Foreclosure Crisis Requires Creative Thinking

As I caught up on my New York Times reading over the weekend, I was struck by how consuming an issue this foreclosure legal mess has become.  It is on the front page, on the Op-Ed page and on the inside.  Well summarized in newspapers and well noted in the blogosphere.

This issue has progressed beyond the economic or financial and has become a political issue.  The fact that one of the most populist presidencies in recent memory has publicly stated their views on the mess (no need to halt foreclosures in a blanket fashion – which is sensible) and has been publicly opposed by all 50 states’ attorneys general is remarkable.  The group of state AGs includes people of all political stripes.  They have made it a political issue.  We read about it in the papers.  We hear confirmation of it in the market from our partners in the foreclosure industry.  In contrast to their thinking a few months back, banks today are desperately seeking a way to avoid foreclosure and a way to retain some homeowner dignity so they don’t turn around and make life miserable for banks.

This particular issue of robo-signing of foreclosure papers is one of those watershed events that historians refer to.  It changes the urgency of the debate.  The seemingly technical problem resonates with people in a way that other types of mortgage fraud do not and is evidence of the anti-foreclosure pushback out there.  This issue does not go away.

Yet no one wants a blanket “amnesty” on mortgages via a nationwide reduction in mortgage principal balance and a lowering of rates, as that rewards bad behavior, and the number reach to the many trillions.  We can’t reward bad behavior by accepting arguments to give all borrowers an amnesty with lower rates, principal forgiveness or both.  Some yes, all no.  But something must be done.  Punish, if you will, poor financial judgment on behalf of the lenders, the borrowers and the markets, but let us avoid bringing down the economy simply to “let the market clear”.  The market solution, a foreclosure, is often a dysfunctional outcome, especially today, when so many foreclosures are expected to occur.

The numbers are staggering.  As of the end of September 2010, according to Lender Processing Services, seven million mortgages were 30+ days late on payments, over two million had foreclosures that had commenced, and over four million were in default pre-foreclosure, with over two million of those 90+ days late.  Foreclose on a small number of homes, and the market and society can absorb the hit but when foreclosures become the norm in places, then the market seizes up and society cannot absorb the resulting economic and family displacement.

Think back to late 2008.  The expectation in the market was that housing would get worse but that the Fed would lower borrowing rates, that some combination of foreclosures and delaying recognition of lender losses would fix the problem.  What happened?  The lowering of rates and pumping in of liquidity has given rise to excess liquidity in parts of the housing market where it is not needed (note exceptionally low mortgage rates for those who qualify), and a complete rationing of credit where it is desperately needed (note how hard it is to actually get one of those mortgages).  Existing foreclosure and pre-foreclosure programs have not worked.  A number of us explicitly stated that serious, scalable and fair foreclosure alternatives had to be adopted that could solve the problem of people with job insecurity in homes with negative equity.  The solutions we saw in the marketplace gave us a sense that would prove insufficient and were poorly implemented.  We were right.  That annoys me.

This should be — and is — a time for some creative thinking.  This is the issue of today.  It is more immediate than deficits, trade and even the securities markets.  This hits us directly through an asset that is typically our largest “investment”.  Smart solutions, and there are a few out there, will strengthen the American Dream.  Conventional answers will not.  As concerned citizens, we should not accept intellectual inertia on this issue.

S. Jafer Hasnain is a Managing Partner of Lifeline Assets, a Chicago-based real-estate private equity firm which he co-founded in 2008.  Mr. Hasnain was previously a portfolio manager and analyst at AllianceBernstein for 14 years, with stints at Merrill Lynch, Citibank and Goldman Sachs prior to that.