalid. The implications of this decision are huge, may affect thousands of past foreclosures in Massachusetts, and is likely a preview of what is to come elsewhere in the nation.

But that’s not the whole story.

Perhaps understanding the national gravity of this question, Associate Justice, Robert J. Cordy, provided an enlightening concurring opinion, which should not be overlooked.

Justice Cordy specifically points out that while the banks erred in foreclosing before ensuring the mortgages were properly assigned, he characterized this as primarily due to “utter carelessness”, rather than some structural flaw. We have seen many argue that assignment flaws will lead to mortgages being wiped out, yet Justice Cordy makes it quite clear that assignments can be cleaned up after the fact and do not even have to be in recordable form or recorded prior to foreclosure, “but they do have to be effectuated.” Makes perfect sense to us. Banks need to follow the law, but mistakes, or even “utter carelessness” aren’t sufficient to wipe out their interests completely. Defaulting borrowers won’t get free homes.

More importantly, he mentions the potential impact of this ruling on bona fide third-party purchasers. This would apply to investors buying foreclosures down at the courthouse steps, and anyone who bought a REO property from a bank. At first glance it may seem that if the underlying foreclosure is invalid, these folks would lose their homes. We do not believe that will be the case, and although Justice Cordy specifically does not address it, we believe he mentioned this issue because he recognized that some might jump to this simplistic conclusion in error. We instead believe that in these cases bona-fide purchasers will not lose their rights to stay in the homes, and that homeowners who were wrongly foreclosed on will be limited to seeking financial damages from the foreclosing bank, not getting the house back. Clearly this has yet to be settled.

So what happens from here?

First, it is important to note that real property laws, including the foreclosure process, are different in every state. What applies in Massachusetts may not apply elsewhere at all. In fact this ruling specifically mentions that “In some jurisdictions it is held that the mere transfer of the debt, without any assignment or even mention of the mortgage, carries the mortgage with it,” but that is not the case in Massachusetts. If it were, this whole matter may have been decided differently.

Second, I expect that we will see the slowdown in foreclosure sales that began in October continue. Between this and robo-gate, it should be very clear to lenders that they need to dot their “i’s” and cross their “t’s”. I doubt they are fully prepared to do that and it will slow down the process considerably. We don’t necessarily see this as bad for the servicers, as depending on their role, it may increase fees or delay losses. For the housing market, this will likely both help, in the form of reduced inventory leading to quicker sales, and hurt, in the form of lower overall home sales due to a lack of inventory, especially at the low end.

Third, we have now officially begun the litigation phase of the foreclosure crisis. Attorneys will likely be the biggest winners in the foreclosure business for 2011. Expect settlements with State Attorneys General that once again give away the store to lenders, with settlement amounts that sound huge in headlines, but are really just gifts. Expect class action lawsuits from those previously foreclosed on that result in monetary awards, but not getting the house back. And expect a lot more lawsuits between investors, original lenders and everyone involved in the securitization process.

Finally, I expect that it will become increasingly clear as we tick through 2011 that it is safe to buy a foreclosure, even if the bank made a mistake it won’t overturn a subsequent sale to a bona-fide buyer, whether that is a sophisticated auction buyer on the courthouse steps, or a first time buyer purchasing directly from a bank.

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It’s that time of year.  You can tell that the holidays are here because the experts are forecasting what housing will look like in the year to come.

Here’s my surefire bet for 2011. It’s a prediction I’ve made before and it’s as true as ever now. If you want to know what the housing market will be like next year, ask the government.

The government’s role in housing is so huge that decisions made in Washington, and our state capitals, over the next twelve months will have more impact on home sales and prices than any other factor.  Consider the following.

Mortgage Rates
The Fed appears committed to do whatever it takes to keep interest rates at record low levels. Should they change course, or fail to maintain current rates, expect home prices to fall. The reality is that buyers buy based on the payment they qualify for – not price. As rates rise that payment buys less house. When that happens to one buyer, they get a smaller house. When it happens to all buyers, home prices fall.

Lending Standards
The housing market would have ceased functioning after the credit crisis in September 2008 without the support of government backed mortgage lending in the form of F.H.A. insured home loans and the government supported enterprises like Fannie Mae and Freddie Mac. Given the increasing call to limit or even eliminate the role these entities play in mortgage lending it is highly unlikely that lending standards will loosen anytime soon. If anything further tightening may be in store. For example, Fannie Mae just increased debt-to-income requirements, and the waiting period after foreclosure. Tighter lending standards result in fewer qualified home buyers leading to lower demand and ultimately lower prices.

Flipping Rules
At the start of the year the Federal Housing Administration temporarily relaxed their anti-flipping rules to allow investors to buy distressed properties, fix them and resell them. This was a critical change for foreclosure auction buyers, who buy homes “wholesale” on the courthouse steps without title insurance, in need of repair, without inspection, for cash, and then clean them up and sell them “retail” to first time home buyers and others who either can’t afford the risks or don’t have the cash to buy foreclosures at auction. This was a win-win-win as it helped banks unload distressed properties, generated income for investors and Realtors, prevented blight, and created a supply of clean, low cost homes for first time buyers. Unfortunately this waiver is currently set to expire in February 2011. Foreclosure investors have worked around the rule before by focusing on non-FHA borrowers, but that limits available demand.

New Tax Credits or Housing Stimulus
At the moment it seems highly unlikely that we’ll see tax credits or other direct housing stimulus in 2011. If anything the tax credits that ended earlier this year likely pulled future demand into 2010, essentially stealing demand from 2011. Home sales slowed substantially after those tax credits ended, and its currently unclear when they will rise without further direct stimulus.

Mortgage Interest Deductibility
While this sacred cow seems unlikely to be slain in 2011, our unprecedented deficits in the federal budget have brought some to call for the end of the mortgage interest tax deduction. Clearly the removal of this homeownership incentive would be another blow to the housing market.

Property Taxes
Like the federal government, states are also facing unprecedented shortfalls. As they search for dollars to make up for revenue losses, unfunded pension liabilities, and ever ballooning costs, property taxes will continue to be seen as potentially fertile ground from which to harvest tax revenue. This will be especially true in hard hit California, where Proposition 13 limits annual increases.

Help for Distressed Homeowners
I’m not confident that most troubled borrowers will ever get real help. What they need most is a principal balance reduction sufficient enough to return their underwater homes back into a sensible investment. Unfortunately the average foreclosure in CA is $150,000 under water on a house that’s now worth $250,000. While that lost equity may be recovered over many years thanks to inflation, it’s hard to make a financial case for that being a sensible continued investment. The unfortunate reality is that neither banks nor the government can afford to bail everyone out.  Nationally we ran up about $4 trillion in excess mortgage debt during the bubble. Instead expect to continue to see more of the same – major programs that ultimately fail, as they are primarily designed as political theater rather than real help. That said, the government is likely to continue the political theater, which is likely to at least have some psychological impact on the housing market.

Foreclosures and the “Shadow Inventory”
Even before the recent robo-signing controversy, the lack of clarity around the foreclosure process has only created fear, uncertainty and doubt among buyers; leaving them to wonder, when, if ever, the millions of homes that are either delinquent or in foreclosure will hit the market. Now issues related to robo-signing and other foreclosure and lending practices have led some to call into question the validity of some foreclosures creating fear among buyers that the purchase of their home may later be deemed invalid. While those fears will likely prove unfounded, government handling of the robo-signing controversy and continued intervention in the foreclosure process will play a role in how quickly buyer regains confidence that the market has stabilized.

My wish for 2011
While I’m confident in my bet that government action or inaction will play the dominate role in 2011, my wish is for reasonable housing policies that clearly articulate a comprehensive, realistic, plan for dealing with the millions of homeowners still underwater, while providing a gradual path back to a healthy housing market, ultimately free of government intervention and subsidies.

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Since Bank of America first announced they would be freezing foreclosures nationally 9 weeks ago, we’ve seen a dramatic drop in foreclosure activity within our coverage area. It wasn’t unusual to see more than a thousand foreclosure sales a week where BofA was identified as the beneficiary on the foreclosure notice prior to the freeze. With the freeze in place that dropped to less than a couple dozen a week… until this week.

While still at 20 percent of their prior volume they are clearly back in business. The Wall Street Journal confirmed this measured approach, and from the article it doesn’t sound like they’ll be back to typical levels until “early next year”. That makes perfect sense given the holidays.

The remaining mystery is why they stopped in Arizona, California, Nevada, Oregon and Washington (ForeclosureRadar’s coverage area) at all. The Wall Street Journal article repeatedly talks about problems in the affidavit filing process, but hat only applies to the judicial foreclosure process, which none of the states we cover commonly use. BofA’s own announcement also didn’t say anything specific about the non-judicial states. Not clear that we’ll ever know if they actually had some documentation problems in the non-judicial states as well, or simply stopped foreclosures everywhere in an abundance of caution.

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