October 19, 2020|Consumer Behavior, Credit, GSEs, Mortgage Industry, Repurchases, Servicing, Virus Response
Time travel[1] and libertarianism
In the original Terminator movie, Sarah Conner is hunted by a time-traveling cyborg (Arnold Schwarzenegger)[2]from a dystopian future where machines take over from humans. The last scene of that movie is this iconic image of Sarah as the face of human determination and personal responsibility against an overwhelming existential threat that government is unwilling and powerless to resolve. She’s the libertarian hero who knows there’s a storm coming, and only she (and her unborn son) can save the world.
Now, pretend you’ve time-traveled back to January 2020 (knowing what you know now) and you read an article about a terrible virus killing people in Wuhan, China. Would you simply turn the page thinking, ‘This virus is nothing to worry about, I can depend on government and leaders to protect me and my family from this threat.’?
Trusting government and leaders to protect you
Maybe time-travel isn’t your thing or you are woke to the overuse of “existential threat” to add gravitas to what is otherwise just a threat.[3]Perhaps your faith in the government’s competence or ability to keep you safe has not been shaken by worldwide reactions to COVID-19 or anything else that has happened in 2020 (or maybe, wisely, you never had such faith). Still, if you’ve been around the mortgage business a few years[4], you certainly remember the devastation of the 2008-2014 period. You remember the “Implode Meter”, servicing litigation (dual tracking, robo-signing etc.), multi-billion dollar 50 state attorney general settlements, False Claims Act liability, endless repurchase litigation with your former business partners over what your contracts said and who should bear the losses, crippling new regulations, and the ignominy of your business being blamed for the worst world-wide economic collapse short of the Great Depression (see e.g. The Big Short).
Is there any reason to think that Congress, the next President, or FHFA Director Calabria[5]will come to the aid of the mortgage business on the next go around?
Record production and earnings
Despite that apocalyptic introduction, right now these are the best of times for the mortgage origination business. Third quarter results are setting eye-popping records and nearly half a dozen mortgage companies have announced or completed public offerings. It is a “cyclical business”, but we somehow only seem to remember that during the tough times, making the cycles even more severe. Still, if you are working overtime and weekends to close loans, it is really hard to find time to plan for the rainy day. For example, what amount of reserves should be set aside to account for repurchase or indemnification claims in the bad times to come?[6]
Semantics about default
The storm, however, has already hit in the form of the massive job losses caused by the COVID-19 virus. Government responded with (among other things) a forbearance program that, at one point, over 8% of all borrowers took advantage of. While use of forbearance has declined as many people returned to work, there was almost $20 billion in missed payments in the third quarter and, even more sobering, July’s 120 + day delinquency rate was double the peak of the Great Recession.
Of course, many people will say that “delinquency” figures includes people in forbearance who aren’t really in default. I dispute that as a semantic perspective. Frankly, viewing borrowers in forbearance as not being in default is a dangerous denial mindset for this industry. Forbearance just means the lender is choosing not to exercise remedies for default; not that there is no default. Even though forbearance was legislatively mandated not to hurt borrowers’ credit scores[7], more borrowers are in trouble now than ever were in the Great Recession. All of them will need loss mitigation efforts to get back on track with loan modifications and repayment plans or will face foreclosure.
Kicked down the road
I’ve written extensively in these Musings about COVID related forbearance and foreclosure moratoria and how those might impact the housing market in the future[8]. I won’t belabor the point much again except to reiterate that we are kicking a giant default, foreclosure and repurchase liability “can” down the road that could dwarf the loss mitigation efforts of the early 2010’s. It would seem that lately we are all kicking a lot of cans down the road, such as greenhouse gases, Social Security and the national debt and GSE reform among others, so if you like to complain about the “younger generation”[9], don’t worry, you’ll get your revenge on them when they have to pay the bills on the checks we are writing today.
Repurchase claims on the horizon
Meanwhile, as previously discussed, FHFA Director Calabria is hell-bent on GSE privatization to get the government out of being at risk for the home finance market. That’s a worthy goal for a libertarian and perhaps our nation, but, right now, there is a clear government role to alleviate the challenges of this pandemic[10]and to support equal homeownership opportunity. Unfortunately for my clients, I expect that at some point in 2021, my repurchase defense business is going to explode (again) as the GSEs and other investors look to put back forbearance induced losses to originators and/or servicers due to early payment default or other reasons.[11]He hasn’t actually said so, but, based on his priors, I expect Mr. Calabria would encourage the GSEs to find recourse against originators and servicers for any losses they can. Hopefully, when collection and foreclosure efforts resume, however, housing prices will remain stable and won’t drop 30-50% like they did in the 2007-2012 time frame.[12] Logan Mohtashami of Housing Wire, for one, poo-poohed concerns of another housing bubble due to massive forbearance, but I don’t know what to make of his calling it “boy-band folklore and fairytales”[13], so I’m not convinced.
Be prepared
We clearly have a different cause for massive defaults this time, but even if losses are low, the servicing challenges could be much worse. For all the nightmares experienced by borrowers and servicers that led to the lawsuits and consent orders the last time, to staff and perform the kind of individualized compassionate and compliant loss mitigation that will be expected in the months to come is a tall order. This will be a massive servicing project requiring staffing, technology and clear government programs (and perhaps regulatory flexibility) to implement. Mortgage lender are not facing an existential threat akin to the dystopian future of the Terminator, but the outcome of this mess is far from certain.
[1] Perhaps you missed the important discovery that time travel is possible. Per Wikipedia, “time travel to the past is theoretically possible in certain general relativity spacetime geometries that permit traveling faster than the speed of light, such as cosmic strings, transversable wormholes, and Alcubierre drives”. So, it could happen. Just don’t ask me to explain it. I got lost after “theoretically possible…”
[2] This recent video from Arnold shows that his accent is not only a cyborg-sounding voice.
[3] Sarah Conner faced an actual existential threat. The COVID-19 virus is a real-life existential threat. That is why I used those analogies. Still those words together are like “grave danger”. Col. Jessup asks, “Is there another kind?”.
[4]Why else would you be reading this? (family, friends and masochists excluded).
[5]Calabria is also a libertarian hero, but not quite Sarah Conner level.
[6] There are people who can help with these questions.
[7] Creditworthiness is going to be impacted regardless. See, e.g.,https://mortgagemusings.com/f/forbearance-trust-credit-scores.
[8]See also, supra.
[9]You know you’re old when you complain about the “younger generation(s)”.
[10] Philosophically, I tend to lean libertarian too, but believe that some limited government intervention and regulation in markets is necessary to further social objectives (like dealing with economic fallout from a pandemic) and to ensure market fairness and efficiency.
[11]See https://mortgagemusings.com/f/edition-6-ensuring-gse-pandemic-losses-repurchases-reduxThe GSEs (under the current leadership of the FHFA) and other investors will claim that every 2020 originated loan that went into forbearance is an EPD. They will also claim such loans have life of loan recourse. I believe that position is wrong due to the moral hazard created by forbearance and other reasons, but I have no doubt this will be the position most investors will take. EPD is the tip of the repurchase/indemnification spear originators will face in 2021 and beyond.
[12]There is a direct correlation between housing prices and repurchase/indemnification losses. There is simply no need to indemnify (or repurchase) if there is no loss incurred or expected.
[13] I like using metaphors and analogies to illustrate a point too, but the right one for Mr. Mohtashami was probably the Chicken Little story. Reference to “Boy bands folklore and fairytales” to highlight housing bubble doomsayers was completely lost on me. Do boy bands even have folklore? Anyway, I hope Mr. Mohtashami is better at predicting the housing market than at using illustrative metaphors.