So Let’s Say the Housing Market Crashes and Burns…

[mydogsarelazy]

Hi Everyone,

There seem to be some saavy folks here, and I have a few questions for you all.

Lets say that housing goes down drastically and significant numbers of homes go into repo…

1) Who ultimately holds all the debt? Chinese Bond holders? American Bond holders? Banks? Mortgage Companies? To put it another way what nations and institutions would be most stressed?

2) What happens when a homeowner who is significantly upside-down (let’s say $75k) declares bankruptcy? With the new bankruptcy laws is he/she likely to be told by the court “you will need to keep paying on this?”

3) Tell me anything of interest about the financial ripples of a meltdown.

I am enjoying this forum!

JS

[waiting hawk]

1) Who ultimately holds all the debt? Chinese Bond holders? American Bond holders? Banks? Mortgage Companies? To put it another way what nations and institutions would be most stressed?

All of them, probably the foreign banks would be most upset if it “did” meltdown and our US dollar took a dive.

2) What happens when a homeowner who is significantly upside-down (let’s say $75k) declares bankruptcy? With the new bankruptcy laws is he/she likely to be told by the court “you will need to keep paying on this?”

If people do not refinance they can walk away from the home without recourse except on credit. Once they refi or HELOC (home equity line of credit-home ATM), banks can take them to court and actually have peoples wages garnished to where you can never get rid of it like taxes.

3) Tell me anything of interest about the financial ripples of a meltdown.

A meltdown in homes where you could pick them up for 100k means that 80% on this board would be jobless and paying 400% more in necessary consumption goods (energy, food, and gas). A price reduction and small recession would be ok but a meltdown I do not hope for.

[SDLaw06]

God help a meltdown, we would all be in a world of hurt, even the ones in good shape now.

[SD Realtor]

I’ll try a bit to…I am way out of my league even trying to answer these questions but I will be in San Jose tomorrow so I am procrastinating at the moment…no warranties on my answers and they will most likely be corrected by those in the know…

Who ultimately holds all the debt? Chinese Bond holders? American Bond holders? Banks? Mortgage Companies? To put it another way what nations and institutions would be most stressed?

– The debt for mortgages are held by whoever currently is servicing that mortgage. Many mortgages are established by a lender or mortgage company and then sold. So when a mortgage is defaulted on, whoever is holding it is boned.

– American or Chinese Bond holders needs to be clarified. If you are referring to people who own 10 or 30 year treasuries, these are NOT mortgages or trust deeds. Treasury notes are bought and sold on the open market and are used to finance federal debt. They are independent of mortgages. (Someone correct me on this as I am at the limits of what tiny tidbits I know about these types of securities)

Now how the holders of these securities are affected by the housing market is TBD.

Now there are lots of other bonds… take muni bonds for instance. Lots of people have those, like my parents. Well remember when the OC went belly up a few years back? Well bond holders for OC municpal projects were S.O.L. I do not know if they were re-imbursed by the state of California or not.

I will defer to waiting hawk on the answer to your second question. From his answer is seems if you default on your primary mortgage then it sounds like the lender cannot go after you. I do not know if you need to go through and declare bankruptcy or not to make sure they stay off your back.

Also I don’t know if that applies to a short sale.

[Doofrat]

From what I understand, you can’t just walk away from the primary loan either. Say you owe $600,000 on the loan and you walk away. The bank forecloses and auctions your previous home for $480,000. The bank cannot come after you for the $120,000, but I believe they are required to send the IRS a 1099-C for the $120,000 of cancelled debt which is considered a gain to you.

See requirements for 1099-A and 1099-C in regards to property abandonment and debt cancellation:

http://www.irs.gov/pub/irs-pdf/i1099ac.pdf

[waiting hawk]

Doofrat ur right I totaly spaced on that. I think that you have to add that to ordinary income making it a mess at tax time. Geez people really didn’t know what they got themselves into..

My website tracking Temecula and South Riverside County

[ybc]

Who holds mortgages and therefore get hurt by a housing price downturn?

– mortgages used to be held by financial institutions (banks, S&Ls) that originated them. But in recent years, more and more of them are packaged into mortgage backed securities and sold to investors, including foreign investors. So if a downturn does occue, the pain will be more spread out, hence less severe at the investor level. Nonetheless, that will drive up the interest rate that investors demand, thus the mortgage rate.

— but there are twists here. For mortgages to be sold, it typically has a guarantee, and Fannie Mae and Freddie Mac have the largest market share that offer mortgage guarantees to conforming loans. Because Fannie and Freddie are government sponsored entities, that give investors the perception that mortgage debt has the implicit US government backing, so that reduces risk in buying mortgage backed securities guaranteed by Fannie and Freddie.

— In order for Fannie and Freddie to give that guarantee, it requires that Loan to Value ratio be lower than 80%. If a 20% downpayment is not made, then mortgage insurance is required in order to get that guarantee. PMI is the largest mortage insurance company in the US, I believe.

So consider that PMI and Fannie and Freddie are buffers to absorb shocks. They are in the front line. Mortgage insurers are the first.

But then another twist is the widespread practice of using piggyback loans to satisfy the 20% downpayment requirement and avoid paying mortgage insurance. So a layer of buffering is removed. In addition, some mortgages are so risky that it’s difficult to securitize them, and they are held by originators.

So who’ll get hurt? Mortgage insurers, banks and mortgage companies that issue a lot of piggyback loans, banks and mortgage companies that hold on to risky loans; Fannie and Freddie (partly because they hold a lot of mortgage backed securities themselves, the guarantee business starts to suffer then price goes down more than 20%, but that’s unlikely because they mostly only guarantee conforming loans, which means that they’d have low exposure to high priced areas like California)…investors who bought the less risky taunches of mortgage securities won’t likely lose their principle if they hold on to maturity.

[powayseller]

I’ve been unable over the past few months to satisfy my own questions about the impact of widespread foreclosure on the MBS market. Who holds MBS? Your mom’s pension fund, your own pension fund, foreign central banks, GSEs, everyone…. I bet even your money market account holds Fannie Mae short term debt, which holds MBS. This is a global holding. The problem is that the global liquidity was so huge, that investors did NOT demand the necessary risk premium for these loans.

The proper interest rate an investor should require on an ARM is not 1% over prime, but 3% over prime, and 5% over prime for a subprime borrower. I’m making up numbers, but you get the point… The investor was not compensated for taking on the risk of I/O, 100% financing, subprime, or any of the other risk layers.

Derivates, CMO (collateralized mortgage obligations), MBS, GSEs, all this is going to be a huge mess, and according to the Fed research papers, can cause a systemic financial crisis.

For more on this, read my post Sell Now, from last spring, which is a summary of John Talbott’s book. He delves into the impact of a financial meltdown of the GSEs and a recession, brought on by the housing bubble.

But this whole MBS problem is a little discussed problem. It is just like $100 oil. The people in charge of buying and drilling oil have known for decades that we are at peak supply, and demand is rising and won’t drop, yet they didn’t warn anyone or do anything about it. Same for the tech stock bubble, the housing bubble. Government, Wall Street, and the media have failed us time and time again. Our only real source of information is blogs, because we can share what is really going on, not what the government data is trying to tell us.

Good questions. If you get the answers, please come back and share. And search the archives, because I made some really good threads about Fannie Mae failures and MBS in the spring.

[waiting hawk]

PS, Can you imagine if people had to use their HELOC Visa cards to fill up their tank???

My website tracking Temecula and South Riverside County

[Anonymous]

Banks will have tons of houses on their hands. They will force quick sales and the government may need to bail them out like in the savings and loan crisis of the 80’s.

When homeowners will be upside down they will say, “why am I working hard to pay the mortgage and will simply let the house go into foreclosure.

I believe there will be a recession in 08, many loan brokers, realtors will be layed off etc. Investors will have a good time though snatching up all the foreclosures.

In L.A. where I live almost everyone I know is in an ARM loan because they can not afford the smallest of houses at more then half a million dollars!

[Author]

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