Friday, November 30, 2007

Is a subprime deal in the offing? 

The Wall Street Journal is reporting that the White House is near to a deal with the big banks and, perhaps, the investors in subprime mortgages to temporarily freeze interest rates on mortgages that otherwise would "reset":

Details of the plan, which could be announced as early as next week, are still being worked out. In general, the government and the coalition have largely agreed to extend the lower introductory rate on home loans for certain borrowers who will have trouble making payments once their mortgages increase.

Many subprime loans carry a low "teaser" interest rate for the first two or three years, then reset to a higher rate for the remainder of the term, which is typically 30 years in total. In a typical case, the rate would rise to around 9.5% to 11% from 7% or 8%. That would boost an average borrower's payment by several hundred dollars a month.

Exactly which borrowers will qualify for the freeze and how long the freeze would last are yet to be determined. Under one scenario, the freeze could run as long as seven years. The parties are developing standard criteria that would determine eligibility. The criteria should be finalized by the end of year....

Among the holdouts have been investors, who typically hold securities backed by mortgages. If interest rates are frozen, they would lose the potential benefit of higher payments. But investors have cautiously moved toward cooperation, likely on the grounds that it's better to get some interest than none at all.

Uber-libertarian Larry Kudlow is guest-hosting "Squawk Box" this morning, and he is strongly endorsing this deal notwithstanding his incessantly repeated commitment to "free market capitalism." His argument is that with the investors in the deal this is not a confiscation of property rights but a renegotiation. It is just a tough renegotiation that is not possible for any one mortgagor because he would have to deal with too many individual counterparties. Only the White House had the capacity to round up all the parties necessary to make a deal possible. So there you have it, a rare TigerHawk bow in the direction of governmental intervention.

Meanwhile, the dollar is stronger notwithstanding new chatter from the Fed on interest rate cuts, gold and oil are down, and the stock market has now been up three days in a row for the first time since September. A lot of different people are registering new confidence that catastrophe is not in the offing. Are we going to dodge this bullet?


By Anonymous Anonymous, at Fri Nov 30, 10:10:00 AM:

The sense of certainty a deal such as this would bring will help the markets a lot, maybe more than a rate cut. The stock market reaction to this deal, if it really happens, will be interesting to see, but I'd bet on a big move up.


By Anonymous Anonymous, at Fri Nov 30, 10:34:00 AM:

In answer to your question - no, we will not dodge this bullet. The economy will go into recession in 2008.

In brighter news, Kirk Ferentz will not be leaving Iowa.  

By Blogger Charlottesvillain, at Fri Nov 30, 01:00:00 PM:

I predict that this deal will have as much impact as, say, the super SIV fund, or M-LEC, that was announced prematurely some weeks ago but has yet to materialize. And it will fail for largely the same reasons, which is that the parties involved have competing interests. Wasn't Paulson behind that atrocity as well?

There are so many problems with this "deal" I don't know where to start, but the first and most obvious one is that a large loss is going to be incurred. Who is taking it? The investors, that's who. They bought transactions promising certain terms, and if this were to somehow go through they will experience a cram down. Were this to happen you could kiss the MBS market goodbye for the foreseeable future, which essentially means no new mortages. At the end of the day, that would be as bad or worse for the housing market than letting the overextended borrower take his lumps.

I don't think it will go through, however, because pooling and servicing agreements allow this type of loan modification only if it can be proven that it is in the best interests of the investor. This will be very hard to do on a blanket basis, and will surely be litigated.

I would also add that, according to the WSJ article, only a subset of ARM borrowers would qualify: they would have to be current on their existing payment at teaser rate, and they would have to "prove" that the increase will be unaffordable. Anyone with an ARM will have every incentive to try to get this deal, so either everyone is going to get it, or the servicers will be drowing in applications that will need to be assessed. Lets not even get into the moral hazard issues here.

No, this deal is an abomination, and it cannot, and will not, be implemented in this form, and even if it were it would be too late to solve the problem, which is enormous.  

By Anonymous Anonymous, at Fri Nov 30, 07:38:00 PM:

Wouldn't a deal like this also help unfairly prop up housing prices that are way too high?  

By Anonymous Anonymous, at Fri Nov 30, 08:02:00 PM:

Gotta love government interventionism when it suits you...  

By Blogger Who Struck John, at Fri Nov 30, 08:35:00 PM:

This deal will go through; the banks need to kick the can down the road (they cannot survive marking to market right now). However, Charlottesvillain is right that it won't fix the problem. The problem is too big for this.

The MBS market is already gone. BBB was 95+ at the start of the year and it's looking overvalued at 20 cents on the dollar now. AAA has fallen to 75 and looks to keep right on dropping.

There is a reason why Bernacke is at the Fed; it's because they didn't want another Mellon at the Fed with what's on the horizon.  

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