US Foreclosure-gate: Subprime 2 housing crisis coming?

The news broke this week on foreclosure-gate. It has been evident for a while the U.S. banks are drowning in foreclosures and this current crisis is just going to make things a lot worse. Back in 2005, there were approximately 100,000 home repossessions in the United States. In 2009, there were approximately 1 million home repossessions in the U.S. and RealtyTrac is now projecting that there will be an all-time record of 1.2 million home repossessions in the United States this year.

Vast numbers of foreclosures across the United States could be invalid because the securitization process has muddied the chain of ownership. In fact, an increasing number of judges have ruled that the "owners" of the mortgage have no right to foreclose on a property because they lack clear title. This has giving rise to a "Show me the Doc" (document for tile deed) movement to help householders restrain the banks' actions.

8 Investment Implications:
House Buyers

• Foreclosure bargains currently on the market may not be the bargains they appear if legal title is not clear.
• How will this affect the middle-upper of the property market with recent social trends to "trading-up"?

• Americans that have recently purchased foreclosed homes may now be facing some serious problems themselves enduring the uncertainty of where legal title actually resides. Managing household budgets will be thrown awry.
  

House Sellers

• Millions of Americans may now "own" homes that they do not have clear title for. When it comes times to sell those homes, many Americans may find themselves unable to do so, thereby restricting labour mobility.

Householders with Foreclosure Notices Served

• For a typical under-water US householder, there may be an incentive to just stay in one's property until a bank or "someone" turns up with the full and proper paperwork to evict. The "Show-me-the-doc" movement is now gaining traction as survival instincts are triggered with social mores thrown out.
• By not paying the mortgage, a householder may gain a "temporary reprieve" to transfer mortgage spending elsewhere.

Banks

• It will make it much more difficult for the banks to sell the massive backlog of foreclosed properties they have accumulated.
• Under current FASB accounting regulations, such loans (assets) should be marked to zero if there is no eligible legal title or in the absence of market validity. Massive write-offs could be looming. It distracts management attention from running the core business.
• How will this affect the ability for banks to sell mortgage-backed-securities (MBS) into the market?
  
• Will banks continue to hoard money and not lend as they consider all conservative means at their disposal to shore up their capital base?
  
• Should another raising of capital arise to boost their Tier 1 and 2 reserve ratios, this will cause dilution to existing shareholders.

Ratings Agencies

• Do they have any credibility left? What checks did they do to validate any of the paperwork before they issued their ratings on the mortgage-backed securities (MBS)?
  
• Warren Buffett has sold down a large proportion of his holdings in Moodys over the last 18 months.

Government

• Another test of the big banks are too big to fail may not be far off depending on the size of write-offs and how market confidence is affected.
• Is there political appetite for another bailout?
• The Federal Reserve is holding US$ trillions of MBS on its balance sheet when it bailed out these banks. One day, it has to divest itself of these. Who will want to buy them and at what yields?
  
• FDIC reserves may not be enough to absorb a wave of smaller bank failures that result from foreclosure inertia. This may necessitate more federal spending to boost their reserves and so further increase the growing fiscal deficit.
  

Lawyers

• Attorneys general in 50 states will be working together on a joint investigation into this foreclosure crisis. It is going to become much harder to get a mortgage. It is going to become much harder to buy a home. It is going to become much harder to sell a home.
• For a bank, this must be a nightmare. Loans on the books are backed by inadequate documentation. Employing low paid back-end staff to sign off mortgage approvals and which were subsequently "re-packaged" without thoroughly questioning any of the paperwork or ensuring completeness of due legal process. At best it's carelessness, at worst negligence. Defective documentation has created millions of blighted titles that could plague the nation for the next decade. Lawyers smell blood!

Economic

• This probably explains why the recent consumer spending indicators have not been worse in the downturn. Is it possible what some foreclosed householders don't pay in mortgages has been "transferred" to other items eg Walmart, iPads etc
• Over time, if this is not quickly resolved, the U.S. housing industry is likely to suffer a significant downturn due to all of this uncertainty. Consumers consume. Housing expenditures and their flow-through to related support industries (eg furniture and furnishings) transmit to the general economy.
  
• To assess if consumers hold back, Thanks-giving and christmas spending over the next two months will be key indicators to watch.

In a litigious society like the U.S., lawyers will have a field day. 2008 subprime could now morph into subprime 2 making tobacco litigation seem like a picnic.

A healthy property market is pivotal for any economy. It promotes labour mobility, greases social development and drives a steadfast flow of consumer spending.

Shorting the US banking sector (symbol:XLF, Financial Select Sector SPDR) seems a reasonable bet until clarity is achieved with this tangle of legal spaghetti. Imagine the financial equivalent of BP having many many small wells gushing oil out into the Gulf all at once and getting confused as to which ones to plug immediately. We know what happened to BP's share price in the first two months of that saga.