Posted on 12/08/2007 4:42:53 AM PST by Kaslin
Like obnoxious relatives, the mortgage mess won’t go away. Some two million adjustable-rate mortgages (ARMs) will reset over the next two years, and analysts say that within the coming year alone, $362 billion in subprime home mortgages will experience rising interest rates. This will lead to ever more payment defaults and foreclosures, a horrible state of affairs not only for the affected homeowners and lenders, but also for the financial markets in general.
As is their wont, officials from both parties are rushing to offer “solutions.” The Bush administration is urging lenders to maintain the low teaser rates on ARMs, while Hillary Clinton recently advocated a 90-day moratorium on home foreclosures. Although casting themselves as knights rescuing beleaguered citizens from greedy corporations, in truth these politicians will only make matters worse.
In his classic Economics in One Lesson, Henry Hazlitt said that the good economist looks not only at the obvious, immediate beneficiaries of a government policy, but also considers the long run, hidden costs. We should do the same with the latest mortgage proposals. Although particular homeowners may benefit in the short run, such government tinkering will ultimately harm average Americans by distorting the mortgage industry.
To understand the downside of the recent proposals, we need to step back and ask ourselves why ARMs and foreclosure clauses exist in the first place. They are obviously advantageous to the lender, so it’s no surprise that banks favor them. But why do the borrowers agree to these terms? Why doesn’t everybody simply take out a conventional fixed rate loan, and moreover one that is unsecured—so that the bank can’t seize one’s house in the event of default? Is every borrower just plain stupid for failing to insist on loans of this nature?
Of course not. The reason borrowers agree to adjustable rates (which have the possibility of skyrocketing) and to pledging their home or other assets as collateral, is that this allows them to receive concessions from the bank—in particular, it allows them to borrow a great deal more money than would otherwise be possible. Very few people would persuade a bank to lend them money to buy a house, if the bank didn’t ultimately have the right to take ownership of the house in the event that the borrower couldn’t make the mortgage payments. Yes, borrowers would prefer that they get a $300,000 mortgage with no strings attached, but lenders wouldn’t be too happy with this arrangement. The beauty of a capitalist system is that property owners must compromise to reach mutually beneficial arrangements, since private transactions are voluntary.
Now after individuals enter into these voluntary arrangements, what happens if the government swoops in and invalidates them? There will be short term winners and losers, naturally. And most Americans have no problem with this, because it seems fair to help struggling homeowners at the expense of Wall Street fat cats.
Yet this conclusion is very superficial. Lenders will learn the lesson that their contracts aren’t safe; contrary to popular belief, the government will not serve to enforce the law. (Or rather, the “law” can change on a dime, depending on the public’s mood.) Lenders won’t simply shrug their shoulders, say “aww shucks,” and continue with business as usual.
No, lenders will rationally respond to the new environment, by being much pickier in giving new loans. After all, it becomes much riskier to grant a mortgage to a young couple with little job experience, if the government will shield them from the consequences of default on the loan. Many people say that “the American dream” involves homeownership, yet this will be harder to achieve if the government introduces yet another uncertainty for lenders.
I am aware that the real world process of home buying and financing has its share of shysters and shady practices; every human enterprise does. But the recent proposals aren’t merely about prosecuting outright fraud; no, the politicians want to grant a mulligan to hundreds of thousands who bought homes they couldn’t afford.
I don't buy it. If CEO's wanted to do something in the '80s they did it. People around here, and including Limbaugh, are claiming that Congress passed laws. I have yet to see evidence. I really would like to see the law.
You got that right. I know of a several couples that went bankrupt. They lost their house, and they now rent houses. Their last priority is paying the rent. A house is an entitlement to some people, and they believe they should have every luxury, screw the rent or mortgage. Going bankrupt will not change their attitude. Incredible.
Yep. And, Bush was just as much a part of this as anyone eles.
The administration indicated it would not use the justice system to block the settlement proposed by the banks. That is not what most of the posts on this thread miss.
This a proposal by the banks to limit the expected losses.
“I have heard this claim several times. Do you have a source for this?”
Community Reinvestment Act (CRA)
Banks are evaluated by the Feds of how and where they lend.
“Are you a bank and want to expand? Fine, how are you doing with your CRA goals?”
This has been around quite a while and isn’t debatable in our industry, it’s a fact of life.
Some lenders were just more responsible on how they met their CRA goals than others.
Fortunately mine has been the most responsible in the nation so we are doing really now right now.
Which is better (for the lender)-
a. Foreclosure and reposession of a home that will likely be TRASHED by the occupants on their way out. How does the lender then sell this foreclosed home, particularly in a neighborhood where there are a LOT of these foreclosures, and break even? I’m sure the houses sell far lower than the original appraised value and loan amount. One new neighborhood in Atlanta has a lot of foreclosures and the remaining residents are battling trying to keep the grass cut in those yards and local riff-raff keep trying to occupy the houses and turn them into “party and crack houses.”
b. Working with the borrower and changing the terms of the loan. I’m for the lender doing this on their own and NOT government finance or control of this. At best, MAYBE the government could offer tax incentives to lenders who creatively try to work with the borrower. Wouldn’t the lenders come out better by trying to work something out with the borrower, which will allow the borrower to stay in the home?
If a mayor starts threatening to fine people for Pink flamingos on their front yard, people with pink flamingos (and a new shed in the back yard that went in without a permit) get their pink flamingo off the front yard.
In the late 90’s, red-lining was the cause of the day in congress ... and arm twisting was in full throttle.
Okay, I see. It's another bureaucracy designed to destroy free thought.
“A lot of these people were told they could afford the house. The mortgage anyway. Most people don’t know the money a house, even a new one, sucks in over a year.”
You’re right. When my mother passed away in 2005, I inherited her house. The mortgage is entirely paid on it. I did not sell the house right away and after I did the accounting for the estate, I found out that the house was costing me around $15,000 a year to maintain, including repairs (big ones periodically come along), home owner’s insurance, property taxes and utilities. Heat needs to be on in the winter so the pipes don’t freeze and it’s useful to keep the electricity going. The only utility that I discontinued was the phone.
Sorry, forgot to say “thanks”.
Oh, maybe you can answer a question. How much are these lenders really going to be hurt when, I assume, that most, if not all of these mortgages have to carry PMI?
I look at Detroit and see the obvious. Record foreclosures in “Red lined” areas, and Jessee Jackson calling the banks “Predators” because they loaned to people with bad credit history.
In the good, old days, when you'd borrow from your local bank and a banker you knew, this wouldn't happen. If you blew out financially and couldn't make the loan payments, then the bank had an incentive to re-paper the loan at term you could meet. There is still a great deal of this sort of activity, and this is how work-outs happen. Foreclosure from a bank's perspective is a bad thing (~$0.40 on the dollar, home in bad shape, etc, etc)
The trouble is... there is also a great deal of mortgage paper that has been sliced and diced by the Wall Street Wizards. No longer does the loan originator have any particular skin in the game (though in some cases a bad loan can be put back to them). Most of the problematic paper is in the form of asset-backed securities -pools of mortgages which have been packaged and sold off as various tranches of bonds at various credit ratings.
The mortgage servicer earns fees for processing the payments and ensuring that the AAA tranche gets paid first, the AA tranche next, and so forth. There are strict and contractually specified limits on how much a mortgage servicer may change the terms of the underlying paper (the mortgages). The bond buyers have expectations of certain cash flows, and they have bought bonds accordingly.
What this plan does is to cram the "freeze" down on bond buyers - who are now the lenders. Don't kid yourself: bond buyers have *not* signed on in any way to this plan. They are so dispersed that one could not even begin to assemble a quorum of them. Imagine you bought a bond with certain cashflows, and the government came in and said: "sorry; the flows are now X0% lower. Eat it." That's what is being forced on the "lenders" here.
There are some who will assert that this workout is better for the lenders because it avoids forclosures and better for the homeowner (homedebtor) because he or she stays put. Maybe, maybe not. That's not the point. When the gov't comes in and forces a change to contract terms between private parties (to benefit one over the other: servicers vs bond holders) it sets a terrible precident. Bondholders are on notice that what's agreed to may be changed if the other side becomes a favored victim class by the gov't. So while there is no explicit government payment flowing here, there also is no such thing as free money. You will pay the cost in the future as the captial markets price in government-fiat risk in the terms. And you can bank on that.
Big government solutions bring out positively the worst in their promoters, too. Since this program cannot be sold on the merits (other than rubbing salve on the poor grasshopper), demagoguery is all that's left. The Chairwoman of the FDIC is in the papers saying that those opposing this plan probably have short positions in ABX securities. She has no evidence to support such slander, but that doesn't matter. Pity...
Yes, I saw JJ on TV about a month ago claiming this was a racial "ishya", and that banks were targeting blacks for foreclosure.
So we twisted the banks arms to "stop being racist" and lend to people who are in no financial position to be taking on large loans, and when the crap hits the fan, that too is racist.
There are lower income whites in this mess too, it is NOT racism.
Wrong. The Paulson plan releases the mortgage servicers from their contractural responsibility to uphold the terms of the securities sold and the underlying assets. The servicers would probably get sued over this, but i suspect that this horrid plan will have so little buy-in from Joe McMansion, that noone will bother.
But don't kid yourself. this is a government rewrite of a contract between a mortgage security buyer and the servicer who is to administer the payments. We're way beyond neighborhood banker and customer now.
Sunk costs are sunk. They can't go back and undo the bad decision made years ago. The issue is, do they want to try to repo and sell a house in a horrible real estate market, or keep some cash coming in from the existing owner?
Making this a crisis is just a way to find somebody else to fund a problem, which will increase the national debt and reward bad behavior.
Or, looked at another way... the government has said that it will not enforce anti-collusion statutes as the mortgage servicers act in concert to benefit their servicing biz. What you seem to be missing is that this has little to do with mortgage owners, who are for sure screwed in this scheme.
That way folks won’t feel the pinch and the banks get their money.
However, either nobody wants to or bureaucratic minutia prevents this.
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