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What Happened? A Summary of the Homeowner Affordability and Stability Plan

By Brian | February 20, 2009 | Share on Facebook

In the spirit of my previous post – What Happened? A Summary of the Financial Crisis, I present what I hope will be a factual, non-partisan view of President Obama’s recently announced plan to reduce home foreclosures – the Homeowner Affordability and Stability Plan.

If such things interest you, click below the fold. Otherwise, please enjoy my next post, which makes reference to alcohol, gambling and sex.

Before we get started, the same disclaimer I made in my previous post:

This comes from me and from me alone. While I’ll do my best to remain factually accurate and politically dispassionate, no one should take this as a statement made by or on behalf of my employer. I haven’t vetted it with anyone at work, and I can’t say with any certainty that some of my colleagues wouldn’t disagree with all or part of it.

Now that we’ve taken care of that, let’s begin (all quotes from the transcript of the President’s speech in Mesa, AZ – Feb 18, 2009). And where to begin? With a young family…(cue the Disney music):

It begins with a young family – maybe in Mesa, or Glendale, or Tempe – or just as likely in suburban Las Vegas, Cleveland, or Miami. They save up. They search. They choose a home that feels like the perfect place to start a life. They secure a fixed-rate mortgage at a reasonable rate, make a down payment, and make their mortgage payments each month. They are as responsible as anyone could ask them to be.

But then they learn that acting responsibly often isn’t enough to escape this crisis. Perhaps someone loses a job in the latest round of layoffs, one of more than three and a half million jobs lost since this recession began – or maybe a child gets sick, or a spouse has his or her hours cut.

In the past, if you found yourself in a situation like this, you could have sold your home and bought a smaller one with more affordable payments. Or you could have refinanced your home at a lower rate. But today, home values have fallen so sharply that even if you made a large down payment, the current value of your mortgage may still be higher than the current value of your house. So no bank will return your calls, and no sale will return your investment.

You can’t afford to leave and you can’t afford to stay. So you cut back on luxuries. Then you cut back on necessities. You spend down your savings to keep up with your payments. Then you open the retirement fund. Then you use the credit cards. And when you’ve gone through everything you have, and done everything you can, you have no choice but to default on your loan. And so your home joins the nearly six million others in foreclosure or at risk of foreclosure across the country, including roughly 150,000 right here in Arizona.

Obama’s description here is right on the money (no pun intended), in that it describes how people with the best of intentions and fiscal responsibility are being affected by our current Financial Crisis(TM). Of course, not everyone is so responsible, but he gets to that later in the speech. For now, let’s break down a couple of the key concepts contained in this vignette:

The first concept to understand through all of this is the “loan-to-value ratio.” It represents the percentage of your home’s value that you’re borrowing from the bank. So, for instance, if you bought a $500,000 home and put $100,000 down, your LTV would be 80% ($400,000 loan / $500,000 home value = 80%). If you only put $50,000 down, your LTV would be 90%.

Under normal conditions, mortgage lenders will offer their best rate to those who are borrowing less than 70% of the value of their home. If your credit is good, they’ll go to 80%, but at a higher interest rate. Over 80%, they would either refuse to write the loan, or charge an exorbitantly high interest rate (to cover the added risk).

The red-hot housing market of the 90′s and 00′s encouraged lenders to relax their lending standards, in hopes of increasing their market share and collecting more fees.

One way to relax those standards was to allow LTV ratios above 80%. President Obama’s scenario suggests that borrowers “made a down payment,” but the size of that down payment varied wildly. In some extreme cases, it even reached zero (the “no money down” option), transferring the risk of foreclosure entirely to the lender, as it left the borrower with nothing to lose by walking away from the home. Note that without a down payment, even the slightest drop in home values would put the mortgage “under water,” i.e., where the value of the loan exceeds the value of the home (LTV > 100%).

The other way to relax lending standards was to offer alternatives to the fixed-rate mortgage. Fixed rate mortgages are less risky, but often more expensive (in the short term) than adjustable-rate (a.k.a., sub-prime) mortgages.

For those who have been reading about sub-prime mortgages for the last few months but don’t know how they work, here’s the quick run-down: rather than paying the same (fixed) interest rate for thirty years, you pay a very low interest rate (typically below the prime rate, or “sub-prime”) for the first five years, and then a much higher rate (typically the prime rate + some premium) for the remaining 25 years.

Originally intended for people who were expecting a sharp rise in income in the near future (e.g., a doctor in his/her early years of residency), the product became popular among people who wanted a larger home than they could afford with a fixed-rate mortgage. With prices on a seemingly endless climb, both lenders and borrowers agreed to this arrangement on the implicit assumption that when the five-year period ended and the rate went above the homeowner’s means, he/she could simply refinance the (now more valuable) home into another adjustable-rate mortgage. The increased value kept the LTV ratio below 70%, and the (initially) low payments kept the homeowner’s credit score at acceptable levels. As the President points out, that worked for a while, but suddenly stopped working around 2006.

The effects of this crisis have also reverberated across the financial markets. When the housing market collapsed, so did the availability of credit on which our economy depends. As that credit has dried up, it has been harder for families to find affordable loans to purchase a car or pay tuition and harder for businesses to secure the capital they need to expand and create jobs.

Obama skips a few steps here, but once again, he’s correct. The collapse of the housing market did freeze the credit markets, but it’s important to understand why:

Banks are limited (by law) in how much money they can lend. This limitation is roughly defined as a percentage of their assets. During the boom, the demand for mortgages exceeded this limit for most banks, so they securitized many of their loans in the form of mortgage-backed securities. This transferred the liabilities off of their balance sheets (and to the MBS investors) and also helped them raise cash (increasing their assets). This is very similar to what reinsurance does for insurance companies – it increases their capacity to do business by distributing a portion of their risk. It doesn’t get said much these days, but this is a very normal and healthy way for the economy to operate.

The downside in this case was the low barriers to entry that the MBS market provided. Smaller, boutique lenders popped up around the country, selling mortgages to homebuyers and securitizing all of them at the point of sale. This isn’t distributing risk, it’s transferring it outright. The result was a lack of incentive on the part of the mortgage writer to make sure the borrower could pay the loan back, which led to predatory lending (coercing people who couldn’t afford a loan to take one) and eventually, to a higher than expected default rate on the loans.

As housing prices came down, the LTV ratios rocketed well past 80%, and many people were forced to default on their loans. This made the value of the mortgages (for banks that still held them) and the mortgage-backed securities (for banks that had securitized them) drop dramatically. The reduction in asset values constricted the banks’ ability to make further loans, which is the very definition of a constricted credit market.

Many of the boutique firms, who existed solely because of the MBS market, went out of business quickly, since they had little to no leverage to write and hold mortgages themselves. This made it even harder to get a loan, because it reduced the supply of available creditors.

(It also meant that the worst actors in this whole scenario had vanished, leaving Congress, the President and the media to assign blame to other, less nefarious players, such as Wall Street CEO’s. But, I said I’d remain fact-based and dispassionate here. Apologies for this momentary lapse into opinion…).

Back to our President:

This plan must be viewed in a larger context. A lost home often begins with a lost job. Many businesses have laid off workers for a lack of revenue and available capital. Credit has become scarce as the markets have been overwhelmed by the collapse of securities backed by failing mortgages. In the end, the home mortgage crisis, the financial crisis, and this broader economic crisis are interconnected. We cannot successfully address any one of them without addressing them all.

Here, Obama eloquently summarizes what I’ve been detailing – the inter-connectedness of the mortgage market, the credit markets, and the job markets. It is a point that I believe needs to be stressed over and over again as we move through the coming year.

Now, to the meat of it:

Here is how my plan works:

First, we will make it possible for an estimated four to five million currently ineligible homeowners who receive their mortgages through Fannie Mae or Freddie Mac to refinance their mortgages at lower rates.

Right now, Fannie Mae and Freddie Mac – the institutions that guarantee home loans for millions of middle class families – are generally not permitted to guarantee refinancing for mortgages valued at more than 80 percent of the home’s worth. So families who are underwater – or close to being underwater – cannot turn to these lending institutions for help.

My plan changes that by removing this restriction on Fannie and Freddie so that they can refinance mortgages they already own or guarantee. This will allow millions of families stuck with loans at a higher rate to refinance.

More specifically, the plan allows Fannie Mae and Freddie Mac to offer refinancing for borrowers with LTV ratios up to 105%. As quasi-government entities, Fannie and Freddie did not have the luxury of relaxing these standards in the past (as pure private-sector lenders did).

I hasten to note, though, that these are exactly the type of loans that the President has criticized the banking industry for making in the past. As the LTV ratio approaches (or exceeds) 100%, the cost to the borrower of walking away from the home (i.e., defaulting) approaches zero. In this way, the solution looks eerily similar to the cause of the problem.

Second, we will create new incentives so that lenders work with borrowers to modify the terms of sub-prime loans at risk of default and foreclosure.

My plan establishes clear guidelines for the entire mortgage industry that will encourage lenders to modify mortgages on primary residences. Any institution that wishes to receive financial assistance from the government, and to modify home mortgages, will have to do so according to these guidelines – which will be in place two weeks from today.

If lenders and homebuyers work together, and the lender agrees to offer rates that the borrower can afford, we’ll make up part of the gap between what the old payments were and what the new payments will be. And under this plan, lenders who participate will be required to reduce those payments to no more than 31 percent of a borrower’s income. This will enable as many as three to four million homeowners to modify the terms of their mortgages to avoid foreclosure.

Here are the specifics:

What I haven’t seen yet is whether or not the modified mortgage must be a fixed-rate mortgage, or if it can be an adjustable-rate mortgage. My guess is that it will be adjustable-rate, and that the lender will achieve the 31% threshold by lowering the initial rate, and raising the future rate (the >5 year rate) to compensate for the risk.

If this is the case, then once again, the solution seems awfully similar to the cause of the problem: banks loaning money to people who are struggling to pay it back, and artificially (and perhaps, temporarily) lowering the rate to make it happen, under the assumption that in five years time, the value of the home will have increased enough to allow for a refinancing (or the borrower’s income will have increased enough to make the higher payment acceptable).

If this is not the case, then it is likely that banks will raise the interest rate on non-modified loans to make up for the additional risk the government is asking them to take on these “troubled” loans. That means that mortgage holders who are not struggling financially will be subsidizing the troubled loans twice – once with tax dollars and then again with higher interest payments.

Third, we will take major steps to keep mortgage rates low for millions of middle class families looking to secure new mortgages.

Using the funds already approved by Congress for this purpose, the Treasury Department and the Federal Reserve will continue to purchase Fannie Mae and Freddie Mac mortgage-backed securities so that there is stability and liquidity in the marketplace. Through its existing authority Treasury will provide up to $200 billion in capital to ensure that Fannie Mae and Freddie Mac can continue to stabilize markets and hold mortgage rates down.

I’m sure I’m starting to sound like a broken record here, but this is yet another solution that looks just like the cause of the problem. The Federal Government is going to expand the capacity of its two biggest mortgage lenders by securitizing their mortgages, taking potentially “toxic assets” onto its balance sheet.

The irony here is that former Treasury Secretary Hank Paulson’s originally proposed solution to this crisis (the original, 3-page TARP plan) was to buy up existing mortgage-backed securities from the troubled banks, freeing up assets so they could be more effective in supporting the credit markets. This is too difficult, says current Treasury Secretary Geithner (and others), because it is very hard to properly price these securities. Yet we are now willing to create new MSB’s for Fannie Mae & Freddie Mac.

This part of the plan, quite frankly, has me baffled. If anyone who’s reading this (is anyone still reading this?) can explain it, please leave a comment. I’d really appreciate it.

Fourth, we will pursue a wide range of reforms designed to help families stay in their homes and avoid foreclosure.

My administration will continue to support reforming our bankruptcy rules so that we allow judges to reduce home mortgages on primary residences to their fair market value – as long as borrowers pay their debts under a court-ordered plan. That’s the rule for investors who own two, three, and four homes. It should be the rule for ordinary homeowners too, as an alternative to foreclosure.

The key word here is “bankruptcy.” No one is saying that a judge can haphazardly change your mortgage terms. But if you declare bankruptcy, it used to be that your bank got paid off first, before other, less secured creditors. This change allows a judge to give banks less than a dollar for each dollar it’s owed, freeing up more money for other creditors. Obama’s passing reference to the wealthy (“investors who own two, three, and four homes”) refers to the fact that liens on investment properties are not as highly secured as residential mortgages in bankruptcy courts.

(I know I’m slipping back into opinion again here, but this strikes me as nothing more than a punitive step against the mortgage industry. Obviously, we want to prevent personal bankruptcies wherever we can, but if someone does declare bankruptcy, I don’t see the point of putting the mortgage bank in a worse position than it is now, given the many difficulties in the industry. Reasonable people, of course, may disagree.)

One more time from President Obama:

We must also acknowledge the limits of this plan.

Our housing crisis was born of eroding home values, but also of the erosion of our common values. It was brought about by big banks that traded in risky mortgages in return for profits that were literally too good to be true; by lenders who knowingly took advantage of homebuyers; by homebuyers who knowingly borrowed too much from lenders; by speculators who gambled on rising prices; and by leaders in our nation’s capital who failed to act amidst a deepening crisis.

So solving this crisis will require more than resources – it will require all of us to take responsibility. Government must take responsibility for setting rules of the road that are fair and fairly enforced. Banks and lenders must be held accountable for ending the practices that got us into this crisis in the first place. Individuals must take responsibility for their own actions. And all of us must learn to live within our means again.

Eloquent as always, but this time, we see stark inconsistencies with the rest of his speech:

End of SpeechMiddle of Speech
“big banks that traded in risky mortgages in return for profits that were literally too good to be true”The Treasury is investing $200B more into Fannie Mae and Freddie Mac mortgages – by definition, the riskiest mortgages in the marketplace.
“lenders who knowingly took advantage of homebuyers [and] homebuyers who knowingly borrowed too much from lenders”The Federal Government is artificially lowering the payment on unsustainable loans for millions of home buyers, counting on a market rebound to support payment or refinancing.
“speculators who gambled on rising prices”The Federal Government is allowing Fannie Mae and Freddie Mac to refinance mortgages with LTV ratios up to 105%.

Here’s the bottom line: these practices created a “bubble” in the mortgage market before, and that bubble sustained our economy for almost twenty years. As a stimulus program, Obama is hoping the same things happens – money flows back into the mortgage markets, recreating some of what happened during the bubble. Combined with the $787B American Recovery and Reinvestment Act and the as-of-yet ill-defined bank bailout, this mini-bubble will hopefully bridge the mortgage market into a broader economic recovery, which will prevent the vicious cycle from repeating.

If it all works, he’s a genius. If any one part of it falls apart, then the whole thing will come crashing down.

(In the meantime, we’ll continue to criticize bank CEO’s for taking too much risk. Sheesh!)

Topics: Money Talk, Political Rantings | 5 Comments »

5 Responses to “What Happened? A Summary of the Homeowner Affordability and Stability Plan”

  1. FamilyGreenberg.Com - What Happened? A Summary of the Financial Crisis says at February 26th, 2009 at 2:16 pm :
    [...] What Happened? A Summary of the Homeowner Affordability and Stability Plan [...]

  2. Jeff Porten says at March 2nd, 2009 at 4:09 am :
    February 20th? Man, I must be slipping.

    Arguing finance with you remains a fool’s errand, but what really bugs me about your post — and 90% of the public debate — is where you choose to be creepily moralistic in your language. For example: “the red-hot market encouraged lenders to relax their standards” implies that lenders were just doing business. Whereas “people who wanted a larger home than they could afford” are obviously greedy, inept, or vaguely criminal.

    My question: it’s 2005, and someone is considering a mortgage. Their options are the ones that have higher monthly payments, or the ones that have lower monthly payments. No matter how many good reasons there might be to go with the one with higher payments, isn’t it quite likely that you’re going to feel like a schmuck, and have many corporate voices lined up to reinforce that feeling?

    It seems to me that sub-prime and balloon interest rates are simply designed to prey on human nature and gullibility. Who doesn’t want to believe that they’ll have better incomes in five years? How many borrowers have the skills to resist when their lenders and media experts tell them that refinancing in five years is a good idea?

    Anyway, from where I sit, it seems the more accurate assessment is that the mortgage industry is generally made up of jackal scumbags, and their customers in trouble are idiots for believing them. The narrative that makes most of the borrowers out to be scumbags strikes me as, well, carefully crafted and extremely expensive, seeing as how it has worked so well. The average guy who identifies with Joe the Plumber is downright terrified that his neighbor might be getting away with something, instead of whether his banker did.

    Of course, we could answer this question with metrics; I’m sure someone could compile financial measurements that show us how many people were greedy, how many were stupid, and how many were outright victims of fraud. What do you think the odds are that the mortgage industry will share that data with us?

    This is very similar to what reinsurance does for insurance companies – it increases their capacity to do business by distributing a portion of their risk. It doesn’t get said much these days, but this is a very normal and healthy way for the economy to operate.

    If you say so. Personally, I find it hard to believe that companies would willingly take risks on the magnitude of “if this fails, it could destroy the company”, when the company in question is, say, 159 years old. Again, on the human nature theory, I think that what this did is allow many people to spread the risk around so much that they didn’t realize that the total risk involved was potentially fatal.

    So I’d suggest this is healthy for an economy in the same way that, perhaps, oxygen is healthy in air. It’s also highly erosive and combustible in high concentrations, and as a result, sane people tend to make sure it’s kept under control and away from smokers.

    Here’s an unfair question: if a terrorist act had done 1/100th the damage to our economy — say, in a power blackout — you’d certainly be passing moral judgment on the people who flipped the switch. But no judgment is necessary when a crucial industry collectively clusterfucks with much more collateral damage?

    The result was a lack of incentive on the part of the mortgage writer to make sure the borrower could pay the loan back

    And this is a good example of the hidden clusterfuck. This isn’t just happening at the point of the mortgage writing, this is a chain of incentivization that goes all the way back to the securities. Everyone along the way was making huge profits by participating, and everyone who assumed that risk got to somehow pretend that they weren’t exposed.

    Again, human nature, for the lender and the borrower alike. But at some point, the scale of all this passed “shut down banks” to “shut down the nation”. And somewhere on that cusp is the point where you say, “you so-called experts who made fortunes are morally reprehensible and should be treated as such.”

    Many of the boutique firms… went out of business quickly…. It also meant that the worst actors in this whole scenario had vanished, leaving Congress, the President and the media to assign blame to other, less nefarious players, such as Wall Street CEO’s.

    Here you go from vague to specific in protecting the guilty. The “less nefarious players” arranged these deals, provided the financial structure that allowed them, and profited from them. And I don’t believe for a second that the worst actors are out of business (or that their owners all suddenly went missing in the Bermuda Triangle, as you imply). Your argument amounts to saying that it’s okay to participate in the slave trade so long as you’re not the guy who captures people and enslaves them in the first place.

    As the LTV ratio approaches (or exceeds) 100%, the cost to the borrower of walking away from the home (i.e., defaulting) approaches zero.

    The financial cost.

    Really, Brian. This is the kind of thinking that causes socialist revolutions, when the capitalists become so utterly bloodless and uncaring about what they’re discussing.

    Assuming that most mortgages are for primary residences, you just said, “The cost to the borrower of uprooting their family, possibly losing their job, and becoming homeless if they cannot rely on family or afford a lesser rental situation (i.e., defaulting) approaches zero.”

    Which, you know, is somewhere between tone-deaf and cruel.

    Here’s your essential dichotomy; call it your class warfare, if you like. For economists, bankers, and most politicians, our economic problems are assets on a spreadsheet. The problem is when those “assets” are closer to the bottom of Maslow’s hierarchy; the costs to those borrowers are far, far greater than zero.

    In fact, the costs to those borrowers are seemingly far, far greater than the costs to any of the bad actors in the financial industry, which is why the essential problem of perceived fairness is what really needs to be solved. In another era, people solved this kind of crisis with a guillotine. I think we need something that is culturally equivalent.

    it is likely that banks will raise the interest rate on non-modified loans to make up for the additional risk the government is asking them to take on these “troubled” loans. That means that mortgage holders who are not struggling financially will be subsidizing the troubled loans twice – once with tax dollars and then again with higher interest payments.

    Well, there’s another option: nationalize the banks that can’t stand on their own, and take the $700 billion in TALF funding and use it to directly make government loans instead of trying to prop up a dying private entity. Joe Stiglitz mentioned in passing on a podcast today that a 10:1 leverage ratio would give a hypothetical government entity $7 trillion in lending power with that capital.

    I’m not in the least bit qualified to understand how that would work, but I don’t understand why it’s impossible for the government to replicate the functions formerly run by a now-gangrenous private market. Certainly seems like the more direct approach to me.

    The Federal Government is going to expand the capacity of its two biggest mortgage lenders by securitizing their mortgages, taking potentially “toxic assets” onto its balance sheet.

    I’m dangerously close to veering into “debating Brian on finance” here, but as I see it: the essential difference is that Fannie and Freddie have some social good hardwired into their reasons for existence, hence their quasigovernmental status, whereas private banks exist to make money with “doing good” a happenstance byproduct.

    This, of course, doesn’t answer the question, but it seems to me that part of the problem is that we’re framing Fannie and Freddie as “just another bank” and misjudging how they can be used (or replaced) to get out of this mess. Fannie was created in 1938 in response to that housing crisis; seems like it’s time for a reboot.

    And seeing as how you presume that Fannie mortgages are riskier, whereas what I hear is that they’ve got a lower default rate than private mortgages, I’m skeptical you and I will even agree on what’s reality here.

    Obviously, we want to prevent personal bankruptcies wherever we can, but if someone does declare bankruptcy, I don’t see the point of putting the mortgage bank in a worse position than it is now, given the many difficulties in the industry.

    Again, you make me think that the socialist revolution is not long coming. As I understand it, people who own more than one home get bankruptcy breaks that don’t apply to the first home.

    In other words, people not at risk of becoming immediately homeless have more financial options in bankruptcy than people who are. Yes?

    So, while this might well suck for the lenders, you’re accurately describing a system that has sucked for a long time for poorer borrowers, while allowing wealthier borrowers to get by much easier. Presumably such a system was developed with the help of banking lobbyists. If fixing a situation that has been rigged against the financially strapped proceeds to suck for banks instead, well, insert crocodile tears here.

    If any one part of it falls apart, then the whole thing will come crashing down.

    You said it, brother, but I think the problem here is that you’re not thinking big enough when you say the “whole thing”. History has not been kind to collapsing middle-class societies. You might be skeptical of my belief that Obama might be another Roosevelt, but I’d really hate to think that the more likely alternative is Weimar.

  3. Brian says at March 2nd, 2009 at 10:30 pm :
    it’s 2005, and someone is considering a mortgage. Their options are the ones that have higher monthly payments, or the ones that have lower monthly payments. No matter how many good reasons there might be to go with the one with higher payments, isn’t it quite likely that you’re going to feel like a schmuck, and have many corporate voices lined up to reinforce that feeling?

    If you’re buying a pack of gum and you pay more than you need to, you can a) feel like a schmuck and b) blame the seller for convincing you to do so. But if you’re committing to thirty years of payments, totaling hundreds of thousands of dollars, and you’re making your decision based only on what the first few payments are, then you are a schmuck.

    It seems to me that sub-prime and balloon interest rates are simply designed to prey on human nature and gullibility. Who doesn’t want to believe that they’ll have better incomes in five years? How many borrowers have the skills to resist when their lenders and media experts tell them that refinancing in five years is a good idea?

    Look, I did not suggest that predatory lending didn’t occur (in fact, I said exactly the opposite). And I’ll be the first to support prosecution for mortgage lenders who lied to their customers and got them into a loan that they never should have taken in the first place.

    But this argument that people who borrowed money are blameless because they took the advice of professionals just doesn’t ring true for me. Refinancing in five years was a good idea for roughly twenty years. A financial advisor or mortgage lender who advised their client that way wasn’t being a “jackal scumbag”, he/she was being accurate. But you don’t take a balloon payment loan because you “want to believe” that your income is going up in five years. You do it when you’re a medical intern, and you know, with reasonable certainty, that in five years you’ll have a much higher income. And even then, you do it with the knowledge that if your job disintegrates in that time, you’re going to have to move.

    All of which, in my opinion, obfuscates the real problem here, which is the birth and growth of a mortgage industry in the 00s that had no financial stake in whether a borrower paid back the loan. Asking a banker in that situation to not sell the loan to someone who wants it is like asking Apple not to sell a teenager an iPhone because he/she likely cannot afford the monthly phone charges. They’re not being jackals, they just don’t have any reason to care.

    I find it hard to believe that companies would willingly take risks on the magnitude of “if this fails, it could destroy the company”, when the company in question is, say, 159 years old. Again, on the human nature theory, I think that what this did is allow many people to spread the risk around so much that they didn’t realize that the total risk involved was potentially fatal.

    I don’t believe anyone knowingly took on a “destroy the company” level of risk. At issue is the ability to measure risk. Realize that the credit crisis we’re facing right now is caused primarily by panic (see my previous post for that explanation). When the housing market collapsed, holding mortgage-backed securities went from hugely profitable to hugely unprofitable. When panic set in, MBS’s went from hugely unprofitable to “toxic.”

    Here’s an unfair question: if a terrorist act had done 1/100th the damage to our economy — say, in a power blackout — you’d certainly be passing moral judgment on the people who flipped the switch. But no judgment is necessary when a crucial industry collectively clusterfucks with much more collateral damage?

    Wow. At least you admitted it was an unfair question. We can assume the terrorist intended to do damage to the economy, no? Have we gone so far down the “demonize the banks” path that we now believe that bank CEO’s intentionally sank the economy (and their own companies in the process) out of spite? Hatred? Short-term, personal financial gain? Do I need to point out that these multi-millionaires stood to make multiple millions more if none of this had happened?

    This isn’t just happening at the point of the mortgage writing, this is a chain of incentivization that goes all the way back to the securities. Everyone along the way was making huge profits by participating, and everyone who assumed that risk got to somehow pretend that they weren’t exposed.

    OK, first of all, the process begins with the mortgages and proceeds to the securities, not the other way around. Second, the people that were making huge profits were doing so because so many people were buying and refinancing houses. No one is/was stealing money here – everyone benefited and everyone is suffering. Third, your understanding of risk dissemination is exactly backwards. A company avoids bankruptcy by off-loading risk to others who can handle it. The boutique firms that off-loaded 100% of the risk didn’t go out of business because the foreclosure rates went up, they went out of business because no one would buy their risk anymore (and the law prevents them from taking on their own risk without capital to back it up).

    Here you go from vague to specific in protecting the guilty. The “less nefarious players” arranged these deals, provided the financial structure that allowed them, and profited from them. And I don’t believe for a second that the worst actors are out of business (or that their owners all suddenly went missing in the Bermuda Triangle, as you imply)

    Not sure what to say here, except that your statement is totally, completely, and 100% incorrect. The first (and last) bank to turn sub-prime lending into an “at scale” business was Countrywide, and they collapsed under their own weight. The only other two were Fannie Mae and Freddie Mac, who were created by the federal government in the 20’s to be the “lender of last resort,” which meant they were mandated to give mortgages to those who couldn’t get them in the private sector.

    Here’s a list of the 337 mortgage lenders that have imploded since 2006. You’ll note that the vast majority of them are no-name banks that opened and closed within two years (No Red Tape Mortgage, OwnIt Mortgage, Quick Loan Funding, etc.). The rest are the divisions of the larger banks that exited the market when it went south, without going out of business (e.g., Bank of America – Wholesale).

    Assuming that most mortgages are for primary residences, you just said, “The cost to the borrower of uprooting their family, possibly losing their job, and becoming homeless if they cannot rely on family or afford a lesser rental situation (i.e., defaulting) approaches zero.”

    Well, yes, if you make that assumption. But again, that assumption would be completely and totally incorrect. Beginning in 2000, when the capital gains rate was cut from ordinary income tax rates (typically 28% to 35%) to 15%, we saw a huge spike in speculative real estate purchasing. Estimates range from 20% to as high as 60% in some of the fastest growing cities in the country. And when you can invest entirely with somebody else’s money, the cost (financial and otherwise) of walking away drops dramatically.

    Of course, if you don’t know that, then you might be prone to suggesting that I’m inciting a socialist revolution…

    Joe Stiglitz mentioned in passing on a podcast today that a 10:1 leverage ratio would give a hypothetical government entity $7 trillion in lending power with that capital.

    I’m not in the least bit qualified to understand how that would work, but I don’t understand why it’s impossible for the government to replicate the functions formerly run by a now-gangrenous private market. Certainly seems like the more direct approach to me.

    Well, there’s nothing hypothetical about it. The government has already invested a lot more than $700B (10% of $7 trillion), and Obama’s plan, as I described, allows them to gain the kind of leverage Mr. Stiglitz is talking about. That’s what I meant at the end of my post about “recreating some of what happened during the bubble.” For the record, the way one creates leverage in the mortgage market (be it the government or anyone else) is by underwriting mortgage-backed securities.

    And seeing as how you presume that Fannie mortgages are riskier, whereas what I hear is that they’ve got a lower default rate than private mortgages, I’m skeptical you and I will even agree on what’s reality here.

    Would it help if I told you that I didn’t presume that Fannie mortgages are riskier? In fact, I said this:

    As quasi-government entities, Fannie and Freddie did not have the luxury of relaxing these standards in the past (as pure private-sector lenders did).

    As I understand it, people who own more than one home get bankruptcy breaks that don’t apply to the first home. In other words, people not at risk of becoming immediately homeless have more financial options in bankruptcy than people who are. Yes?

    No. Banks who write mortgages for investment properties can have a bankruptcy judge write down the value of that mortgage for the purpose of getting other, higher priority creditors more of their money. It’s only a “financial option” for the bankrupt person in that it increases the chance of them getting out of bankruptcy faster.
    A mortgage on the primary residence was not, until the HASP, eligible for this kind of write-down. The purpose of this was to make first mortgages cheaper for borrowers by reducing the bankruptcy risk on the loan and encouraging the banks to offer lower rates (which, by and large, they do). Now that so many homes are in or near foreclosure, President Obama is reasoning that the risk mitigation benefits of this rule are outweighed by the bankruptcy benefits of the investment property rule. I don’t disagree with his logic.

    Not everything is a scandal and a sham.

    So, while this might well suck for the lenders, you’re accurately describing a system that has sucked for a long time for poorer borrowers, while allowing wealthier borrowers to get by much easier.

    Every system in the world is better for wealthier borrowers than for poorer borrowers. If it weren’t, banks wouldn’t lend money. Also, the very same system you’re trashing right now was a fantastic one for poorer borrowers for almost two decades. I notice that you (nor anyone else) was complaining then…

  4. FamilyGreenberg.Com - Validation from Above says at March 9th, 2009 at 2:18 pm :
    [...] What Happened? A Summary of the Homeowner Affordability and Stability Plan [...]

  5. FamilyGreenberg.Com - What Happened? The AIG Bonus Kerfuffle says at March 18th, 2009 at 5:02 pm :
    [...] [The third in a series of "What Happened" posts that endeavor to explain the causes and impacts of the Current Financial Crisis(TM) - the first two parts are available here and here.] [...]

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