… most subprime borrowers aren’t going to default. Suppose even one in four does and lenders recover somewhat more than half the mortgage amount. A fourth of $1.3 trillion in subprime mortgages is $325 billion, and a 55 percent recovery would mean a loss of about $145 billion.
Here’s hoping he doesn’t ever manage a hedge fund. Or run a mortgage banking operation.
Two words matter here: leverage and derivatives. One dollar paid in by a mortgage borrower has been stretched out over so many different securities that Berry’s scenario ends up being naively Pollyanna-ish. Think CDOs-squared here; think credit default swaps, too. Just as each dollar in a mortgage payment pumped up balance sheets for holders of various derivatives, the disappearance of that same mortgage dollar — even at the one in four level cited by Berry — drives losses that go well beyond any basic sort of dollar-to-dollar math, and certainly well beyond whatever a lender might recover in foreclosure.
Further, the current mortgage mess isn’t just about subprime, and hasn’t been for some time — it’s about the losses coming from HEL/HELOCs, the losses coming from Alt-A, the losses starting to be seen in Option ARMs. Writing about subprime mortgages as if they exist in a vacuum, separate from the rest of the housing market and distinct from other mortgage classes, is at best described as absurd.
Those who know anything about the foreclosure industry, however, likely already know the entire discussion is academic at best.
In states where non-judicial foreclosure is an option, a foreclosing party will rarely will pursue a deficiency judgment via judicial foreclosure, simply because of the cost involved in so doing. Add in the fact that many borrowers would be unable to pay even if a deficiency was awarded, not to mention significantly greater exposure to legal risk, and it shouldn’t be a surprise that most lenders choose to avoid judicial foreclosures at almost all costs in states that permit foreclosure by other means.
The bottom line is this: processing a foreclosure is about minimizing legal risk and keeping costs low, in an effort to keep losses to a minimum. Exploding legal risk and blowing up the cost structure just to get a judgment that might impact loss severity is the very opposite of that.
California pain: Christopher Thornberg, who I’ve had the good fortune of interviewing numerous times in the past when he was with UCLA’s Anderson Forecast, put the state of California’s housing market into blunt terms:
The cold, hard truth is that foreclosures are serving only to hasten the painful process of shifting housing prices back to a level the market can sustain. Prices must and will fall. Everywhere. Probably 25% to 30% from their peak.
Scary number for the day: HW readers know I’ve been pointing to option ARMs for some time. The OC Register’s Mathew Padilla did some digging around a recent Standard & Poor’s report and found the following:
One key fact in the S&P report: More than 75% of folks with an option ARM loan have been making the minimum payment, which is subject to negative amortization. It’s not clear from the report if that figure is for all option ARM loans or just those made in 2006.
I’m guessing, although I haven’t seen the study yet, that we’re talking 2006 vintage here.
You might want to read that again: 75 percent of option ARMs originated in 2006 are seeing negative amortization — and that’s on top of likely price declines, given that most of these loans were originated in California. Something tells me we won’t be waiting until 2009 to see problems in the option ARM sector.