credit crisis

A Mortgage Crisis Solution

Philip Brewer — Tue, 12 Oct 2010 13:00:10 +0000

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.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Book Review: Complicit - How Greed and Collusion Made the Credit Crisis Unstoppable

Xin Lu — Sun, 17 Jan 2010 16:00:02 +0000

This week a government committee is investigating the cause of the financial crisis by interrogating bank titans what exactly went wrong. Complicit: How Greed and Collusion Made the Credit Crisis Unstoppable by Mark Gilbert is exactly what these government officials need to read to learn what went on in the last few years to cause the debacle. Here are some of what I learned from the book.

The book described the myriad of derivative investments that bankers essentially created out of thin air. As long as these derivatives were selling, the bankers were pocketing huge bonuses and their bosses did not care how they made the profit. It was also a strange period where all investments including stocks, commodities, and real estate were going up. As long as everything went up and money rolled in no one seemed to inquire how it was possible.

While this was happening regulators did not really do much to stop anything. In fact, the Glass-Steagall laws established during the Great Depression which separated investment banking and commercial banking was dismantled during the Clinton era. This allowed commercial banks that takes deposits to take much larger risks than they could previously. Bankers took on too much risk with too little capital, and this was described by the author as an "inverted pyramid". Basically the real assets backing all the derivative products was much too small, and just a small portion of the real investments going bad caused many more multiples of that money to evaporate.

This book basically reads like many news reports from the last few years put into chapters and categories. If you want to understand why a small fraction of bad mortgages could have caused so much damage, then you should read this book. The last chapter of the book offers some advice and prescriptions on how to avoid this in the future. I think my favorite part from that chapter is where the author suggested that more women should be hired as banking executives to perhaps soften the risk hungry "macho culture" in finance.

In conclusion, I think this book is a great objective view of what went on in the financial industry and government that caused the crisis to be so devastating. If you are a news junkie or a history buff then you would love this book.

Disclosure: I received a free advanced reading copy of this book and this post contains an affiliate link to the book.

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Is your credit score suffering without your knowledge?

Andrea Karim — Tue, 21 Oct 2008 21:33:08 +0000

The warning signs were there as early as July. Even if your credit card interest rates aren't going up, your credit limit might be going down. If you're like me, and you tend to shread your credit card statements as soon as you receive them, you might want to open them up and ascertain that your credit card company hasn't suddenly lowered your limit.

It's not just your portfolio that may be shrinking lately. The spending limit on your credit card may be heading south as well. Credit-card issuers have been decreasing credit limits.

"Most banks are cutting their credit limits," says Carol Kaplan, spokeswoman for the American Bankers Association. "They're doing it to everyone."

According to John Ulzheimer, president of Credit.com Educational Services:

To maintain a good score, Ulzheimer recommends that consumers use only 10 percent of their available credit. For example, someone with a credit limit of $100,000 should never carry a balance over $10,000. But in today’s climate, however, that $100,000 limit could be cut to $50,000, meaning that the $10,000 balance now represents 20 percent of your credit limit, and thus your credit score is dinged. Your score could go down even if you regularly pay off your minimum balance and your loans.

With delinquencies mounting by the day, credit card companies are going to try to limit consumer lending, not just in new loans and lines of credit, but with existing ones. Companies are looking at your salary, current debt, job, and locale to figure out if you are a riskier investment than you were, say, six months ago.

If you haven't gotten your free credit score this year, you might want to consider doing so. Keep an eye on your credit card limits, too, to see if they have shifted. It's not against the law for a credit card company to suddenly lower your credit score below the amount you currently owe, thereby inducing a whole boatload of over-limit penalties. Remember, when it comes to debt, credit card companies can do pretty much whatever they want.

Want to protect yourself?

Pay down as much of your debt as you possibly can.
Haggle with your credit card company to keep your credit limit at its current level.
Keep an eye out for any mail from your bank or credit card company - don't just shred them!
Know your credit score (click to read about a way to get your score for free).

I hate facing debt when I know I have a lot of it, but let's face it, folks, this problem isn't going away anytime soon.

This article is from Andrea Karim of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: