From Mike Larson at www.moneyandmarkets.com
by Tom on December 7, 2007
in Uncategorized
Here’s a simple and relatively concise explanation of President Bush’s mortgage plan. I’ve copied the majority of it here, but you can read the entire thing on their site if you want to…..
“By now, you’ve probably heard of what I’m calling the “Paulson Plan” a federal government proposal to ease the pain of the housing and mortgage market collapse. President Bush and Treasury Secretary Henry Paulson held press conferences to highlight the key points yesterday.
I’ll be discussing it on CNN’s “Open House” show this weekend [Editor's note: 9:30 A.M. Saturday on CNN and 3:30 P.M. EST Saturday and Sunday on CNN Headline News]. But first, I wanted to share my thoughts with you.
Let’s start with what we know about the severity of the crisis:
Roughly 100,000 subprime adjustable rate mortgages (ARMs) are on track to “reset” EVERY MONTH for the next two years, according to UBS. A reset is when the interest rate and payment on an ARM adjusts higher.
The FDIC projects that total resets will amount to roughly $330 billion through next December. Interest rates on many ARMs are expected to rise from a range of 7% to 9% to 11% to 13%.
Thanks to these resets … falling home values … and the lagged effect of reckless lending (falsifying incomes, writing loans at excessively high debt-to-income ratios, etc.), we’re facing a foreclosure tsunami. The Center for Responsible Lending projects that souring subprime mortgages alone will result in 2.2 million foreclosures over the next few years.
The Mortgage Bankers Association just released awful data on third-quarter mortgage delinquencies and foreclosures. Some 5.59% of mortgage borrowers were behind on payments in the three months ended this September. That’s up from 4.67% a year earlier and the worst reading going all the way back to 1986.
A record 0.78% of U.S. mortgages entered foreclosure in the quarter. And the overall foreclosure rate jumped to 1.69% from 1.05% a year earlier. That’s the highest the MBA has ever found since it started collecting data in 1972. Worse than the 1991 economic downturn. Worse than the dismal early-1980s recession. And worse than when 30-year mortgages were going for 18%!
All told, the mortgage and housing crisis could cost investors and banks as much as $400 billion because of writedowns and losses on mortgage-related securities and other investments.
In fact, a New York Times story in late October pegged the total loss in household wealth due to falling home values at anywhere from $2 trillion to $4 trillion!
So now, the Treasury Department is jumping into the fray with a plan designed to cushion the blow of ARM resets on overstretched borrowers.
President Bush and Treasury Secretary Henry Paulson outlined their latest bailout plan yesterday …
To understand what’s going on, you need to know that Paulson’s plan splits borrowers into four basic categories:
Category #1. Those who can afford their mortgages now, and who can afford them post-reset. These people won’t be helped because they don’t “need” it.
Category #2. Those who can’t even afford their loans at the current teaser rates. These people can’t be helped because their mortgages and homes are just plain unaffordable. In simple terms, they’re hosed and many of them will lose their homes.
Category #3. Those who can probably refinance if they want to (i.e. they have enough equity and their credit is good enough for them to qualify for a loan despite today’s tighter lending standards). Paulson would prefer that these people be refinanced into new mortgages, rather than have their existing loans modified.
Category #4. Those who can handle their mortgages at the current teaser rates, but who couldn’t afford them if their rates and payments were to reset higher.
It’s the people in category four that are being targeted for relief, provided they have steady incomes and “relatively clean” payment histories. Specifically, borrowers who are at least 30 days behind on their loans at the time of the potential modification or who have been more than 60 days late within the past year will be excluded.
The program will apply to anyone who took out a subprime ARM between January 1, 2005 and July 31, 2007 and whose rates reset between January 1, 2008 and July 31, 2010. The idea is that these folks will have their low teaser rates “frozen” for five years.
That will theoretically allow these borrowers to stay in their homes, improve their credit, and eventually refinance. It’s also designed to prevent even more foreclosures, which could exacerbate the home inventory glut and push home prices even lower.
Another part of Paulson’s plan: Allow state and local governments to sell tax-exempt bonds to raise money to refinance borrowers out of subprime loans. Currently, such bonds can only be used to finance things like first-time home buyer purchase loans.
The $400-Billion Question:Will the Plan Work?
My belief is that it will help some borrowers at the margin. But it’s far from a panacea … there are several major hurdles to success … and the risk of unintended consequences is high.
In other words, like the FHA reform proposals I wrote about back in September, this program will make life easier for some borrowers, but won’t “fix” the overall market.
There are three major problems that I see …
Problem #1: It’s going to be extremely difficult to get everyone on the same page. This isn’t your father’s mortgage market. Banks generally don’t make 30-year loans to borrowers and hold them on the books forever.
They originate those loans, and then unload them into the secondary market. There, those mortgages are bunched together into all types of securities, which in turn are bought by income-seeking investors the world over. To see what I mean, check out this mortgage flow chart that was included in Congressional testimony delivered back in April by FDIC Chairman Sheila Bair.
The net impact of all this is that the interests of loan investors, loan servicers (the guys who collect our mortgage payments), and mortgage borrowers aren’t always aligned.
Holders of certain chunks, or tranches, of mortgage bonds may lose some money from modifications; holders of others tranches may benefit. No wonder BNP Paribas calls the plan a “recipe for serious litigation.”
Problem #2: Modifications aren’t a permanent fix because modified loans frequently go bad anyway. You may have seen the term “recidivism rate” before. It’s the rate at which criminals, after being tried, convicted, and incarcerated, turn around and commit new crimes.
Rates are pretty high — a 1994 study here in the U.S. found that almost 68% of prisoners released that year were re-arrested within three years.
Turns out the record isn’t so good for homeowners whose mortgages are modified, either! Joshua Rosner at Graham-Fisher & Co. says a full 40% to 60% of subprime and Alt-A borrowers who have their loans modified end up defaulting anyway within the next two years.
At best, this proposed bailout plan could lead to a bunch of lenders kicking the can down the road. Losses won’t be eliminated; they’ll just be pushed out into the future.
And if home prices keep falling as I expect them to losses on those defaulted loans will just get worse!
So put yourself in the shoes of a banker. You can foreclose and sell now, and get maybe 75 cents of every dollar you lent back. Or you can roll the dice on your borrower who has at least a 4 in 10 chance of defaulting anyway. If he does, and values keep falling in the meantime, you might get just 60 cents on the dollar in a year or two.
Neither option is very good!
And what about borrowers? If they stick around in a falling-price environment, even at a lower interest rate, they’ll end up making mont
hly payments for several months against properties that are losing value. Then when they go to sell one or two or three years down the road, they’ll find themselves upside down to an even greater degree.
In other words, modifying loans on a wholesale basis may not be the best deal for lenders or borrowers.
Problem #3: Resets aren’t the only cause of foreclosure or even the biggest one. Here’s a shocking statistic: Borrowers are already behind on roughly 25% of subprime loans made in 2006 that don’t reset until 2008.
Reason: Because home prices are falling. As a recent Federal Reserve Bank of Boston paper points out, declining home prices play a “dominant role in generating foreclosures.”
