US Mortgage foreclosure (repossession) problems mount to crisis levels: over to you Ben Bernanke!

We saw yesterday a quiet day in world equity markets with the Dow Jones Industrial Average falling one point to 11,094. However yet again there was action in the currency world with the Japanese Yen strengthening against the recently weak US dollar rising to 80.89 at one point which of course is a fair bit higher than the level at which the Bank of Japan chose to intervene at on the 15th of September. The situation has improved a little from the lows as this exchange rate now stands at 81.25 but troubles remain, combining this with fears about capital raising from Japan’s banks led the Nikkei 225 equity index to drop by some 83 points to 9500 this morning. This leaves the spread between it and the Dow Jones wider at 1594 points or 16.8% of the Nikkei’s value.

Today will see a speech from the Chairman of the Federal Reserve Ben Bernanke and all eyes will be on it particularly as it is titled “Monetary Policy Objectives and Tools in a Low-Inflation Environment”. There are also figures for consumer prices and retail sales due in the United States today but we received some more information on the US economy yesterday and I also wish to take a look at the mortgage foreclosure scandal which is beginning to have a real impact in the US. I do not mean on the mortgage market it was already having that I mean on banking stocks which came under pressure yesterday as some of the implications were digested.

The Mortgage Foreclosure scandal in the United States

In essence the situation here does not involve the mortgage holder as it impacts on them but does not involve them so if we leave him or her for the moment and look at the mortgage itself we get the following. The problem comes with the way that mortgages were securitised. You see every time ownership in a mortgage changes (meaning the title holder collecting payments) paperwork must physically change hands. Because of the trading in such securities it has been estimated that the title to these mortgages will have changed hands an average of four times and up to ten times in some cases. When a review was completed it became clear that some mortgages has been foreclosed upon when the ownership of the title can be questioned and accordingly questions were raised as to whether this was illegal. When US banks and mortgage companies realised this they did the following they tried to deal with it by hiring lots of people who lacked legal skills or experience to get affidavit’s signed to try to clear up the problems with property title.

This may look like it would solve the problem but oh no. First, it would appear that many of the individuals signing these affidavits had no knowledge of the matters in question despite the fact that they were legally swearing that they did. Second, the affidavits may be irrelevant because the issue is not that the documents were lost but they were never properly transferred at each step of the aforementioned securitization process.

As you can imagine this has quite a few implications for the US mortgage industry. One is that the foreclosure process has been halted in many states and  many banks have stopped theirs too. This means that such properties cannot be sold as there is doubt as to whether any new purchase would be legal.  There is a further problem as many US mortgages have a  caveat that if something was not processed properly at origination or in the paperwork, the mortgage can be put back to the original seller.

As you can imagine this puts the US mortgage industry into a crisis and its attempt to fix this has only made it worse returning to a theme of these times of official and institutional incompetence. The US legislature has tried to step into the crisis as the Senate and the House of Representatives passed a bill to in effect suspend US law in this respect presumably on the basis that political classes like these days of suspending things which are inconvenient. However the President sent it back and it is to his credit.

Scale of the problem

This only affects mortgages or mortgage chains so new builds are not affected by it. However according to the real estate data company RealtyTrac Inc banks were expected to take over a record 1.2 million homes this year, up from about 1 million last year. So the potential scale of this problem is huge as some of these will be links in the chain for other house purchases.

Implications of the problem

The scale of the problem is only just beginning to be realised for example take a look at this from the Washington Post.

In Georgia, an employee of a document processing company, Linda Green, for years claimed to be executives of Bank of America , Wells Fargo, U.S. Bank and dozens of other lenders while signing off on tens of thousands of foreclosure affidavits. In many cases, her signature appeared to be forged by different employees.

 And perhaps in a moment of guilt she did this:

Green also submitted to courts documents that listed “Bogus Assignee” as the owner of a mortgage instead of the real name

There are clear implications here for the US mortgage industry and her banks and they could be very expensive. Even on more optimistic scenarios they are going to run-up large legal bills! There is a danger of the mortgage industry grinding to a halt and a danger of yet again the banks having to take large losses. The mortgage-backed securities market or MBS now has a lot of doubt put upon it as to what the underlying mortgages may be worth or if they are even legal. This is an enormous market estimated at around US $14 trillion.

The Federal Reserve

In its attempt to shore up the US financial system the Federal Reserve bought some US $1.5 trillion of MBS’s and many US taxpayers may well be wondering exactly what these are now worth. There already was some doubt but now there is a lot more. From time to time I discuss the credit rating of central banks as it is plain that expansionary monetary policies have reduced them.Plainly that of the Federal Reserve is falling as this crisis spreads and it may well now be competing with the European Central Bank at the bottom of the pile.

Theoretical Economics

Some types of theoretical economics have been predicated on what is called a risk-free interest rate. This was usually assumed to be a sovereign interest rate and perhaps the US may have been advanced as it. However this crisis and the fall in the effective credit rating of central banks means that this is another section of theoretical economics that at a minimum needs reviewing and in truth is likely to have bitten the dust.

Also we have an impact on pricing theory. This foreclosure crisis comes as mortgage rates particularly fixed mortgage rates hit new lows, for example Freddie Mac reported that the  30-year fixed-rate mortgage rate now averages 4.19 percent  down from last week when it averaged 4.27 percent and this is a 50 year low. So prices would be predicting a surge in mortgages and remortgages but yet again we are hitting supply problems with the latest being the foreclosure crisis.

Latest US Economic data

This too was somewhat problematic yesterday. Initial jobless claims rose from a reported 445,000 last week to 462,000. Also in a sequence which now represents 24 out of the last 25 reports last week’s figure was revised higher to 449,000. The four-week moving average edged higher by 2500 to 459,000 so the improving trend seems to be ending. In addition US producer prices rose by 0.4% in September which was caused by food and fuel prices. As an aside here this is higher than what was expected so yet again we are back to my theme of what do these guys actually expect? Increases in food prices and fuel are hardly a surprise if you look at the trends and commodity prices.

The trade balance was also higher than expected at some US $46.2 billion. Regular readers will know that I have little faith in the accuracy of trade figures on a monthly basis so I usually look at the three-month average although rather oddly this in a fluke of statistics turns out to be US $46.2 billion too!  This number is also turning upwards and appears consistent with the charts on the official report which go back to August 2008.

Perhaps more insight can be gained by the figures with China where imports measured US $35 billion whilst exports measured a mere US $7 billion. Even trade figures are unlikely to be wrong by this amount and these figures do have some support from anecdotal evidence. My point here is what can we reasonably do about such a gulf? In a way this number in itself is a signal of US economic problems and also is a sign of the issue right at the heart of the current currency war.

The US administration’s attempted solution appears to be to try to reduce the value of the US dollar.In this they are having some success as I have reported but the problem is that the gap is so large and that changes in short-term exchange rates have a much weaker effect on trade balances than many economics text-books assume as my country the UK has often found to its cost. If there is to be any real impact then the lower exchange rate will have to be maintained for some time which of course is unfortunate as we look like we may be at a nexus for economic events implying that time is short.

After mentioning Ben Bernanke’s speech today I guess it is now over to you Ben………..

The UK Monetary Policy Committee

There was a speech given by Andrew Sentance which is the polar opposite to that recently given by Adam Posen. In it to give a flavour he said the following.

If we continue to experience above-target inflation, while the MPC sets policy to head off the opposite risk – of deflation – confidence in the inflation target and the credibility of the MPC risk being eroded…. “The longer the period of above-target inflation goes on without any policy response, the greater this risk becomes.

This morning he has got some support from previous members of the MPC as Deanne Julius and Rachel Lomax have both suggested that they would not be in favour of more monetary easing either. So the MPC has at least three camps at this time.

Sadly for Mr.Sentance it is my opinion that the MPC has long-lost its credibility reminding me of the saying that central banks like old generals always fight the last war.