Is a Horde of Deadbeat Borrowers Again Walking Among Us?

In 2022, a San Ramon, California, couple who hadn’t made a mortgage payment since 2009 was finally evicted. Anita and Mahesh Khurana had put on a masterclass in the use of the courts to keep foreclosure at bay. The holdouts had lived in their home payment-free for 13 years. A state court finally ruled they had exhausted all appeals, and they were ejected.

In 2021, Congress and the Biden administration began creating programs to win over allies in the housing sector, letting future leaders deal with the clean-up. A new wave of deadbeat borrowers – some having learned from the Khuranas’ maneuvering – are walking among us. You can see them catching flights at airports worldwide, checking into luxury hotels and taking Ubers to cruise ship embarkation terminals.

Experts who looked at the Khuranas court filings told Kate Berry with the publication American Banker that the holdouts were extremely innovative in avoiding foreclosure on their $1.7 million home. They had made six payments on their mortgage in 2009 and then stopped cold.

Deadbeat borrowers exploit the system The Khuranas’ genius and tenacity aside, there are signs of a new horde of deadbeat borrowers, but the foreclosure filings are being delayed and masked by the government itself. Some of the current deadbeat borrowers will learn to expertly work the system, like the Khuranas, and avoid housing costs well into the 2030s. Others will plow their winnings into less brilliant legal strategies and simply settle for a few years of free housing. In the aftermath of the 2007-2008 financial crisis, every American knew someone who had simply stopped making payments and was living rent-free for months, and then years. Many took trips of a lifetime with the money saved.

After flooding borrowers with new lending, the administration now looks to be extending payment deadlines, providing forbearance and instructing mortgage giants to quietly sell properties with nonperforming loans at $0.35 to $0.50 on the dollar to private investment companies and nonprofits willing to play along politically. These homes are not repricing in the marketplace as they should. They’re being rented, taken out of circulation.

It’s hard to cut through the misleading jargon and omitted information by Freddie and Fannie to know what’s happening with nonperforming and so-called “reperforming” loans, but the Federal Housing Administration, which also guarantees mortgages, is a government agency, so there’s more transparency. It offers clues.

In its National Delinquency Survey, the Mortgage Bankers Association reported in the first quarter of 2024 that almost 11% of FHA-insured loans were delinquent (along with nearly 5% of all VA loans). This should be shocking to all Americans.

Since 2020, the FHA has insured $1.18 trillion in new mortgage originations. The FHA’s average loan amount for forward mortgages in fiscal year 2023 was around $265,000 per mortgage. That’s about 4.45 million individual mortgages if you do the math. If 11% of its loans are nonperforming, it implies the owners of 489,500 individual homes are on a clandestine federal welfare program in which each household is receiving an average of over $21,000 annually in free housing. By not allowing homes back into the market to reprice, the FHA is helping jack up home prices for everyone in the process.

Fannie recently reported its conventional single-family “serious delinquency rate” was just 0.55%, and the multifamily “serious delinquency rate” was 0.46%. Freddie reported its “serious delinquency rate” at 0.55% for single-family properties and 0.28% for multifamily properties. These rates are preposterously low.

With the politics-infused Fannie and Freddie, it’s a near impossibility that the actual delinquency rate would be less than the FHA’s. Along with the politicization of the twins has come the gutting of underwriting standards.

The twins have been quietly purging pools of nonperforming loans from their books or holding the loans under misleading labels, such as “reperforming.” In the past, both entities have been caught using accounting strategies that underreported expenses and inflated income. If Fannie and Freddie are deceiving the public, it wouldn’t be the first time.

“When I was at Fannie Mae in the aftermath of the financial crisis,” said Brian Jarrard, now a real property appraiser in Georgia, “the estimated cost to remove a single nonperforming loan from the portfolio of a mortgage-backed security was between $50,000 and $100,000. That could easily be double today.”

The restrictions in fine print placed on the purchasers of Freddie and Fannie’s nonperforming loans offer a big clue as to what the twins are up to in staving off foreclosures of botched mortgages. As damaging as it will be, these foreclosures need to occur as part of a healthy market and to relieve upward pressure on home prices. Since these individual homes are not being offered to individual buyers, it’s keeping all homes from repricing. It’s subverting price discovery and it’s contributing to the current housing bubble.

Since Covid, Fannie alone has auctioned off dozens of pools of nonperforming and so-called delinquent “reperforming” loans.

Many of Fannie’s nonperforming loan sales require the buyer to offer loss mitigation options designed to be “sustainable” for borrowers. We know from experience what this means. All buyers of nonperforming loans are required to honor any approved or in-process loss-mitigation efforts at the time of closing, including forbearance, principal forgiveness, loan modifications and first right of refusal to owner-occupants and nonprofits before the properties can be sold to individuals who need those homes. This is a recipe for fraud.

We know that since 2010, the Federal Reserve has been purchasing mortgage-backed securities from Fannie, Freddie and the Federal Home Loan Bank. Prior to 2009, the Federal Reserve’s assets were almost entirely Treasury securities.

Earlier in the month, the Federal Reserve reported it held $2.3 trillion in mortgage-backed securities. (That’s the face value of the remaining principal balance of these mortgage-backed securities.) The Fed’s holdings of these ever-more-dubious securities began to decline but then shot way up during the early days of the pandemic.

“I question how much equity the underlying homes in these securities actually have,” said Jarrard. “This would directly impact the current rating of the security, not to mention the full faith and credit of the United States. I question the amount of unrealized losses they contain,” he said.

“Congress has allowed this artificial market at the Federal Reserve to exist. It accommodates Fannie and Freddie. There is no longer an alternative secondary market for these securities other than the Federal Reserve. There is no other party capable of shouldering that amount of debt, in this case, $2.3 trillion.”

Jarrard said he has personally met with congressional staffers, raising concern that this debt level is beyond the remedy of the types of bailouts seen during the Great Financial Crisis.

Both Freddie and Fannie have a history of lying to Congress, investors and the public, from hiding the trillions they held in toxic Alt-A loans, stated-income loans and negatively amortizing loans, and publishing misleading studies, such as a recent politics-inspired study that damaged the reputations of 80,000 state-licensed appraisers (the study has since been discredited and debunked).

The twins have also been selling junk-rated default swaps called CRTs to unknown counterparties. More than a decade ago, AIG required the third-largest taxpayer bailout of the financial crisis as a result of similar swaps. Fannie also recently stonewalled a Maryland state task force after inquiries regarding its computer valuation models.

The mortgage giants have also been pushing to eliminate critical checks and balances in a radical experiment with U.S. taxpayers’ money and the U.S. economy. The twins began scrapping or weakening long-accepted underwriting safeguards like standard FICO scoring, title insurance, mortgage insurance, downpayments and appraisals. In 2008, Americans bailed out the mortgage giants to the tune of nearly $200 billion.

One of the most disturbing new developments at Freddie and Fannie is the censorship of appraisers. Freddie, in particular, is actively censoring appraisers for the use of words like “crime,” “graffiti,” “student,” “preferred,” “school district,” “well-kept,” “desirable,” “undesirable,” “good” and “bad” in appraisal reports. Also being censored are words any economist, financial analyst or market observer would use like “high,” “low,” “strong,” “weak,” “slow,” and “rapid.” Many puzzlingly innocuous phrases like “convenient to” are also being censored.

The new policy is contained in Freddie’s Soviet-like directive “5603.4 Unacceptable Appraisal Practices.” Its aim is to silence appraisers and cow them into sidestepping critical adjustments and rubber-stamping values to make deals work.

You simply can’t make this stuff up.

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Jeremy Bagott

Certified General Real Estate Appraiser at Bender Rosenthal Inc

Jeremy Bagott is a real estate appraiser and former newspaperman. His most recent book, “The Ichthyologist’s Guide to the Subprime Meltdown,” is a concise almanac that distills the cataclysmic financial crisis of 2007-2008 to its essence. This pithy guide to the upheaval includes essays, chronologies, roundups and key lists, weaving together the stories of the politics-infused Freddie and Fannie; the doomed Wall Street investment banks Lehman and Bear Stearns; the dereliction of duty by the Big Three credit-rating services; the mayhem caused by the shadowy nonbank lenders; and the massive government bailouts. It provides a rapid-fire succession of “ah-hah” moments as it lays out the meltdown, convulsion by convulsion.

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