What If

The World Economic Forum is going on in Davos again. This time around the world is telling bankers to expect regulation, and lots of it, and soon. The bankers engaged the regulators, and were allowed to provide input, though that is probably meaningless, considering Barney Frank's attitude at the conference.

One of the biggest things guys like Frank would like to do is once again separate commercial and investment banking from each other. In the world according to Barney, the entire financial crisis was created because banks both lend money for housing (commercial enterprise) then package those loans as mortgage backed derivatives (investment banking) and sell them.

What Barney refuses to admit, or see, is that it wasn't the derivatives that brought down the market, it was the mortgages themselves, made easy by the rules he insisted on for mortgage lenders. When you push for regulations that make zero down mortgages, interest only payments, etc. the norm, you end up with a skewed market, that will crash.

What if Barney decided that the same capital reserve standards had to apply to government entities as the Davos crowd is pushing for banks? Would the US government be able to meet that standard considering it has 10 trillion in outstanding debt?

What if the bankers say "Okay", and just jump out of markets considered risky? Will Frank, Obama and the European leaders who are pushing these regulations admit the regulations might be the problem when capital sources start drying up for businesses? We've already seen the start of that, as banks are much less willing to lend right now. When they are told to be even more stringent in their investment standards do regulators really think that suddenly money will flow?

The proposed regulations will help prevent another economic collapse. That's because they'll prevent an economic recovery of any scale, and the folks pushing the regulations will lament they don't understand why.

If you'd like my cynical view of why the current US government and European governments want more, and very heavy handed regulation, it's because they want to be the major sources of capital, not the banks. It's much easier for governments to be the hero's, and pick the winners and losers when they don't have to worry about pesky free markets to make decisions.

Want an example? Green energy products. The markets have been slow to invest in them because they don't pay back the investment quickly, if at all. Solar cells, wind turbines and fuel cells are all great sources of clean energy, the problem; as real investors note; is that you can't sell them at a price that makes a reasonable profit, so they don't invest.

Governments chastise them for not investing in such a worthwhile endeavor, and ignore the fiscal facts of the industry. So then governments get to play king makers in the industry, and use it as a reason to say the markets don't work.

Take your Fusion hybrid as an example, Ford loses money on every unit it sells. But they get credits from the government for selling them, in the form of tax breaks and access to federal money to build the plants.

The markets actually work fine. As soon as someone comes up with a hybrid or all electric car, or fuel cell for the home that is profitable, and priced where it can be successfully marketed, they'll be all over it. Until then all but a few altruistic venture capitalists will opt out.

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The Bailout

Okay, so we are now looking at spending $700 BILLION to bail out failing financial institutions due to the mortgage crisis.

One of the Barack Obama talking points is how the current administration has been asleep at the wheel and allowed this to happen. Actually, if Mr. Obama would do a little Google searching, or just read Mac Ranger's blog, he's know that it's Congressional Democrats who allowed this to fester to the point of a melt down.

Mac does impeccable research, and he dug up a 2003 article from the NY Times about a proposal by President Bush to create an oversight agency for Freddie Mac and Fannie Mae.

If you go click on my site meter you'll find at least 4 hits per day, some days many more of people searching for "Barney Frank Bailout", that would be Congressional Democrat Barney Frank of Massachusetts, who in the article from 2003 said there was no problem with Freddie and Fannie:

''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.''

In March of this year, Rep. Frank came up with his own mortgage bailout plan, to help the people affected by the problems at Freddie and Fannie, and the general lack of oversight in the mortgage industry.

As history is showing us Republicans have been on the ball in the mortgage crisis for 5 years, and didn't just try one time to reform things.

In 2005 Chuck Hagel introduced S.190, "Federal Housing Enterprise Regulatory Reform Act of 2005", which would also have established oversite of Freddie and Fannie, and set capital reserve levels for them to maintain that would have prevented a large part of this crisis. It never made it out of committee, had it Senate Democrats would have killed it on the floor.

So why were the Democrats so against the idea of reform, when it's been obvious for 5 or more years that there was an issue? Simply put, fixing the mortgage process would have probably made it harder for low income people, one of their key constituencies, to game the system and buy homes. Frank said as much in the 2003 quote above.

The problem is that a lot of those people who were looking for "affordable housing" ended up with loans that went bad when they became unaffordable. The system allowed them to buy more than they could afford through ARM's and balloon loans.

They are no longer in their homes, and have had their credit ruined. The same folks who wouldn't allow reforms that might have prevented such things are now telling them, as always, that it's somebody elses fault.

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Fixing The Housing Problem?

The House finally passed Barney Frank's home bail out bill yesterday, though it probably won't make it through the Senate, or past the veto pen of President Bush. Hopefully there is a compromise bill out there waiting in the wings, one that unlike the Frank's plan helps the folks who need it, not anyone who wants it.

I know that there are a lot of people out there wondering about the Frank's plan, since I wrote about it in early March that has been the top search hit on my blog. (Sorry Tonya Harding, your nake pix search comes in much lower).

Frank's plan, for those who don't remember, would allow a homeowner to refinance the current value of their house into a federally insured FHA loan, provided the lender was willing to take the loss between the original loan and the new value.

I'm not sure lenders are going to run to this program, in any case. While they may look at some loans and think it's worthwhile, they'll probably turn down the short sell offer on a lot of them, figuring they can get a better deal in liquidation sales. While it might be popular in California, Florida and Nevada, where speculators ran up the prices, they'll probably ignore it altogether in the North East, middle south, and Texas where the housing market hasn't taken such a big hit.

Frank's plan also allows borrowers who wouldn't qualify under current FHA lending rules to participate, based on having the income (but not credit worthiness) to make the new payments.

One of the things I find oddest about this plan is that the very reason for a chunk of the housing market problem, according to congress, was lenders allowing people who shouldn't have qualified for a mortgage to get one. Now, they want to change the rules so that the government can guarantee those same types of loans! Evidently making bad loans is only okay if the fed's are involved.

There is one good point, if the owner makes a profit on a refinancing or sale of the home, part of those proceeds go to the feds. I'm pretty sure though that decent accountants will figure out a way to shield a lot of that money.

Here's my prediction, should the Frank's bill pass as is. You'll see a six month drop in foreclosures, as a number of people refinance into the FHA program. Then, in about 12 months, foreclosures of those loans will spike, and we'll have Congress pulling in the head of the FHA to find out why he needs so much money to pay off those loans.

Here's a few common sense changes I'd like to see before they pass anything.

First, if the person applying owns two homes, and isn't behind, or upside down on one of them, they be required to sell it, and use the proceeds to pay part of the difference in the loan they want to refinance. Right now 25% or so of foreclosures are on second homes, those folks shouldn't be rewarded.

Second, the loans need to go to people who have paid their bills (other than mortgages) on time. In other words, help those who obviously are trying to keep up on their other bills, but can't because of the mortgage. Suspending credit rules to refinance allows the worst offenders to get the biggest break, and they probably deserve it the least.

Third, require automatic payment debits for the mortgage after refinancing. If that's going to cause a hardship, the borrower probably can't afford the new mortgage either, and needs to become a renter.

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Bottoming Out Too Soon?

The Dow was up 187 yesterday, mostly on news that (existing) home sales went up by 3% in February, and that JP Morgan Chase was looking to up it's Bear Stearns offer from $2 to $10 per share. That in turn lead to a rise in the dollar, and a fall in oil prices, all good things for the economy.

The Bear Stearns news was a psychological boost for investors. If JP Morgan was upping the offer to $10 per share to appease Stearns investors, there had to be an "on paper" reason for it. Let's call the reason sanity. When actual money driven accountants started looking at all that paper Stearns was holding that said "mortgage secured debt" they ran the numbers and found out what's been said for months, the subprime meltdown is only a small fraction of the mortgage industry. A lot of that paper is worth more money that the news would have the emotion driven investors and politicians believing.

The housing number was actually mixed, while sales were up for the first time in 6 months, prices were down. But, as most everyone knows when those occur together you've probably found the bottom of a market.

National Association of Realtors regional figures show that the Northeast seems to be coming out of the slump, with sales up 11% and prices up slightly, while the West coast remains a drag on the overall picture. It's not totally surprising, since the west was where the ridiculous run up in prices began. The South would have done well if not for Florida, another hotbed of speculative buying.

For some folks, finding light at the end of the subprime tunnel isn't good news. If you have another month of homes sales increases, even slight, without Congressional intervention, it will show that the market is capable of correcting itself. That doesn't work well for the folks on the campaign trail telling us more government regulation is the solution to the problem.

It will be harder for Hillary Clinton to sell her fix for the housing crisis, which Barack Obama says looks suspiciously like one he laid out last year, but with more money. It will be harder for the doomsayers to beat up John McCain for not having a plan for the government to fix the problem, if it's fixing itself.

She's also supporting the Barney Frank proposal (written about here) with a few added features, like the feds actually buying foreclosed houses (not held by FHA/VA type loans), and then holding them until the market improves. Something she claims would be "revenue neutral". Since the average price for foreclosed homes is discounted at sale by about 19%, the revenue neutral idea doesn't hold much water.

If month to month foreclosures continue to fall (as they did in February) and houses continue to sell, suddenly a lot of the pessimism in the general public will start to fade. Add to that the fact that if home sales increase again in March the Fed will be less likely to cut interest rates, which will again help the dollar. Suddenly all of the gloomy numbers look better (not great, but better), and selling despair becomes a tougher job.

It must be tough being a politician who hopes that good news doesn't continue, only for self gain.

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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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