Hat tip to Simon Johnson at The Baseline Scenario.
From Dem Rep. Brad Miller of NC’s 13th District at Daily Kos:
Almost half of home mortgages in 2006 had “piggyback” second mortgages. The first mortgage was typically for 80 percent of the value of the home, and the second was for the rest of the loan. So if a borrower had no equity, the first mortgage was for 80 percent of the value of the home and the second was for 20 percent. The lender then sold the first and second mortgages separately to investment banks like Bear Stearns and Lehman Brothers, which sold bonds on pools of mortgages, like the one in the Times’ article.
Here’s how it all works: the holder of a first mortgage gets paid everything before the holder of a second gets paid anything. If the holder of the first forecloses, the proceeds of the sale pay the foreclosure costs, then the first mortgage, then the second—if there is anything left. If the holder of the second forecloses, the holder of the second pays all foreclosure costs and the holder of the first gets paid in full from foreclosure before the holder of the second gets anything.
Home values nationwide have now fallen 25.1 percent from the peak, which is probably when the second mortgages that backed the bond in the Times’ article were made.
In short, most second mortgages effectively now have no collateral. Holders of second mortgages are unsecured creditors, just like credit card companies…
It makes perfect economic sense for a safe and sound institution to avoid the ruinous costs of foreclosure by agreeing to reduce the principal and monthly payment for homeowners who can pay a mortgage, but not the one they’ve got. But according to the National Association of Consumer Bankruptcy Attorneys, fewer than ten percent of mortgage modifications in November reduced the principal. About half added late payments and penalties to the principal, and either increased monthly payments or added payments at the back end of the mortgage. If a borrower was in default already, what’s the chance the borrower can make a higher monthly payment?…
John Kenneth Galbraith wrote that embezzlement is “the most interesting of crimes” for an economist. Embezzlement is almost always eventually discovered, but for a time results in “a net increase in psychic wealth,” when the embezzler “has his gain” and the victim doesn’t miss it. Galbraith called the undiscovered and therefore unfelt loss “the bezzle.”
From Simon Johnson at the WaPo:
Starting at 10 this morning, the investigations and oversight subcommittee (part of the House Committee on Science and Technology) will hold a hearing on “The Science of Insolvency.”
Chairman Brad Miller (D-N.C.) apparently wants to explore what we know and don’t know about how to measure and enforce the insolvency of big banks – measurement is the science, but presumably enforcement is more of an art. He’s worried, as are many, that creating banks that are Too Big To Fail distorts the financial system and hurts ordinary consumers – for example, by creating the conditions for a financial crash and deep recession.
Here is Congressman Miller’s opening statement:
The factual premise of our policy to this point appears to be that our banks are facing a rough patch, since many of their assets are illiquid because there is no active market for those assets and persnickety accounting rules make those banks appear to be on shaky ground, but the assets are really just fine and the banks are too. The determination, or discovery, of value appears to be the core competency of markets, and some who now argue that the markets are befuddled in valuing complex financial assets have for years genuflected when the word “market” was spoken.
Others argue that the market is correctly valuing assets, and the problem is that the assets are simply not worth much, and that many of our banks are insolvent.
Here are the witness statements.
Recent Comments