Totally clueless
Hank Paulson is at it again. This time, he’s trying to organize a major bailout for homeowners. Will he succeed? Who knows, but the plan lacks any common sense and reeks of desperation.
Hank Paulson and Sheila Bair are spearheading an effort to freeze interest rates on adjustable rate loans:
U.S. Treasury Secretary Henry Paulson is negotiating an agreement with lenders to stem a surge in foreclosures by fixing interest rates on loans to troubled subprime borrowers, according to people familiar with a meeting he led yesterday.
Paulson, who addresses a housing conference on Dec. 3, presided over a one-hour gathering at the Treasury Department in Washington with federal regulators, bankers and lobbyists. Executives of Citigroup Inc., Wells Fargo & Co. and Washington Mutual Inc. attended, said a person present, who spoke on condition they not be identified.
The Bush administration cut its growth forecast yesterday, reflecting a deepening housing recession that’s roiled financial markets since August. The Commerce Department reported the same day that the median price of a new house fell 13 percent in October from a year earlier, while fewer homes were sold than economists anticipated.
Bair has proposed letting borrowers with adjustable-rate subprime mortgages, who are living in their homes and unable to afford resets, get extensions on the starter rate for at least five years. They could also be offered 30-year fixed-rate loans. Reich prefers a three-year freeze.
Bair is from FDIC, and she has been advocating rate freezes for adjustable rates for quite some time. Maybe she realizes what the implications are for FDIC if a lot of these loans go bad. Or maybe desperate times call for desperate measures. In the last housing bust before the Great Depression, state legislatures passed moratoriums on foreclosures and many state courts refused to evict delinquent borrowers. I guess the rule of law is honored until it becomes socially disruptive.
Paulson and Bair can certainly make a solid economic argument that the investor and lender stands to lose the entire loan amount (or get a property they don’t want), and a partial loss through an interest rate extension is better. That assumes these interest rate resets will be the sole driver of foreclosures moving forward. Given that these policymakers couldn’t even see this obvious problem as of 6 months ago, I have a hard time believing they have the situation under control with this piecemeal approach. In fact, this problem is so large that it will probably wallop the entire Bush administration and the next one that follows them.
The problem is not just about interest rate resets. It’s also about recession, job losses, too much supply, ridiculously unaffordable home prices, and rising interest rate spreads as well. I can imagine that foreign investors will be too eager to provide the money to offer low-interest 30 year loans to these same defaulting borrowers. If the credit market stress is revealing a clue, it’s that Hank Paulson and Sheila Bair have no clue.
If you force investors and lenders to accept less, are you not in fact forcing them to devalue their debt asset? In doing so, are you not in fact devaluing a good chunk of their assets immediately? Apparently, this might be enough to upset some mortgage note investors:
Mortgage-industry lobbyists have argued an across-the-board solution is difficult to apply. Rewriting contracts also risks moral hazard — encouraging borrowers to take on more debt in the expectation of being bailed out if needed later.
“It is really an indiscriminate procedure that would violate the terms of the contract that provide for loan-by-loan decision making,” George Miller, executive director of the American Securitization Forum, said in an interview this month. A broad approach would “significantly disrupt the reasonable expectation of investors” in the $7.1 trillion market for bonds backed by mortgages.
Perhaps the biggest problem I have with this is it seems like a government-led massive re-negotiation of contracts. You could call it class-action, bulk handling. And with all class-action problems, it has a distinct feel of a one size fits all approach to this.
November 30th, 2007 at 11:21 am
Any idea what the teaser rates are on the majority of these loans? I’m guessing there is going to be political backlash if these rates are below prime rates or below rental costs.
While it sounds good, keeping people tied to their over-priced debt traps is only going to exacerbate the consumer spending decline. Every additional payment before foreclosure is one less payment that can go towards new consumption. Slowing the rate of foreclosures isn’t going to offset job losses as consumers try to fix their balance sheets.
November 30th, 2007 at 12:16 pm
Interest rate resets are not the problem. The vintages with the highest default rates have not reset yet, and increasing foreclosures will continue driving collateral values down, resulting in more foreclosures. Interest rates don’t matter - what does matter is impaired collateral and poor underwriting standards. I suspect a lot of folks who bought houses with NINJA loans can’t afford the note at any interest rate.
November 30th, 2007 at 12:26 pm
This is a taking of assets from the lender by gov’t decree. I suspect we will see Mr. Paulson in court soon.
November 30th, 2007 at 12:26 pm
As long as public money is not used then it does not matter to me what these banks do. I suspect that Paulson and Bair have used a carrot and stick approach by warning banks about their reserve ratios and implying that some loosening of capital requirements may be forthcoming.
I agree with most that this is unlikely to help many borrowers. What is not mentioned is that this plan ONLY helps the loans that are still owned by the banks (i.e not sold off yet to the street).
November 30th, 2007 at 12:52 pm
This is positively insane. They wouldn’t even be able to settle on a definition of “subprime”. I know HR3915 makes a reasonable stab at distinguishing among loan types, but it’s not perfect. An Option ARM could have been - for some borrowers - merely a lousy loan, but one they can handle, while for others it was a loan that they never could have paid (after it recast). Fannie Mae & Freddie Mac have been offering interest-only ARMs for years. Some people will be hard-pressed to make the payments on those loans when they adjust. Will the government dictate interest rate freezes on those? That would wreak havoc with the market for agency mortgage-backed-securities at a time when they’re the only MBS’s trading with any liquidity at all. Furthermore, freezing the rate of an Option ARM (if amortized over the remainder of the term) does nothing to free up the cash-flow of Option ARM borrowers, since that government-dictated payment would be the same as the re-cast payment that would come at the end of the neg am period. Many Option ARM borrowers can’t even afford the interest on their loans - which aren’t an overly high rate anyway. This proposal will only worsen the troubles in the securitization market, cause more loan products to disappear, and cause further tightening of underwriting guidelines. It will cut the legs out from under home values and, perversely, could increase the foreclosure problem, since some people won’t want to keep paying a loan that’s 125% of their home value - without regard to whether the interest rate had been capped. The government can’t “fix” the fact that housing is overpriced by historical standards (having been inflated by lax standards and the Fed having kept rates too low for too long). At this point, the best thing the government could do is “don’t just DO something, sit there!”.
November 30th, 2007 at 1:17 pm
Once they publish the debt to income requirements that qualify you for getting the free fake rate extended, then you will see all these currently stable buyers take on huge CC debt just so they can try to qualify for the fake rate extension.
So this plan is only going to stimulate another round of mass fraud all over again and is unfair to borrowers who bought within their means in the first place as their rate is higher.
Let the free markets take care of themselves. Foreign money is already coming in and refinance rates are at 40 year lows.
November 30th, 2007 at 2:00 pm
I have a radical idea that the banks will hate. Why not charge simple amortization rather than collecting all the interest up front? If people’s 1500/mo mortgage were 1400 principal and 100 interest instead of 100 principal and 1400 interest, the asset backing would be transferred from the stuckee investors or the taxpayers to the homeowner. Making these ARM people actually get some skin in the game would not be the worst thing in the world, would it? Oh yeah I forgot, banks wouldn’t be able to extract 10000% interest in the first year, etc. My bad.
November 30th, 2007 at 2:23 pm
Any renegotiation of the terms will further reduce the values of the securities which are backed by these mortgages.
That’s where the whole scheme falls apart.
November 30th, 2007 at 3:29 pm
Seems like Nouriel Roubini likes this plan.
Check out his November 30th blogpost entitled “Finally moving from a case-by-case to an across-the-board approach to mortgage restructuring.”
November 30th, 2007 at 3:31 pm
The last thing the lenders (owners of the mortgages and related derivative debt) want to do is extend the teaser rates, seeing as it just forestalls the inevitable. If I’m the lender I’s rather take a 25% haircut on some financially inept scumbag’s $500,000 house in a foreclosure today than get full value for the same POS 5 years from now when it’s value has declined to $225,000 as well as bear the brunt of subsidizing these a-holes for 5 years while they trash the place.
November 30th, 2007 at 4:42 pm
Sounds like Das Kapital — from each according to his means, to each according to his needs.
November 30th, 2007 at 4:50 pm
Banks haven’t been limited by reserve requirements for a long time. Savings accounts have zero reserve requirements and the wide use of sweep accounts means that very little cash is held in demand accounts anymore:
http://www.ny.frb.org/research/epr/02v08n1/0205benn/0205benn.html
Banks are pretty much limited these days by Basel II capital requirements (3%-6% of balance sheet). Reducing capital requirements would seriously reduce the stability of the entire US banking system. There is only so much leverage you can add before you can’t get any mor “alpha” from your operations (no matter how good they are).
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2006/IO+December+2006.htm
November 30th, 2007 at 7:10 pm
Hi,
I have lived in Australia for the past 8 years, but I’m originally a native San Franciscan and an ex-U.S. Mortgage Banker of some 20 plus years. (What in the Hell is going on back there?)
It appears from here everybody (and I mean everybody) from Government Officials, Government Regulators, Banking Industry Giants, Wall Street, Investors and the Media have absolutely lost your collective minds.
Since when has it become a good thing when the watch dog (Government) helps the burgular (Mortgage Industry, Banks, Investment Bankers, Bond Brokers, Bond & Mortgage Insurers, etc…) escape with the loot?
Someone please stand up and just say, “NO, this has to stop now and everyone accountable needs to take your licks. PERIOD!”
COVER UP, SMOKE AND MIRRORS AND ALL OF THE OTHER ACCOUNTING GAMES GETTING PLAYED IS ONLY DELAYING WHAT WOULD BE A TOUGH RECESSION AND DRIVING THE ECONOMY DIRECTLY INTO WHAT WILL BE THE SECOND GREAT DEPRESSION!
Hank Paulson! Has that man completely lost his mind? Super SIV? Freeze the Rates? How stupid can one man be and the rest of you act like the “King isn’t naked.” He’s Naked folkes and he doesn’t have a clue! Throw him out of office and get someone with some balls in there that will call a “Spade a Spade” and fix the problem with the sensible solution of holding the guilty accountable.
No more games, all of the cards on the table now and deal with it!
My children and grand children still live in the U.S. I need someone to stand up and take control of the mess back there so I can sleep at night knowing my loved ones will be OK.
Respectfully,
Jim T.
American & Australian Citizen
November 30th, 2007 at 8:13 pm
“Throw him out of office and get someone with some balls in there that will call a “Spade a Spade” and fix the problem with the sensible solution of holding the guilty accountable.
No more games, all of the cards on the table now and deal with it!
My children and grand children still live in the U.S. I need someone to stand up and take control of the mess back there so I can sleep at night knowing my loved ones will be OK.”
Jim (and those who empathize with him), I suggest you read up on Presidential candidate Ron Paul.
http://www.ronpaul2008.com