Tuesday, February 12, 2008

Another Week, Another Mortgage Bailout Plan

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Nanny State strikes again. The latest...
  • Bank of America Corp., Citigroup Inc. and four other U.S. lenders agreed with Treasury Secretary Henry Paulson to take new steps to help borrowers in danger of foreclosure stay in their homes.
  • Paulson and the banks offered a 30-day freeze on some foreclosures while loan modifications are considered. The Treasury chief, with Housing and Urban Development Secretary Alphonso Jackson, said today at a news conference in Washington that ``Project Lifeline'' would help stabilize communities disrupted by mortgage defaults.
  • The program is designed to help a broad range of homeowners, not just subprime debtors who borrowed more than they could afford. (huh? wait. You told us this was a contained problem, and it was just those nasty "subprime people". Funny how the truth hurts - it is worse to think they lied to us (deceit) about how bad a problem it was, or they truly had no clue (incompetence) - either way, pathetic)
  • In a statement, the banks said the program would start with a letter to homeowners more than 90 days delinquent on payments that lays out procedures for them to ``pause'' the foreclosure process. The homeowner has 10 days to respond to the notice and give additional financial information so the lender is able to weigh new payment options.
  • The Treasury chief said the six banks account for half of the U.S. mortgage market, and called on other lenders to adopt the plan as well.
  • Paulson, who as recently as last month opposed a moratorium on foreclosures, wants lenders to go beyond earlier pledges to freeze subprime interest rates for five years. The deepest housing slump in a generation is threatening consumer spending and the job market, pushing the economy to the verge of a recession.

Now, the funny thing is many of these "nasty subprime people" is they are a lot smarter than they look. They took fre money from dumb institutions (0% down!) and now instead of slaving to pay for an asset that is dropping in value by the week they are simply walking away. Downside? A hit in credit. But these were SUBPRIME folks in the first place - by definition a hit in credit means nothing. So they walk away. And will... in droves. Why struggle under a frozen rate paying $2500 a month (or more) for something that is depreciating? That's what all these plans do not get.... heck it even makes "financial" sense for many people higher in the FICO score range. Take your 1x credit hit, get it over with, rent for 3-4 years, and by year 5 you can get a much lower priced home, your credit score will have recovered 90% of the way and the % of budget devoted to housing will be far lower - rather than struggle under the weight of Atlas for next 5 years. I've written about this last fall - we have a sea change due to this stupid 0-5% down rules on mortgages. In the past, people used to give up everything else to keep the house payment going - since they actually PUT MONEY into the house. Now we have a new generation.... they put little to nothing (want a house?! 0% down and we'll pay the closing costs!) down, so they have no reason to make the house payments. So they make the car payments, and the credit card payments - and live rent free until they get kicked out. Then they will go rent again. Magic! Financial innovation at it's best! See, people on Main Street are "innovators" too.

  • Fitch Ratings, while telling investors last Friday to expect additional "widespread and significant downgrades" on $139 billion worth of subprime loans, has cited a new factor in their "worsening performance."
  • "The apparent willingness of borrowers to 'walk away' from mortgage debt," the analysts noted, "has contributed to extraordinary high levels of early default" on loans issued during the 18 months before the mortgage bubble burst. It expects losses to reach 21% of initial loan balances for subprime mortgages issued in 2006 and 26% for those issued in early 2007.
  • Such behavior, where not precipitated by willful fraud, shows that American homebuyers supposedly duped by their lenders aren't so dumb. They're perfectly capable of acting rationally without political interference.
  • A decade ago, most people started off with enough equity in their homes to make foreclosure irrational from a financial standpoint. Consider: If you made a 20% down payment on a house, prices would have to fall by 20%, almost immediately, before you lost all your money and had much incentive to walk away. This scenario was unlikely, particularly since an independent appraiser had assigned a clear value to the home. Foreclosure was remote, absent a personal financial crisis, for another reason: Every month your mortgage payment would reduce your debt and increase your equity, giving you more room for prices to fall.
  • But over the past few years -- until last spring -- banks and the mortgage-backed securities investors who bought the loans the banks packaged weren't demanding substantial down payments; they were happy with 5% or even nothing down. They also didn't worry about whether or not borrowers were building up equity. "Interest-only" loans, quick mortgage refinancings to cash out any equity, and other inventions often led to just the opposite.
  • Now the bloom is off the residential mortgage-backed securities (RMBS) rose. And some borrowers, even those who can theoretically afford to keep their homes, realize they owe much more than what comparable houses in the neighborhood are selling for -- and think that prices won't rebound anytime soon. So they're walking away, according to anecdotal reports as well as recent statements by top executives of both Wachovia and Bank of America.
  • In most cases, once a homebuyer splits, the mortgage-securities investors are stuck with the loss. In some states, including California and Arizona, this provision is the letter of the law. In others, the bank forgives the balance of the loan -- a common practice that's unlikely to change now, given the criminal and civil investigations banks are already sweating through.
  • Essentially, mortgage-bond investors, seemingly unwittingly, sold homebuyers a put option, without properly pricing it, and now homeowners are exercising that option. Moreover, prime borrowers in many markets face the same incentives.
  • Yes, this behavior is new -- but only when it comes to houses. Americans have long been able to cut their losses from bad investments and start over. It stands to reason that when the market made houses into yet another speculative investment, Americans would do the same.
  • Borrowers acted rationally in response to market forces and incentives during the bubble: Buy a house because prices always go up; you can't lose. Many are acting rationally now: Mail the keys back and un-borrow the money, because prices are sinking fast while the debt isn't. When the house was purchased not as a first home but as a rental investment, the decision is even easier.
  • Of course, there's a price. Mortgage "walkers" will take a hit to their personal credit rating. Yet this once-forbidding punishment may be discounted. That's because, just as when markets change their behavior, people change, when people change their behavior, markets change also. Many walkers are going to want to buy houses again some day; and when they do, lenders are going to want to make money lending them money to do so (hopefully requiring a good down payment). Investors searching for yield likely won't bypass what could be a large pool of borrowers.

Somehow there is some amazing irony in all this. And I ask again, all these lovely financials talking about kitchen sink quarters. Have you modeled the "walk away nation" you created in 2004-2006? Somehow, I think not.

I can just imagine the conversations:

Bank employee: Hello Mr Jones - great news! The Treasury Department has authorized me to lock in your $2500 monthly payment plan for 5 years! I realize your 4 months behind but we're gonna fix that - together!

Home "owner": Uhhh... my house just dropped in value from $425K to $350K... I think. My neighbor can't sell his for $315K. So maybe it's less. Uhhh.... I do realize my payment was going to go up to $3800 in 3 months but as you can see I am already behind.

Bank employee: Yes! Mr Paulson said it's ok! Hillary too! Let us help you stay in that home for just $2500 a month.

Home "owner": Uhhh... look lady I already have a place picked out I'm going to rent for $1100 a month. I was just going to sit here into you folks came and kicked me out. (snicker to self) And now you want to keep me here? Umm... no.

Bank employee: PLEASE!!! TAKE OUR DEAL!! WE ARE TRYING TO HELP YOU!!

Home "owner": They keys will be on the counter. I'll be out in 2 months; but you won't be seeing any money from me. So take your plan and shove it. (click)

Bank employee: *sob*

Bank employee Boss: So did you convince him to stay in the home and keep paying it off

Bank employee: *sob*

Bank employee Boss: Damnit!! Another house we're stuck with! What do we look like? Toll Brothers!!! *sob*


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