For Lenders, the Name of the Game Is Extend and Pretend
Thursday 11 November 2010
by: Paul Krugman, Krugman & Co. | Op-Ed
Foreclosed homes in Toledo, Ohio, whose liens were sold to private investors, are foreclosing with less discretion. (Photo: Fabrizio Costantini / The New York Times)
I’m finding it difficult to write about the recent foreclosure mess in the United States.
Amid the revelations in October that so many mortgage lenders might have been sloppy when processing foreclosure paperwork, attorneys general in all 50 states have now announced they are investigating lenders’ foreclosure practices.
It’s clear that there has been massive malfeasance on the part of the banks (again), but it’s less easy to decide what should be done about it.
One thing is obvious: the main argument in favor of turning a blind eye to this whole situation and avoiding a temporary freeze on foreclosures is wrong.
Some Obama administration officials have suggested that we need to let foreclosures proceed because it’s important that those properties be seized and sold so that the mess can be cleaned up.
That sounds reasonable, but let’s look at what actually happens to foreclosed homes.
The fact is that a startling number of those homes are not on the market: there is a huge “shadow inventory” of houses that have been seized but not yet offered for sale. The Wall Street Journal estimates that this inventory stood at about 5.2 million homes in October.
If mortgage servicers really wanted those homes sold and the issue resolved, they would be allowing more short sales — essentially, letting the current owners sell the homes for whatever they can get. Then they hand the proceeds over to the bank and call it quits.
There are a lot of short sales happening out there, but there are also cases in which short sales are being refused, and foreclosures are taking place instead.
The official reason for any aversion to short sales is the potential for fraud (for example, the homeowner can sell the house cheap to his cousin, or whomever, and then maybe even move back in). But how hard is it to police that potential fraud — at least, to police it sufficiently enough in order to avoid gross abuses?
Remember, a house sold for less than its value is still a better deal for the lender than a house not sold at all.
An alternative explanation for banks’ preference for foreclosures and their willingness to sit on foreclosed homes for long periods of time is that this is simply a game of extend and pretend.
Essentially, a short sale means that lenders have to acknowledge their losses, while an empty, foreclosed home can be kept on the books at an unrealistic value.
If I’m correct, then the paperwork crisis presents an opportunity for the Obama administration to help fix a major market failure — an opportunity to prod lenders into either allowing short sales or striking deals with homeowners, and to stop the socially harmful buildup of this growing shadow inventory.
But this is an opportunity that is, as usual, going to waste.
Backstory: Problematic Paperwork
In September, allegations surfaced that American banks with bad loans on their books might have been rubber-stamping foreclosure documents. The issue came to a head in early October when some of the largest lenders in the country, under pressure from state and federal regulators to authenticate the legitimacy of foreclosure claims, put a moratorium on their foreclosure operations.
Lax lending standards during the United States’s recent housing boom have been blamed for leaving many homeowners with mortgage loans that they could not afford. This year foreclosure rates have soared to record highs across the nation, which has generated an enormous amount of paperwork.
There’s no quick fix for the lenders’ problem, given the complicated legal nature of the securitization process — the method by which mortgage loan payments are pooled to form collateral for a bond issuance.
In a foreclosure, the long chain of legal documents detailing the securitization must be verified; at that point the breakdowns occurred. Banks and mortgage servicers were buried by the high number of foreclosures, leading to speculation that at times so-called “robo-signers” — bank employees who approved hundreds of documents a day — were haphazardly pushing through paperwork rather than carefully sorting it out.
By the end of October, major banks such as Bank of America and GMAC Mortgage had resumed foreclosure operations. But Federal Reserve Chairman Ben S. Bernanke said that regulators are examining mortgage companies’ processes. Mr. Bernanke said a report is expected in December.
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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.
Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).
Copyright 2010 The New York Times Company.
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