Friday, February 22, 2008

Naked Capital on Housing Bailout Plans (Part 1)

(Naked Capitalism) Any doubts that we are going down the Japan path of trying to shore up inflated asset value rather than letting the market find the right level, should now be over. Bloomberg tells us that the Office of Thrift Supervision is looking into a plan that will enable homeowners to refinance houses that have negative equity.

Before we get into the fact that this might be very difficult to put into effect (as Tanta alludes), this move is all about propping up the portion of the housing market where the lenders/investors have the most to lose, and correspondingly, where it is most rational for the homeowner to walk away. Consider, as Credit Slips did, that the Hope Now Alliance program was also targeted at borrowers who had very low (less than 3%) to negative equity) and as Credit Slips discussed, 75% of the interventions resulted repayment plans. These do not change the terms of the mortgage.

A different post at Credit Slips discussed the concept of "hostage value" in these loans:
A side note for the Not-Commercial-Law-Jocks: "Hostage value" in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to repossess the collateral. The classic example was the old practice of taking a security interest in all of a family's household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released. This version of the practice involving household goods is now banned by the FTC. In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions.

Rescue programs [operated by the states] limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender. But the mortgage lenders want more. If they don't get it, they won't release the mortgage--even though the lenders won't get anything close to 100% of the value of the home if they are forced to foreclose. They hold the home hostage: Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home.

Irony of ironies, borrowers may be savvying up to the fact that it isn't rational to let the bank threaten to make you pay more for your property than it is now worth (morality is another issue.....).

Increasingly, economists are finding that falling house prices, and not just payment stress, leads to higher default/foreclosure rates. The lending industry is no doubt alarmed that "jingle mail" is on the rise, and even some borrowers who can afford to make payments are abandoning their homes.

The last 15+ years of encouraging homeowners to view their residence as a financial asset are coming home to roost. By any rational calculus, staying in a home with negative equity, particularly if you are having trouble making the payments, is not a good bet.

Thus, it isn't clear how much this OTS concept, even it if sees the light of day, will help. But if it does, it benefits the mortgage industry far more than the public at large. Notice it also makes an explicit subsidy of underwater houses with government resources, We have now entered explicit bailout territory.

Update 9:00 PM: I wanted to clarify the point in the paragraph above about explicit government subsidies, since most reporting on this (and the reporting is muddied, which may be due to the plan being in flux) is the idea that the old, above market mortgage balance will be validated and continued via a government guaranteed new mortgage, or perhaps merely the warrant would be guaranteed.

This proposal flies in the face of good sense. The reason home prices are falling in many markets is that they are out of line wit incomes and rental prices. This measure appears to be an attempt to stymie various proposals to enable mortgages to be restructured by writing balances down to something more consistent with current market values. One such proposal is a Democrat-sponsored bankruptcy bill, which is regularly attacked by Republicans and the mortgage industry as allowing judges to rewrite mortgages, In fact, what this does is bring practice for residential mortgages in line with bankruptcy rules for businesses. Wonder why none of these critics has a problem with judges reducing a secured loan to the value of its collateral when the borrower is a corporation.

The idea that a government guarantee is not a bailout is such a canard that it is almost beneath comment, but this Administration knows no shame.

Update 2/22, 12:50 AM: Later reports (as per the New York Times) indicate that the negative amortization certificates would be privately issued, but the underlying fixed rate mortgages could come from the FHA. Still looks sus to me (one wonders, for instance, how generous the FHA appraisals will be, since they will determine the level at which the mortgage ends and the certificate begins).

From Bloomberg:
The U.S. Treasury is ``interested'' in a proposal to help homeowners facing foreclosure by refinancing their mortgages on homes that have fallen in value, a department spokeswoman said.

The Office of Thrift Supervision is developing a program to prevent borrowers from abandoning homes worth less than the amount of the loan. Homeowners would be able to refinance their mortgage at the current market values, with the lender getting a ``negative-equity certificate'' to be redeemed once the home is sold, OTS Director John Reich said yesterday.

``Treasury certainly wants to hear all ideas on ways to help homeowners, so we are interested in learning the details of this proposal as they develop,'' Treasury spokeswoman Jennifer Zuccarelli said. ``We welcome innovative, market-based proposals to encourage flexibility for struggling homeowners.''

The OTS, the Treasury's savings-and-loan regulator, joins other policy makers in suggesting ways to head off the worst housing slump in a quarter-century by limiting foreclosures. Treasury last week announced an agreement with loan servicers to place a 30-day freeze on foreclosures for borrowers meeting certain criteria.

Negative-equity certificates could help servicers limit loan losses and avoid an ``avalanche of borrowers who choose to walk away from the mortgage,'' Scott Polakoff, the agency's senior deputy director, said yesterday. The Federal Housing Administration could help homeowners refinance, he said.

Earlier today, Robert Steel, the Treasury's undersecretary for domestic finance, told Reuters that ``we're just learning about it,'' adding that he had talked with Reich about the proposal last night. ``They're still working out the details too,'' Reuters quoted Steel as saying.

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