A Mortgage Crisis Solution
The latest twist in the ongoing saga of the mortgage crisis is that some fraction of the banks (and other owners of mortgages) didn't manage the paperwork well enough to be able to prove that they actually own each particular mortgage on each particular house. This is bad and sloppy — but it just might contain the seeds to a solution.
I've written before that the root cause of the whole financial crisis was not (as many have suggested) falling house prices; rather it was that housing prices got too high. If you think about it, the average house has to be affordable to the average household — who else is going to buy it? Once prices got too high, they had to fall. The government and many other institutions have done what they can to "fix" the problem of falling house prices, but that's an effort doomed to failure.
Although propping up housing prices is a losing effort, it's a popular one. Homeowners like it — and homeowners tend to be voters. Bankers also like it, and the government has been looking out for them as well, for several reasons: They're a source of political contributions; bank regulators are tasked with preserving the banks (which are endangered by collapsing housing prices); even legislators and regulators who are primarily looking out for the interests of ordinary people know that a collapsing financial sector would be hard on everyone — not just bankers.
The upshot has been that, despite the fact that a lot of people would like nothing better than to stick it to the banks, there's been very little effort to actually do so.
This latest twist in the crisis, though, may give us an opportunity to make the banks do the right thing.
The Right Thing
The right thing would be for the pain to fall where it belongs. A lot of failed mortgages have two culprits. It's as much the fault of the homeowner who bought a house they couldn't afford as it is the fault of the banker who lent them money they'd never be able to pay back. But I'm not too worried about sticking it to the poor homeowner — they're going to suffer plenty. My main concern is that helping them not cost the rest of us a lot more money.
So, to my mind, the right thing to have happen is for the banks who made stupid mortgages to be the ones who lose a lot of money. That's not a popular idea with bankers (who won't get nearly as much bonus money), and it's not a popular idea with bank regulators (who worry that banks that lose money might go under, dragging the rest of the financial system down with it). But the discovery of this record-keeping failure may have taken matters out of their hands.
Banks have been resisting efforts to write mortgages down to the value of the house, even when the only alternative is foreclosure. All those foreclosures are sad. They'd be sad even if the only people being foreclosed on were foolish people who bought houses they couldn't afford — I don't want to see even foolish people turned out of their home. But it's worse than that. Many innocent people are caught up in the housing catastrophe. (You can see the stories of some innocent victims in the comments on my post Six Options if You're Underwater on Your Mortgage.)
Up to now, though, there's been no pressure on banks to negotiate with homeowners to straighten things out. It's been cheaper to just foreclose, write off the loss, and go on.
But now that everyone knows that the banks had been cutting a lot of corners on the paperwork, the situation is very different. A few egregious mistakes aside, in most cases there really is a mortgage and the owner really hasn't been making his payments. But because of the mistakes, it now seems clear that the bankers will no longer be allowed to slide things through quick and easy. Instead, they're going to be forced to cross every t and dot every i.
This changes everything. In the cases where the record keeping has been very sloppy, it may be impossible to prove that the bank really owns the mortgage. Even where it's possible, it may be expensive. The banks, looking for the cheapest solution, just may find that it's cheaper to negotiate with the owner, and then write a new mortgage (and make darn sure that the paperwork for the new mortgage gets filed correctly). Even if they write the mortgage down to fair market value, they'll probably come out ahead of where they'd be if they had to foreclose, maintain the house for a while, and then sell it into a down housing market. (And they'll come out way ahead of where they'd be if the homeowner discovered that the bank can't prove that they've actually got a mortgage on the house at all.)
I see this as a win for everyone except the bankers. Homeowners get to stay in their house, with a new mortgage that reflects the actual value of the house. House prices fall to where they belong, making houses available to ordinary people — but they do so without the dislocations of so many foreclosures and forced sales. Bank profits will suffer, but in exchange the banks get a chance to clean up their paperwork — valid, provable mortgages that will stand up in court. Really, it's just the bankers — whose bonuses will be under considerable pressure until this is all worked through — who lose.
As a bonus: Going on the theory that there's considerable overlap between the banks most prone to screw up the paperwork and the banks most prone to lend money to people who couldn't pay it back — I'm thinking that the worst of the pain will tend to fall right where it's most deserved.
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