Even before some of the nation's biggest mortgage lenders
were forced to suspend foreclosure proceedings because of faulty paperwork, it
was becoming clear that the Obama administration's year-old effort to pump life
into the housing market was falling short.
The federal government just reported that 4.2 million
homeowners are "seriously delinquent" on their mortgages and some
10.9 million borrowers are underwater, meaning their loans exceed the value of
their homes.
To make matter worse, there is the threat of protracted
litigation between banks and borrowers because lenders might not have followed
the letter of law in processing foreclosure paperwork.
An even bigger source of worry is the $426 billion in
so-called second liens - home equity loans, second mortgages and other loans
"junior" to the primary mortgage - that sit on the balance sheets of
Bank of America, J.P. Morgan Chase, Wells Fargo and Citigroup.
The nation's four biggest banks report that less than 4.5
percent of these loans are delinquent, according to Weiss Ratings. But some
mortgage finance analysts like Joshua Rosner of Graham Fisher & Co. remain
skeptical. "Are the second liens properly reserved for? The banks say they
are but that's debatable," said Rosner.
Add it all up and there's the potential for the US
housing market to languish in a stupor for years to come.
As bleak as all that might sound, there could be a way
out - one that doesn't involve another government bailout.
Reuters found that after talking to nearly two-dozen
housing experts, mortgage traders, lawyers, securities experts and others,
there is broad agreement about what a solution to the mortgage crisis might
look like. They say a fix must allow many borrowers to stay in their homes,
compensate disgruntled mortgage investors and allow banks to take write down
loans without causing a repeat of the financial crisis of 2008.
"In the end, everyone has got to give a little and
that includes investors, banks, homeowners and regulators," said Barbara
Novick, vice chairman at BlackRock Inc., the world's largest money management
firm. "We want to keep as many people in their homes as possible, but
there isn't a free lunch. We want to keep losses manageable for the banks, but
enforce principles of contract law as well."
As always, the devil is in the details. And while
everyone may talk about the need for all sides to cooperate, there is still
wide disagreement about a solution.
The standoff between banks, borrowers and bond investors
benefits few. The only ones who stand to gain from such recalcitrance are the
bloggers, pundits and polemicists who throw around catcalls like
"banksters" to describe Wall Street bankers and
"freeloaders" to describe borrowers who have stopped making mortgage
payments.
So a grand compromise would seem to make sense.
BlackRock, for instance, is a proponent of giving federal
bankruptcy judges the power to take a holistic approach to a borrower's debt
that doesn't just focus on a homeowner's mortgage debt as part of a loan
modification. So far, the money manager's so-called mortgage cramdown proposal
has not garnered much support on Capitol Hill.
BlackRock, which manages funds that have invested heavily
in mortgage-backed securities, maintains that banks should take bigger
writedowns on home equity loans, especially if bond investors must assume any
losses from a principal writedown on the underlying mortgage.
It's a position that other bond investors endorse. They
say one reason the market for mortgage-backed securities has been slow to
recover is the federal government's decision to let banks modify mortgages
without taking a corresponding hit on home equity loans.
Rosner said the banks are acting as if their big
portfolios of home equity loans are performing well, but that may not be the
case, especially if the first mortgages fail to perform.
Given that many borrowers are underwater on their
mortgages, he said, and "if the possibility of a broad program of
principal writedowns occurs, the big four banks could, through the cycle, lose
40 to 60 cents on the dollar on their second lien exposures."
Others say that the only reason the delinquency rate on
home equity loans has remained low is that banks often permit borrowers to make
minimal monthly payments on that debt, much like a credit card.
The critics contend that in the worst case scenario, the
big four banks could suffer losses on home equity loans of up to $200 billion.
To put that in perspective, J.P. Morgan's total shareholder equity as of June
30 was about $171 billion.
For the last few quarters, the biggest banks have been
reducing the reserves set aside for delinquent loans, and they are fairly
uniform in rejecting the doomsday scenarios about the mountain of home equity
loans sitting on balance sheet.
Bank of America, with $141.7 billion in second-lien
exposure - the most of any US bank - said its hefty book of home equity loans
is in good shape because 90 percent "are stands-alone originations"
not tied to troubled mortgages.
"It's not fair to do a broad industrywide analysis
on home equity loans and assume they are all the same," said Bank
spokesman Jerome Dubrowski.
J.P. Morgan, with $112 billion in second liens, has
charged off about $2.6 billion in home equity loans this year, not including
impaired loans it absorbed from Washington Mutual.
