Friday, November 30, 2007
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.
Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups: those who can continue to make their payments even if rates rise, those who can't afford their mortgages even if rates stay steady, and those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates. Only the third group would be eligible for help.
So now the lenders all get together and decide who can afford to pay what. I have a counter proposal. Why don't grocery stores all get together and decide how much customers can afford to pay for a loaf of bread? Seriously, that is what is being discussed here. (Editor: I would also point out that this kind of credit assessment is what the mortgage underwriters were supposed to be doing when the loans were originated in the first place. What makes anyone think they will do a better job of it now?)
But let's get one thing straight right up front. This has nothing whatsoever to do with "saving people's homes". This is about saving financial institutions from collapse. And the plan will fail. It rewards those who cannot afford to pay. The details are not in yet but I suspect one measure of the ability to pay will be whether or not one is current on their loans.
Anyone who wants a freeze should stop paying their mortgage now. It's clear that lending institutions do not want those homes back.
Mish can be pretty harsh but his bleak assessments have been right on the money, and I think he's right on this one too. One more general point he makes about this whole thing seems beyond obvious.
Even if is theoretically possible for such meddling to work, history shows that government meddling always makes things worse in actual practice.I have to say I find few holes in that logic.
The question, though, is whether the deal will have the practical effect of distributing foreclosures more evenly over time. If it did, perhaps it would lower the risk of a cascading collapse in real estate values because of the sudden oversupply in foreclosed properties. That, in turn, would avoid a lot of other consequences. Isn't that really the point?
I don't see that happening; as Charlottesvillain said, either the criteria for lock-in would be impossibly stringent, or the process of being evaluated would be impossibly tedious. I think the lenders are only agreeing to this because they want to avoid any possible legislation on the issue; wishful thinking on their parts imo.
A few years ago I heard real estate likened to tech stocks, but that may have been overly optimistic; the whole situation could end up being much worse than that.
I'm surprised the banks haven't already started doing this on their own to avoid suddenly being the proud owners of lots of distressed property.
When you owe the bank $10,000 it is your problem. When 10,000 prople owe the bank $10,000 it is the bank's problem.
Actually, that is exactly what the loan servicers are TRYING to do. But its a pig in a python thing. There are too many loans on the edge to process in an expeditious way. The idea behind the deal is to come up with a blanket approach that could somehow shorten the process, but it doesn't make any sense.
Also, I kind of get the Kudlow argument that this is cool if it comes in the form of investor "concession" as opposed to a cram down, but who are the investors? These loans are in MBS, tranches of which are in CDOs, tranches of which are in other CDOs, all sold to investors around the world. Just sorting out who has voting rights on the deals will take months. The trustees, never known for sticking their neck out, will face the choice of trying to organize votes of noteholders, proceeding with approvals for blanket modifications without the approval of noteholders, or doing nothing. Which of the three do you think their lawyers will recommend that they do?
TH, you may be right about the point of the exercise, but from a practical standpoint it makes no sense. I was amazed to see rallies in the stock prices of home builders and bond insurers as a result of this leak. Wise investors will take this gift and sell into the rally. There is no salvation here.
A history for this this type of loan "restructuring" can be found in the Farm Credit system. A farm credit loan can not be foreclosed on if the cost of forebearance is less. In other words, you get an automatic restructure if your loan to value ratio is out of wack. As is noted above this provides a powerful incentive to simply stop paying on a loan, even if you have the ability to pay, since this forces the bank to then offer you a better, restructured deal.
Lest there be any confusion, I think that home builders are in for a very tough time. This deal will not help them, and I do not understand the rally in their stocks. I do think, though, that it might be possible to prevent cascading foreclosures by freezing resets if enough investors can be found to control the votes in the mortgage pools. I defer to you on the likelihood of that, but presumably the parties involved in these negotiations have some plausible path to a solution.
As I see it, banks do not want to be property managers and those in financially shaky mortgages do not want to give up their houses, generally. I think for a lot of banks/investors and homeowners, trading a shorter payoff period for a stable and fixed (and performing) mortgage would be functional. For lenders it protects them from additional forclosures. For property owners fewer foreclosures will underpin property values. Banks would like that also.
Actually, TH, I think the market is already solving the problem. You've seen interest rates coming down - it's a big part of the reason the dollar has been sliding. But the real move has been short rates: the yield curve had been very flat for a couple of years now, and in the last month or so has gotten much steeper as short rates drop faster than long rates. I expect that will continue - Fed policy adjustments affect short rates only.
Why is that important to 30 year mortgages? Because ARMs reset on formulas based on a premium to a benchmark, in my case 2 year treasuries, but different adjustable rate mortgages use different benchmarks and different markups. When the yield curve was flat, short rates were as high as long rates, and introductory rates were adjusting to be equivalent to the long rates.
When we refinanced our current mortgage I had a choice of 30 year fixed at 6+% and a 3 year fix at just over 4%. When the yield flattened, all the rates were above 6%, and nobody could avoid high rates by borrowing short or refinancing using short maturity.
Now the curve is steep again two things will happen. First, credit worthy borrowers will be able to refinance to lower short rates. Second, banks will be able to proactively contact their customers and offer them lower rates without cutting into the banks' own normal margins. (Again, my own bank has done that with our mortgage, cutting more than a percent off the rate.) Of course, the banks will have to give up the abnormally large margins but if they don't, their customers will refinance elsewhere.
The question of who owns the mortgages is mere handwringing. The originating banks keep the mortgage servicing rights even after they have sold the actual mortgages off to bundlers. The owners of the MSRs have wide authority to renegotiate rates, especially if the alternative is to lose the customer entirely to a refinancing or to incur an asset hit on a foreclosure.
This issue is within 3 months of moving to the back burner. Then we can all get back to worrying about global warming!