Solutions!
I’ve been waiting for someone to outline an idea to me about good forward-looking proposals to help clean up this mess and now here comes Andrew Jakabovics for CAP:
While securitization adds complexity to the question of where the authority to modify loans lies, we believe that recent actions by the Federal Deposit Insurance Corporation to engage in wholesale loan modifications for bankrupt California lender IndyMac Bank’s loans—which it now holds directly or in a servicing portfolio—serve as guidance for where U.S. mortgage giants Fannie Mae and Freddie Mac and the private mortgage servicing companies must go.
The housing bill that recently passed into law mandates a Treasury study of auctions of mortgage pools based on the Center for American Progress’s Saving America’s Family Equity, or SAFE loan program, to get large numbers of loans into the hands of new investors who could restructure the existing loans so that they would perform. Under the SAFE loan program, the discount below face paid at the auction would allow the new note holders to do the necessary writedowns without incurring losses.
The SAFE loan program, like the FDIC actions, recognize that both borrowers and investors, and ultimately taxpayers, are better off when loans are restructured rather than allowed to proceed to foreclosure. Liquidity will return to Wall Street when the confidence in Main Street’s ability to pay its mortgages is restored. The Bush administration should accelerate that study so that U.S. financial regulators can get down to the real business at hand—finally fixing the problem in the mortgage marketplace at its source.
This sounds reasonable to me. I also don’t really understand why the Fed decided to eschew a rate cut earlier this week. Recent inflationary pressure had all come from rising commodity prices, and those prices seem to be headed down in anticipation of a worldwide downturn. Nothing remotely resembling a dangerous wage-price spiral was ever in sight and certainly isn’t in sight now. The big risk would be that the scary news from the financial market leads to job and income losses in the “real world” that lead more people to miss their mortgage payments and send us into a downward spiral.
30 Responses to “Solutions!”
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September 17th, 2008 at 4:53 pm
Not much comment from various quarters about just how relatively MIA Bush has been during the last few days in dealing with U.S. finance issues.
September 17th, 2008 at 5:02 pm
My understanding is that the fed chose not to lower interest rates, because they are already low, and they want to save some ammunition if/when the next big crisis arrives for which a further rate cut is essential.
September 17th, 2008 at 5:13 pm
I also don’t really understand why the Fed decided to eschew a rate cut earlier this week.
2% is pretty darn low, historically. And being sub 2% for all of ‘03 was a major contributer to the housing bubble. Also, it would be wrong for all kinds of reasons for the fed to do a rate change just to respond to whatever happened to the stock market the day before.
September 17th, 2008 at 5:16 pm
For future reference: when you hear pols telling you they just want to “keep people in their homes” or some other mom-and-apple-pie bullshyt, you can bet on 2 things: they’re setting up more banker bailouts, and you’re going to pay for it.
September 17th, 2008 at 5:22 pm
Look, just follow the E. O’Neal plan: you take the $5 trillion in liabilities he says we took on from FNM and FRE and multiply it by the declines in the stock markets. Since negative x negative = positive, liabilities magically become assets. Problem solved.
September 17th, 2008 at 5:57 pm
Isn’t inflation a worry, given that the Fed, with the takeover of Fannie and Freddie, has already taken on unbelievable amounts of debt?
With the FDIC fund perhaps looking a little anemic if there are lots of bank failures, this may just be the *beginning* of the Fed minting money.
Can someone talk me down? *I’m* worried about inflation, which is, like, weird.
September 17th, 2008 at 6:16 pm
why no rate cut? did you check the return on 3 month Treasury notes? Almost 0. Zero. Nada. Zilch.
So, if the Fed cuts rates, what’s the effect?
And if they cut rates now and then things get worse in the economy (but let’s say the 3 month T note yield returns to normal positive territory), then what?
Look to Japan: trouble if you wait too long to cut rates, trouble if you cut rates too much. Also, long term trouble if you don’t get the bad loans and bad institutions out of the financial system.
The enormity of the problem here has to be faced. The asset deflation in progress is huge, or should I say HUGE! Take the FDIC inspired plan to stem foreclosures. What we’ve got to come to grips with is that this isn’t about wiping out 5% or 10% off existing mortgages. No, it is much more than that because 1) house prices are going to bottom at 50% off or more in the voluminous bubble areas, voluminous in number of mortgages and dollar volume, and 2) writing down mortgages to a level at which people can pay their mortgages in a failing economy and financial crisis and housing crash also requires a major write down.
I’m not saying it is a bad plan, just saying we’d better get a grip on just how big a write down we’re talking about, and come to grips with what such a big write down will mean as it tumbles through the securities markets and all the institutions holding these pieces of paper.
September 17th, 2008 at 6:46 pm
Could we construct a fix which is paid for by buyers and sellers of bubble properties, and is NOT paid for by innocent bystanders? Maybe unwind the bubble transactions back to a certain date, and do it in some way that leaves the bubble seller with half the gain from the transaction, and gives the other half to the bubble buyer?
September 17th, 2008 at 7:28 pm
sorry Ferd. That’s the beauty of capitalism and living in a nation state. Think of the same logic applied to, say, Mr Bush. Why should we all suffer for his bad decisions? Why can’t we make him pay personally for the Iraq War, instead of having the debt from his war sink the whole economy? Better still, why can’t we have him die the 4,200 deaths, and suffer the 40,000 or so wounds? The decisions he made take us all down with him and, in fact, make most people suffer way more than he will ever suffer. Loosely speaking, the economy works the same way. Let the world’s biggest financial firms cook up a toxic stew, lure several years of booming home buyers into eat it, and then contaminate all the investors. Can’t put the disease back into its toxic crib.
Other way to look at it is that the country let Bush be President and let a series of Presidents since Reagan gut the regulatory system, and about half the country still seems to believe in that sort of vodoo economics.
No one could get elected by the telling the American people the truth. As a nation, it is our own damned fault.
September 17th, 2008 at 7:35 pm
Could we construct a fix which is paid for by buyers and sellers of bubble properties, and is NOT paid for by innocent bystanders? Maybe unwind the bubble transactions back to a certain date, and do it in some way that leaves the bubble seller with half the gain from the transaction, and gives the other half to the bubble buyer?
Despite the iconography that depicts subprime borrowers as home purchasers who greedily snatched up large new properties beyond their means, the worst performing subprime loans are not purchase money, but are refinance transactions that were made to people who have owned their home for years. In these transactions there’s no buyers or sellers. These involve refinance borrowers struggling to keep up in an economy where wages have stagnated but the cost of living has steadily climbed. On the other end are Wall Street underwriters of predatory refinance loans that were alchemically morphed into AAA securities.
If you want a solution that is “paid for” by those with appropriate levels of culpability, this is already happening when holders of predatory mortgage backed securities write-down and restructure mortgages to where they will perform. Borrowers pay up to affordability, and financiers write-down the rest. We just need mechanisms that facilitate those transactions. Where holders are too recalcitrant, we need legislation and regulatory action to pressure them. And if write-downs become not just undesirable for denialist firms, but actually financially unfeasible because holders can’t remain solvent while writing-down to borrower affordability, then agencies should step in and finance the rest.
September 17th, 2008 at 7:38 pm
I left out the scumbag originators and brokers, but that kind of accountability is best left to attorneys general and legal services lawyers. In other words, donate to your neighborhood legal services offices.
September 17th, 2008 at 8:06 pm
Re: the worst performing subprime loans are not purchase money, but are refinance transactions that were made to people who have owned their home for years.
???
Why would these be a problem? If people had owned their homes for years then presumably they had a fair anount of equity in them. Some of these people may be in default for the usual reasons (job loss, illness, divorce) but few, if any, should be upside down in their mortagges. The problem loans are generally those where there was no equity (or even negative equity). Morever, why would they trade a loan they could afford for one they couldn’t?
September 17th, 2008 at 8:29 pm
Skip that. The government could prevent the next Great Depression far more efficiently if Fannie May just straight up refinanced homeowners’ mortgages directly at sub market rates, like the Direct Student Loan Program.
The government is the best collection agency in the world when it wants to be, and real, physical property is much better collateral than those worthless derivatives that the Fed is currently accepting.
Direct mortgages would be a better investment for taxpayers that would keep people in their homes and prevent mortgage lenders from going bankrupt at the same time. Win, win, win.
September 17th, 2008 at 8:33 pm
StJoe is right, though the exact proportions are difficult to nail down. Still, it is absolutely true that many people are over their head from refi deals. Some refi deals were for buying cars and vacations and whatnot, but many were for medical bills or for basic retirement income. Many people are losing homes owned for decades due to refi deals that took equity out. Take out too much equity, then get a price collapse, and suddenly you owe more than the house is worth. One little ding in your income and you can’t pay off the loan, and that’s even before any interest rate resets.
One small mistake in the commentary, however. It isn’t just “sub-prime loans”, by the strict definition meaning loans to people with low FICO scores. The problem is across the board, including prime and Alt-A, especially.
Or, to put it the best way – We are all sub-prime now.
September 17th, 2008 at 9:12 pm
I also don’t really understand why the Fed decided to eschew a rate cut earlier this week. Recent inflationary pressure had all come from rising commodity prices, and those prices seem to be headed down in anticipation of a worldwide downturn.
The Fed is going to have to print a lot of money to pay for the AIG bailout, which will cause plenty of inflationary pressures of its own.
September 17th, 2008 at 9:42 pm
the fed is afraid of falling into a liquidity trap, not having more room to stimulate the economy via monetary policy. so they want to leave themselves some room.
unfortunately, the market is leaving them no room. the 3-month treasury bill yield is 0.06%, effectively zero.
this is real scary . . .
September 18th, 2008 at 8:03 am
“The SAFE loan program, like the FDIC actions, recognize that both borrowers and investors, and ultimately taxpayers, are better off when loans are restructured rather than allowed to proceed to foreclosure. ”
Unfortunately, that’s simply not the case. It depends on what type of investor you are, and how bad the situation is with your holdings. Often, if you have a senior or super senior position (ie now or formerly triple-A), then you’re much better off foreclosing and getting the principal back than restructuring and eroding excess spread. Let the junior noteholders take the principal hit, assuming the loss severity isn’t too high. That’s the central problem here, on top of the typical 5% loan mod cap in securitisations. Servicers have to act in the interests of all noteholders, but noteholders have conflicting interests in a downturn.
September 23rd, 2008 at 12:11 am
JonF wrote:
???
Why would these be a problem? If people had owned their homes for years then presumably they had a fair anount of equity in them. Some of these people may be in default for the usual reasons (job loss, illness, divorce) but few, if any, should be upside down in their mortagges. The problem loans are generally those where there was no equity (or even negative equity). Morever, why would they trade a loan they could afford for one they couldn’t?
I am trying to point out an essential fact about the subprime market, which is that it thrived primarily on extraction of equity, not the financing of new home purchases (although that is a significant part). Subprime lenders targetted people with equity in their homes for refinancing. This is because, in part, purchase money loans comprise a very limited market. Homes with equity were also thought be to smarter from an “asset-based lending” perspective, whereby it was assumed that a holder of a mortgage could be made whole by retaking the collateral.
There are only so many new home purchases, but you can always try to sell new mortgage products, lines of credit, refinancings, and so on, to existing homeowners who might have generated a little equity in the past year — and if they haven’t, you could simply obtain an inflated appraisal to generate loan principal from thin air (nevermind that is greatly enhanced the indebtedness of the borrower and necessarily entailed larger and more unaffordable monthly payments).
A very large portion of this market was predatory. It started out with elderly homeowners who had owned their houses since the 70s or 80s and now had vast equity ready to be extracted by lenders, who devised ever-evolving mortgage products to sell them. It ended when the desperate need to feed reckless Wall Street demand for mortgage products lead lenders to abandon all standards whatsoever. Hence you get ridiculous stuff like negative amortizing loans, which are designed for people expecting huge increases in their income, being sold on a widespread basis to elderly people on fixed incomes.
You are partially right that the problem houses are the ones with no equity — but a great deal of them got that way through predatory structured refinance.
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