Saturday, April 04, 2009

Elizabeth Warren explains the roots of the Mortgage Mess

I put up a post in December pointing to the role of loan servicers in untangling the mortgage mess at the heat of what has now become a global recession of unprecedented size. This is tedious reading, not for the feint of heart. But anyone who actually wants to understand part of the problem should go read Loan Servicers and the Credit Crunch. At the end you will find linked a Terry Gross interview with Elizabeth Warren which was the easiest to understand statement of the problem I had heard.

This morning I came across The Real Cost of the Geithner Plan by Jed Graham, a writer for Investor's Business Daily, which criticized the Geitner plan.

It is truly remarkable that an administration that preaches progressive economics intends to deploy $1 trillion – including hard-to-value but nevertheless very pricey subsidies – to help banks in a way that avoids helping their existing borrowers.

Of even greater concern is the relatively weak economic thrust of a plan that will take many months to implement and – if successful – may only marginally increase lending because the pool of potential creditworthy borrowers is shrinking as the economy deflates.

The biggest cost of the Geithner plan may be the missed opportunity to deploy these resources in a way that gets at the heart of one of our economy’s central problems – an excess of mortgage debt based on now-fanciful home values.

If we are going to be giving banks subsidies, at least we should make sure they are aimed directly at helping overburdened households to deleverage while bringing a quick end to the foreclosure crisis.

In contrast to the Geithner plan, devoting these resources and subsidies to facilitate a restructuring of the debts of under-water borrowers and those merely treading water could provide an immediate and lasting boost to household cash flow and confidence
At some level I agree with his criticism. Not only are banks focusing more on problems than solutions, ignoring (even punishing) good customers while directing their investment energies on the bad ones, all while a pool of good customers continues to shrink.

The problem with this criticism is that it calls for "bringing a quick end to the foreclosure crisis." Therein lies the challenge. We are witnessing a slow-motion train wreck and when you look into the details there seems to be no way to speed it up. Two realities are in the way.

First, until all the problem mortgages already in place (sliced and diced in the form of "securitized debt") are either helt to maturity or pulled out ot the system by the roots) there isno way to predict the end game for toxic (or, if you prefer, illiquid) assets.

Second, the process of servicing existing loans is not only an"unfunded mandate" but a job which will not end until the first problem has played out.

My comment at Mr. Graham's article was this.

Last year I heard a wide ranging interview with Elizabeth Warren which mentioned, among other topics, the problem of loan servicers. My recollection of her explanation is that once closed, loans are sold in an aftermarket which subsequently slices and dices them for repackaging and bundling in the form of the now famous toxic assets. Between the origination and the sale of those "securitized debts" (Is that an oxymoron?) is the low-profile business of "processing."

Under normal conditions the job of servicing is time-consuming but straightforward. In fact, when a loan defaults the servicers make more because their job is done.

But problems at the origination end of the process are very time-consuming to trace backward through the system. It's like unthreading woofs and warps in a textile mill then running new threads where the old ones are removed, all the while trying not to stop the loom.

Consequently servicers faced with that task becomes some greater multiple of time-consuming than before. The problem is that processors are paid at the originating end. In the case of foreclosures the costs of paying processors to track mortgages backward up the food chain simply adds to the already mounting losses.

With no compelling (i.e. legally enforceable) reason for servicers to do this totally essential job, the stimulus bill includes funds to "bribe" that business to follow up on the tedious but necessary job of replacing all those missing strings on the loom.

Unless and until that task is done, a toxin remains in the toxic asset.

What am I missing?

As I was putting together the comment I found that Elizabeth Warren's interview had been updated and included in a follow-up program in March.

Elizabeth Warren: Foreclosures Threaten Economy is a lucid explanation of what's unfolding.
The program is about half an hour and very easy listening.
Very highly-recommended.
The comments thread of forty-odd comments is now closed. I glanced at it but found it to be the usual collection of carping, finger-pointing and righteous indignation that comments threads typically become. No need to wast your time there.

(Most such threads need to be put out of their misery early on, but I suppose it feeds the ego of the writer or blogmaster to have a lot of words from a lot of places.)

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