Bailing Out The Banks

Congress passed the "mortgage rescue" bill that will help 400,000 home owners, but is really a benefit for banks and Freddie Mac and Fannie Mae.

Unfortunately the President doesn't have the guts to veto it, due to the bad publicity he'd get for it, and that would go to the GOP during an election cycle.

The bill is definitely a contradiction. On one hand 400,000 "at risk" home owners could get bailed out IF their banks are willing to take a loss on their loans and refinance them through FHA. If everyone takes that deal, taxpayers are on the hook for 300 BILLION dollars in new loan guarantees.

However, the bill also gives nearly 4 billion in grants to banks to rehab foreclosed properties to get them ready to sell. In other words, the bank gets two choices, take a loss and refinance, or get a grant after foreclosure to repair the house and resell it; hopefully at less of a loss.

The block grants, opposed by Bush and the GOP are an issue. Banks generally stay out of the real estate business as much as possible. In most cases, when possible, they'd rather work out a short sale, or refinance instead of foreclosing so they don't have to deal with the inevitable problems associated with holding a home. This bill gives them as much an incentive to foreclose as it does to refinance, possibly more since the government is willing to mitigate part of their loss under the block grant program.

Freddie and Fannie also get sweet deals, with the Federal Reserve being able to loan them basically unlimited amounts of money over the next 18 months to help shore up their poor loan portfolios. Yes, they get some extra oversight (finally), and have to pay for some new programs, but on the whole, it's a big wet kiss for getting in over their heads with risky loans.

Who loses in the bill? The tax payers, that's who. We get put on the hook for hundreds of billions in new loans through FHA, and hundreds more by tossing cash at Freddie and Fannie. While Congress sees this as "doing their job" the truth is both the GOP lead congress and the one run by Democrats fell down on their jobs by not having some of the new protections in place previously. They were too busy rolling around in the cash that was coming in from a housing driven economy to look at how wobbly the foundation was.

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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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A Bailout Won't Work

I keep listening to the news, reading the papers, and checking out the lasted plans being hatched to fix the sub prime mortgage problem. The problem with all of them is they are temporary fixes, and in all likelihood will end up being tossed in a few years.

Here's the problem, when the fixes are put into place, we will end up back where we were ten years ago, when people with questionable credit and income couldn't buy houses. Many of them are minorites, and suddenly we'll be having hearings (again) about why they can't get houses.

Congress, directly, and the Fed, indirectly, created the current mess. Congress passed laws that basically mandated that banks and mortgage lenders work out ways to get more minorities into homes. Even before the housing boom of the 2002-2006 that worked. Those with so-so credit, but an ability to pay (at a higher rate due to the credit score) were able to get into houses. Many of them were able to refinance with "A grade" loans after a few years of good payment history.

However, when the Fed dropped interest rates to historic lows to keep a full blown recession from occurring after the 2000 stock market meltdown and 9/11, it created a huge influx of new home buyers. Folks with lower credit scores could suddenly qualify for "sub prime" loans because the rates on them were 7-9%. (By comparison in 1998 those were the best rates for an A grade loan).

Lenders, following Congress's mandates, really didn't have a choice but loan money to folks. Then of course, we all got greedy, and wanted a McMansion. Lenders found creative ways to work that, too. By getting an ARM at 1% below prime for 2 years, and then Prime +2% after that, with questionable credit, and less than stellar income, just about anyone could afford twice as much house as they needed.

Today, though, those ARMS are going from the 3-4% (maybe 5-7% for sub prime borrowers) to their natural rate, 10.5% rate, and even folks with decent credit and income, who didn't refinance out of the ARM, are facing the crunch.

There are a number of proposals to "fix" the subprime problem other than the natural way, home forclosures. Some want to freeze rates on all loans, others suggest limiting how far up they can adjust. Some want the government to guarantee the loans, and not forclose when they have to make the home owners payments.

The problem with all of them is they are going to make those who didn't make a poor choice about a loan to pay for those who did. In fact, just the scare of it already is, as lenders are once again tightening rules on refinancing and purchasing homes.

The worst of the ideas is the government guaranteeing loans that never should have been written in the first place. If you thought the S&L bailout of the 80's was expensive, you haven't seen anything yet.

It would be in most lenders interest to try and find ways to refinance the sub prime loans they've got out there, before Congress "fixes" the problem, again.

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