Only one day to go until ‘the cuts’.
It’s like the mirror image of Christmas Eve. Instead of getting presents, tomorrow we’ll wake up and find out about all the things that the government is planning to take away from us.
I’m not going to waste your time here by speculating on what might happen. Obviously we’ve already seen several changes announced, but you never know what they’ll pull out of the hat on the day.
The key things to watch will be how the pound and gilts react. If the cuts are less violent than expected, we’ll see a weaker pound, higher gilt yields and probably a relief rally in stocks. If they’re tougher than expected (though that seems unlikely), the opposite will happen.
In the meantime, let’s take a look at something completely different – this US foreclosures business. It’s been bubbling away in the background, but there’s every sign that it won’t stay that way…
The foreclosure scandal: what’s going on?
Given the damage that the sub-prime crisis did to the rest of the global economy, you’d think that further problems in the US mortgage market would make front-page headlines across the world.
So far, that’s not been the case. The US media is getting het up about the ‘foreclosure scandal’ (foreclosure is the same as repossession in the UK), but we’ve not read a huge amount about it over here. That could change, depending on how serious things become.
So what’s going on?
A quick recap: the boom in property prices, and the availability of credit to buy property, was fuelled by ‘mortgage securitisation’. This was the process of packaging up home loans and selling them on to investors, rather than keeping them on banks’ balance sheets.
That all sounds very abstract. But of course, there are back office processes involved in doing all these clever financial things. Someone has to dot the ‘i’s and cross the ‘t’s, and do all the paperwork every time one of these things is sold and bundled up.
If you’ve ever worked in any sort of business, you’ll know yourself that sometimes in busy periods, the sales team charges ahead of the company’s general ability to process the deals they’re making. The more complex the administration process behind the deals, the more of a problem that can become.
Now, if you’ve ever bought a house, you’ll know that it involves a lot of paperwork. And if you’ve ever then sold your house, you may have had the occasional worrying moment when no one could quite locate a critical piece of paperwork, like the deeds to your house, say.
Why the paperwork really matters
Well, when you chop up all these loans, the paperwork gets really complicated. And in the rush to make all these sales, people got sloppy on the administration side. The long and the short of it is that the piece of paper which explains who the homeowner actually owes money to for the home loan, isn’t correctly filled in. To use the jargon, the “chain of title” is broken.
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This isn’t a problem as long as no one is worrying about the paperwork. After all, you buy a house, you pay the bill every month – you aren’t fretting about the ultimate recipient of that money.
The trouble arises when suddenly you, the homeowner, can’t or won’t pay your bills any more. So someone has to throw you out of your home and attempt to sell it to recoup the money. It’s at this point that all the paperwork starts to matter again. Because to sling someone out of their house, you need to prove that you own it in the first place. And you can’t easily do that if the “chain of title” isn’t intact.
That’s the first big problem. The next big problem is when you start getting too many foreclosures to deal with, as a result of house prices collapsing and people losing their jobs left, right and centre. So banks hired “foreclosure mills” to process all these evictions. As John Mauldin points out in his latest newsletter, these were the first to spot the broken chain of titles. And it turns out that in some cases, the foreclosure mills decided to – not to put too fine a point on it – falsify documents in order to ‘repair’ the chain.
So how big a deal is it? At first glance, it’s perhaps not that significant. Bank of America yesterday said that it plans to restart the foreclosure process next week, having halted it temporarily to review its procedures. At the end of the day, as Mauldin puts it, this is something that should be resolvable using common sense: “Someone borrowed money for a home loan. Some entity is cashing a cheque if that person is paying. That entity should have the title until it is paid off.”
Are banks about to face a legal fiasco?
That’s all very well. But when the legal profession gets an issue between its teeth, common sense can sometimes go out of the window. As Kevin Hassett puts it on Bloomberg, “the only thing between banks and a humungous legal fiasco is the possibility that trial lawyers and state attorneys general will show restraint. Ask tobacco companies how that might work out.”
We suspect that if it looks as though things are going to get seriously nasty on this front – adding up to serious losses for the banks or even threatening the US property system – the US government may have to step in.
We’ll be keeping an eye on the story as it develops. But as my colleague David Stevenson noted last week, US property prices are going to remain under serious pressure in any case. All of this just adds to the case for staying cautious and avoiding the banking sector.
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