Free Fallin' Foreclosures

You can't fix what you can't see--a major reason that distressed mortgages are cascading into default at a such a dizzying pace. It used to be that a homeowner struggling to keep up with his payments could sit down with a loan officer at his friendly neighborhood bank or mortgage lender and work something out. Perhaps the lender could allow some breathing room by accepting interest-only payments for an interim period. Or the payback period could be extended, reducing monthly payments. Or a short sale could take place, where the lender agrees to accept a discounted payoff.

It was all subject to negotiation. In some cases the lender would recognize a deficiency, but at least there would be an accounting mechanism in place by which the lender could write off a loss over the life of the mortgage. Problem is, such a workout can only take place with two people at the table. Lenders who have securitized loans for re-sale have insulated themselves from their customers. They have ceded their place at the table to anonymous investors with no local knowledge. If you are the borrower trying to make ends meet, who are you gonna call?

Many lenders in recent years became motivated not to give their customers something called "service," but to push their customers' loans off their balance sheets and into the secondary market, recovering their capital so that they could make more loans. Long-term customer relationships were sacrificed for short-term profits. To keep the money in motion, lenders inevitably migrated down the customer food chain to unqualified borrowers with insufficient means to repay the loans (so-called NINA loans: no income, no assets). The collateral for such transactions was nothing more than the imagined future price of each property in an inflating market.

Now housing prices are going the other way. Many mortgages have gone "upside down" (the amount owed exceeds the value of the house), and borrowers are walking away. Repossessed homes are being auctioned off at fire-sale prices, exacerbating the downward spiral. The default rate for subprime loans originated in 2007 hit double digits before the year was out, stark evidence that there were fools on both sides.

Meanwhile, many investors in mortgage-backed securities are left holding the bag now that this game of musical chairs has come to an end. Those investors will not be able to amortize their losses over time; they will be recording them all together, all at once (MaineFail, anyone?). This will be a once-in-a-lifetime destruction of debt. Be thankful if you are fortunate enough to be but a spectator.