1-888-995-Hope: Hope For Housing Markets?

Public economic discussion is dominated by the disclosure of trouble, panic, calm and the return of optimism. Within a few weeks, reality creeps back into focus. Reality brings further disclosure of trouble. The cycle repeats. Month after month of reassurances ring hallow. Further elaborate pronouncements and Federal Reserve credit action do less to increase confidence and sentiment. Housing firms, home owners, residential mortgage backed securities (RMBS), and financial earnings keep falling. Write-offs keep rising.

Into this fray strides Treasury Secretary Henry Paulson. He is armed with a plan to help those "with the financial wherewithal to own a home." We will set aside why there are hundreds of thousands of folks who own homes but don't have the financial wherewithal to own a home. Sub-prime borrowers fall into four groups, as defined by Secretary Paulson and the Treasury team. A coalition of the mortgage willing is being assembled.

There are those who can afford their adjusted interest rate; these homeowners need no assistance. There are also a substantial number of homeowners who haven't been making payments at the starter rate on their subprime loan and may not have the financial wherewithal to sustain home ownership; some of these homeowners will become renters again. A third category of homeowners might choose to refinance their mortgage - putting them in a sustainable mortgage while keeping investors whole. This is the first, best option. Servicers should move quickly to assist those who can refinance. And the fourth category is those with steady incomes and relatively clean payment histories who could afford the lower introductory mortgage rate but cannot afford the higher adjusted rate. We are focusing on this group, determining who they are and what steps may appropriately assist them. (emphasis added)

-- Treasury Secretary Paulson, 12/3/2007

In response, a Hope Now national alliance has been launched. Hope Now "is an alliance between counselors, servicers, investors, and other mortgage market participants." (pdf) Help will be directed to those who have made payments and can afford intro teaser rates but will likely default when these rates move up. The proposal is built around helping these folks refinance in order to lock in affordable rates.

There are issues aplenty. Mortgages were made under a dizzying array of conditions, contracts and stipulations. In addition, mortgages were made and sold so that the originators no longer own, but rather only service many mortgages. You can find the best and broadest description of the types and kinds of adjustable rate mortgages on the market here. Here you will see that there is no standard contract, ownership structure, or reset date.

The complexity of the market will be a significant impediment to solution. The law will be an issue; changing the terms of a bundled and sold mortgage may constitute tortious interference. I am sure you will be hearing plenty about this. Whatever is attempted will have to grind its way through the court system. There will be impacts on the quality, credit rating and price of the securities made out of bundled mortgages. Most adjustable rate mortgages have either 6 month or 1 year reset agreements. This means the mortgage rate was designed to reset between 27 and 54 times over the next three decades, once every 6 months or year for the life of the mortgage. Replacing this with a fixed rate would constitute massive contractual change. It would also mean a serious revaluation of any security made up of such loans. Credit ratings on securities that hold these loans would have to be redone.

There are 4 main issues with the plan as it stands now.

1. The assumption behind the plan

The assumption is that resetting rates causes delinquency and default. I am not sure this is correct. Research suggests that falling house prices and loans to folks without the income to pay are the leading issues. Delinquency research published in the September 2007 IMF Global Financial Stability Report (pdf) suggests trouble starts before interest rates reset upward. The chart (Figure 1.6) below makes this clear. The below data suggest that as we move forward in time, more folks are defaulting faster and faster. These defaults are not predominantly the result of resets. We know this because a rising portion of people are missing payments before rates change.

This group is offered nothing by the plan. What is the problem here? Home price and market condition, income variation and fraud are behind these default rates. Housing and mortgage fraud seems to have surged as the market topped out in late 2006. House prices are now falling nationally and will continue to do so through 2008. Employment growth is likely to slow with economic growth across 2008. If peak market mortgage fraud, falling house prices and income issues are driving defaults, the Hope Now alliance offers little solution. The assumption on which the Treasury plan rests may not be adequately grounded. The problems with this assumption will become increasingly clear as house prices continue to fall, incomes are pressured and further fraud comes to light.

2) The Proposed solution

The long term solution offers folks fixed rate mortgages to remove the risk and uncertainty of upward adjusting rates. There is some question about how much this would help if market rates were used. You can reference the chart below, to see how little relief fixed rates offer; the data is from HSH Associates. I include this chart to illustrate that fixed and adjustable rates are converging. The spread, or difference between fixed rates and adjustable rates, does not look large enough to bring borrowers back from the edge. The spread is also falling, suggesting that the move to fixed rates offers less relief now than it offered in the past.

The only way to lower payments would be to offer longer term fixed mortgages at or near the low teaser rates. This is easier said than done. Such a plan involves drastically altering contracts. This will require the owners of the debt to suffer losses. Holders of this mortgage debt will see the credit quality, return and value of the debt they own fall. They will be recommitting to troubled lenders with falling collateral values at below market rates. This course of action will be taken by holders of mortgage debt that have just experienced significant losses? This is possible. It is doubtful that investors would select this course. Government co-ordination and possibly assistance and inducement will be required. Even with this support, success is far from assured. If rescue is to be so arranged, don't we need a little more debate as to who gets rescued?

3) Affectivity- Is this a favor to those who do get help?

The grand plan possesses few clearly defined elements. Is the plan really a favor to the distressed but "worthy"? All expect several rounds of interest rate cuts. We have already seen two rounds of cutting since August. If we are moving people from adjustable to fixed product, we will lock in the present market rates, less whatever special cost-reducing deals are negotiated by borrowers and officials. We could be "helping" people toward products that they can't afford and that will be increasingly less expensive over the next 18 months.

What do I mean? If rates are falling, they will be lower in the future. Adjustable rates are set to fall and fixed rates that are locked now will be above rates in the future. In addition, house prices will be falling. We might then be "helping" people stay in overvalued houses at new interest rates negotiated at peak interest rates. No less than Bill Gross of PIMCO is forecasting a Fed Funds rate at, or under, 3%. This is 1.5% less than the present Fed Funds Rate. Locking people who are struggling into rates now- ahead of massive downward rate pressures- may not be the gift of century. In fact, it may mean longer-term and greater future trouble, as these folks are pushed to lock in above market rates on housing valued well above present and future worth. If we are not reaching out to those in the worst position, and the market rates are already falling, what exactly is the main purpose and desired effect of this action?

4) General economic social benefit?

The most vulnerable bought at the peak of the market with no/low money down. If they did have equity, they borrowed it out. The target -- distressed but "worthy" group -- need credit terms eased. These people have little in the way of collateral. When one adjusts for modest home price declines, many borrowers owe more than their houses will be worth for the next several years. There are legitimate questions regarding how good it is for people's financial futures to struggle to pay off a house assessed at well above its real value.

Inflated home prices and costs are an enormous economic drag on people. A ten-year boom with five years of outrageous price growth takes time and pain to cure. Intervention to cushion the blow and redistribute pain makes sense. It requires broad social discussion and an honest accounting of what interests are helped and hurt by various plans. We need an honest accounting of where we are, where we are headed and who the public, should be intervening to help and punish. I don't doubt many earnest and intelligent folks are hard at work on the present plan. How we respond to this crisis is an important measure of our economy, policy and culture. I have many concerns about the assumption, solution, affectivity and benefit of this plan.

Comments

[mmckinl]

Interest rate 'freeze' - the real story is fraud ...

Bankers pay lip service to families while scurrying to avert suits, prison ...

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/12/09/IN5BTNJ2V.DTL

"The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it."
"The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC."

There's a lot more, especially on Paulson ... read it!

[NABNYC]

I know someone who bought a house 9 years ago for $250,000. If their loan was 100% financing at 6%, monthly payment would have been about $1500. By 2006 the same house was appraised at $750,000. If it sold with 100% financing and a loan at 6%, the monthly payment would have been about $3500. Who can afford that?

The problem is that Greenspan held down the interest rates so people could borrow more money, with the low rates. This allowed sellers to keep raising the sales price, so that some houses were raised 3 times their previous value. But that increase in value, for older deteriorating homes, was illusory, just as the crazy tech stock values were illusory -- non-existent. But the professionals who made money off these pyramid schemes claimed the values were real. So they made lots of money, and everyone else loses.

Let the foreclosure proceed. It makes no sense for society to jump in and pay the mortgage on houses grossly inflated with absurd loans, to bail out people that couldn't afford the house in the first place. Those people believed they had become "homeowners" in George Bush's America. In fact, they are just renters and they always were, and the payments they've made on the mortgage created no equity in the home they could not afford to buy.

If society wants to help people, we should invest in affordable housing -- rental as well as for sale -- so that all people can have housing at a reasonable price. To invest in housing only for the small sector who bought into this latest fraudulent scheme is to reward those who were the fools as well as those who are the thiefs.

[Halsey]

I'm conflicted on bailing out..people who cannot afford their house payments...I mean..there must be consequences for stupid decisions..and refi's to buy that plasma TV..how many of these people on the verge of losing their homes..also have other debt for unnecessary (but nice) extras...what kind of cars to they drive..If they drive a Lexus and want a bailout..no way.. if they actually take public transportation to work..still watch a non HD 19" TV...cut coupons..etc...then sure...I'd like to help them out.

I am NOT a home owner..it never occured to me to buy a home I might not be able to pay for.
Am I missing something here?

[realitytrumpsbull]

2 words: Jingle mail. There is no such thing
as an accident...

[OregonJay]

We might also keep in mind that this long credit expansion has kept the economy growing (if you belief the official government data that the economy has been/is growing) in the 30 year era of declining real wages and deindustrialization. American society has largely been living in a fantasy that the economy could continue to prosper as industrial corporations downsized, the low wage service sector expanded, with insufficient investment in education, the development of human capital, the infrastructure and high technology industries. We know that increasing energy efficiency, biotechnology and other technology-oriented production that takes into account the resource scarcities and climate changes of the future will soon be in great demand, and those nations gearing for this reality will prosper. Yet the nation has gone $10 trillion in debt to create energy inefficient, oversized, inferior quality housing that won't be able to withstand the increasingly violent weather. Debt is supposed to get us through tough times and provide for future growth. How is America going to get out of this current mess and prepare, economically and in other ways, for a future that looks brutal? Is it time for a mass social movement that demands and brings an awakening from our current collective fantasies?

[curiousasheck]

Don't forget housing prices falling as the boxcars careen off the tracks.

Kind of got used to Real Estate Agents, knowing absolutely nothing about a neighborhood, demographics, conditions of the current housing stock, basic construction and historical building methods and long term trends marching into a neighborhood claiming out of the blue that a $125,000 home is now worth $225,000 just because they say so.

[mmckinl]

Plan won't help : Dean Baker

" It is unfortunate that most reporting on the rash of foreclosures in the mortgage market continues to focus on the mortgages as the source of the problem. This is leading to seriously misguided policy, since the core problem is falling house prices, not resetting mortgages."

http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=12&year=2007&base_name=subprime_solution_to_mortgage

This is a plan to keep the little guy in debt , more debt than the house is worth.

They will use the 2005 Bankruptcy Law to shackle people to debt. If they try to walk away they face years if not decades of garnished wages.

They know people in debt are more easily controlled.

Welcome to Republican supply side debt slavery.

[mmckinl]

Plan won't help : Dean Baker

" It is unfortunate that most reporting on the rash of foreclosures in the mortgage market continues to focus on the mortgages as the source of the problem. This is leading to seriously misguided policy, since the core problem is falling house prices, not resetting mortgages."

http://www.prospect.org/csnc/blogs/beat_the_press_archive?month=12&year=2007&base_name=subprime_solution_to_mortgage

This is a plan to keep the little guy in debt , more debt than the house is worth.

They will use the 2005 Bankruptcy Law to shackle people to debt. If they try to walk away they face years if not decades of garnished wages.

They know people in debt are more easily controlled.

Welcome to Republican supply side debt slavery.

[joebaggadonuts]

Max, Your point number three is something that I don't think many had thought of before. Thanks.

[mmckinl]

There can not be an accounting.

If there were such an accounting dozens of banks, brokerages, and insurance companies would be crippled if not bankrupt, debilitating the financial sector and crippling the economy.

The privately owned and operated Federal Reserve System is fighting for its life and willl take down the economy before it relinquishes its grasp on the throat of the banking system and the economy.

Yes , it is that bad.

[mmckinl]

There cannot be an honest accounting.

Too many banks , brokers and insurance companies would be severely cripled or go bust. This would slash the money supply, and debilitate the economy.

Yes , It's that bad ...

[realitytrumpsbull]

Maybe a lot of people signed up for mortgages
believing there were going to be enough jobs
and stuff, and they got over-leveraged and
now they're broke? Too many money games, too
much red ink, not enough common sense. Real
estate is a racket to begin with. Freddie/Fannie
Scammy/Wammy.

[Raven]

While I'm glad there's a plan afoot to help homeowners directly, I agree wholeheartedly with all of your concerns.

When you say,

"Intervention to cushion the blow and redistribute pain makes sense. It requires broad social discussion and an honest accounting of what interests are helped and hurt by various plans. We need an honest accounting of where we are, where we are headed and who the public, should be intervening to help and punish,"

you've really hit the nose on the head, Max.

Intervention at this point really can only be seen as something that will cushion the blow.

There's no way to stem the tide of what's coming. But helping even some homeowners stay in their homes is at least a meager start to redistributing the pain.

But this plan is so limited in scope and is based on so many inaccurate assumptions, it's hardly going to be a bump in housing's downward spiral. It will ease the pain for some folks. But it won't change the big picture.

Anyone who thinks it is can't be paying attention.

The problem is, how to get to that "honest accounting" you so correctly advise.

No one knows what those assets are worth. They're going from being highly overrated to almost worthless, given the growing inventory. And we know even less about the extent of fraud that's bound to be all over the no docs.

And by the time they figure it out, the answer will be pretty bleak. The prices are going nowhere but down.

The public's got to be involved in this. This is a crisis that's going to require huge interventions on many levels. Not to stop what's coming - but to ease the pain and find creative solutions to the social ramifications. Every community will be effected before it's over.

Doesn't that, in and of itself, just make the whole situation cry out for more debate?

And instead, the folks who created the mess in the first place are still looking for places to hide it.

That's got to stop.