Dear Mr. Buffett_ What an Investor Learns 1,269 Miles From Wall Street - Janet M. Tavakoli [49]
In some parts of the Midwest every third home is vacant in minority neighborhoods. Housing prices have plummeted. Fixing the problem for innocent homeowners will mean losses must be born by lenders, including subprime mortgage bankers, investment banks that provided financing to the mortgage bankers, and the investors in subprime mortgages and securitizations backed with subprime mortgages. There is no reason for U.S. taxpayers to bail out the sophisticated financiers.
It is counterintuitive, but limiting losses by reappraising and rewriting mortgages would result in a higher recovery rate that would be good for everyone and limit overall losses.
Servicers collect and record loan payments and credit loan accounts. In the summer of 2007, a major Midwest-based servicer of mortgage loans told me the rating agencies’ subprime recovery rates were much too optimistic.The servicer said modifying a mortgage was highly preferable to recovering zero or negative value after foreclosure fees and depressed asset prices took their toll on recovery of relatively low loan balances. These were geographically diverse U.S. subprime loans, but they were alike in risk characteristics.The servicer’s staff worked frantic 13-hour days to salvage value. The servicer underreported delinquencies, overdue payments, which were usually reported one month behind prime mortgages already. The day a homeowner missed a payment, the servicer got on the phone trying to work out a new deal. The servicer allowed skipped payments and did not report them as delinquencies. The servicer discovered that if homeowners missed two payments, the loan was virtually doomed to default because most homeowners gave up after that. It aggressively “re-aged” mortgages—ignoring missed payments urging borrowers to make even one payment so the loan could appear alive. If this practice was typical, the scope of the subprime problem was underreported.The servicer restructured loans doomed to fail in the future. It sold loans for pennies (3 cents to 6 cents) on the dollar. Some of the loans had negative equity (the homeowner owed more than the home was worth) at the time of delinquency. The servicer avoided foreclosure, because legal costs relative to low loan balances and long delays ate up more money than it recovered. Assets included trailers, mobile homes, and homes in areas with depressed prices.
If this sounds odd, consider that in 2008 a plethora of banks started reclassifying loans on their balance sheets (Astoria Financial,Wells Fargo & Co., and others) or began using more optimistic data (Wachovia Corp. and Washington Mutual). If you don’t like the numbers, just change the definition. In July 2008,Wells Fargo stock price jumped 33 percent when its losses were less than expected, but it announced that, as of April 2008, it would wait an additional two months before writing off a loan (180 days instead of 120 days) saying it did not affect its earnings announcement. At the time Wells Fargo’s portfolio of home equity loans was $83.6 billion and it was showing signs of stress.2122
JPMorgan Chase’s CEO Jamie Dimon is a master at balancing the short game of earnings announcements with the long game of running a bank. He steered away from most of the mortgage madness, but announced that “jumbo” mortgages (large balance mortgages to good credits) showed increasing losses. Dimon announced that these prime mortgages to the bank’s best customers had losses of 0.95 percent (up from 0.05 percent the prior year), and the losses could triple. For example in California, housing prices had collapsed leading to higher loan losses even for prime (good credit) borrowers. He said JPMorgan may have waded back into the mortgage market early: “We were wrong.We obviously wish we hadn’t done it.”23
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