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Sunday, March 09, 2008

Barney Frank's Bailout Idea

I just finished reading Barney Frank's housing bailout idea, and it's clear he doesn't understand a lot of the mess housing is in.

First, he gets a few things right. Many folks did act imprudently when getting loans for houses, and some lenders did act stupidly as to who they gave loans to.

He gets wrong why it happened. It wasn't just lenders going after every sale they could get. Instead it was a combination of congressionally mandated lending rules designed to make redlining more difficult and home ownership easier, and stupidly low Fed Rates that caused the perfect storm for this crisis.

What he gets wrong is the biggest problem in this crisis. The biggest problem hasn't been the folks who got "sub prime" loans, but instead the folks with 'A List credit' who got ARMS, but didn't do what was necessary to adapt to the higher payments down the road. If he did the research, he'd know that as a percentage of total loans 'A list' ARMS are going into foreclosure faster than 'D credit' sub prime fixed loans.

His idea is another crisis waiting to happen. He proposes that lenders be forced to rewrite loans at the new value of homes, then after they do that FHA refinance the houses at a lower rate, to save the homeowner from the high payments.

The first problem is he doesn't seem to get how much money is involved. Current estimates are that $2 TRILLION of equity has been lost nationwide since home prices started falling. Writing off that much money will cause more financial institutions to fail than are currently at risk of it. JP Morgan estimates that there is already a $325 billion dollar hit coming in missed margin calls for banks. Let's just multiply that by about 7 times and see what kind of shapes that leaves banks in, and their ability to get back to lending.

Second, many of the folks who've lost equity, and their houses, aren't in need of a bailout. Yet his proposal doesn't address that at all. As Holman W. Jenkins Jr. pointed out in the Wall St. Journal a week or so ago, many folks are defaulting not because they can't afford the loan, but because it's not worth it to stay in a house that's "upside down" after taking out a zero down loan.

There is actually quite a bit of evidence that people with "buyers remorse" over getting into too much house for the money are, before foreclosure, buying a new house that isn't upside down on the loan, then letting the first get taken by the bank. Because many states don't allow secondary judgement lawsuits after a foreclosure it's seen as an attractive way of getting out of a bad loan.
Yes, it hurts your credit because there is a foreclosure on it, but the "good loan" helps offset that hit.

The Frank plan would give these folks the same bailout options as people who truly need the help. That's not what I consider a wise use of my tax money.

Finally, as Jenkin's points out, all of the housing bailout proposals out there are delaying the inevitable "bottom" in the housing market. While a smoother landing sounds good, it actually delays the recovery after the bottom, meaning that the credit crisis will hang on longer, and the associated economic slowdown will be harder to recover from.

Martin Feldstein had a plan that makes more sense ; at least for the financial sector; in Friday's Wall St. Journal, and would achieve the goals of Frank's idea, without causing a huge hit to financial stocks. In fact, it would probably boost them which would mostly likely help the economy as a whole. It would also insulate the government from much of the risk it would assume under Frank's plan.

His scenario would have the government loan you the money at the government's rate on T-Bill repayment (about 1.6%) to pay down 20% of your mortgage with a 15 year repayment. Your future wages would act as collateral, along with a lein on the house. In other words, if you default, they attach your wages to get the money back if a sale didn't bring it in.

The loan money would go not to the home owner as it does in a home equity loan, but to the primary mortgage holder who would then rewrite the loan, with a corresponding 20% drop in interest and principle payments. The immediate boost in cash flow to the banks would be very helpful in the current money crunch.

The problem with Feldstein's idea is that it wouldn't help the homeowner who can't make the payments. Here's the math, a 200k loan at 5.5% for 30 years has a P&I payment of about $1135 per month. Using Feldstein's proposal, that would become a 160k loan with a P&I payment of $908. That part looks good. But the payback for the government backed portion would be $250 per month, meaning that ther would be a net increase of about $20 per month to the homeowner. (Math courtesy of Real Data Real Estate Calculator).

This of course assumes that the 20% would not be enough to get the Loan to Value ratio down to 80% (because of falling prices) and that Mortgage insurance would still have to be paid.

For his plan to work for both parties under the above assumption the payback to the government would have to be over a 20 year period, which would then save the homeown about $30 per month.

As you can see, there isn't a "perfect" bailout plan. Congress needs to act prudently when it gets into this business to help avert a huge hit to taxpayers, lenders, and homeowners. At the same time, homeowners have to start acting more responsibly, with whatever plan is brought forth.

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Blogger The Envelope Superstore said...

I hope you can do an article correcting the misperception that Republicans are at fault for the Mortgage Crisis. Here are 2 NY Times articles. One from September 1999 predicts the mortgage meltdown that would be caused by Fannie Mae’s easing of credit which was encouraged by Bill Clinton. The second from September 2003 shows that Bush was blocked by Democrats from creating a new oversight committee.

Here are the links:

Article 1

Article 2

Here are a few key excerpts:

1st Article - 1999:

"Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits."

"In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's."

2nd Article - 2003:

The Bush administration today recommended the most significant regulatory overhaul in the housing finance industry since the savings and loan crisis a decade ago.

Significant details must still be worked out before Congress can approve a bill. Among the groups denouncing the proposal today were the National Association of Home Builders and Congressional Democrats who fear that tighter regulation of the companies could sharply reduce their commitment to financing low-income and affordable housing.

''These two entities -- Fannie Mae and Freddie Mac -- are not facing any kind of financial crisis,'' said Representative Barney Frank of Massachusetts, the ranking Democrat on the Financial Services Committee. ''The more people exaggerate these problems, the more pressure there is on these companies, the less we will see in terms of affordable housing.''

David A Warner
Acworth GA.

6:50 PM  
Anonymous Anonymous said...

Acccording to news, on JUne 10 this year, Obama Bailout turned a profit" of $1.8 billion in interest payments on the first set of bank loans that were repaid." That's a very good indication! :)

1:12 AM  

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