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The real Bush mortgage relief plan
CalculatedRisk writes:
A lot of people are very worked up over the idea that the New Hope Plan is, in essence, the government mandating a kind of reneging on private contracts (the PSAs or Pooling and Servicing Agreements that govern how securitized loans are handled). I personally think you can all stand down on that one. From what I have seen about the plan to date, it is clear to me that it is in fact structured with the overarching goal of making sure that it stays on the allowable side of the existing contracts. I proceed from the assumption that nobody could write such a convoluted and counter-intuitive plan if that wasn’t the goal. So everyone who is thinking, “Gee, we’re violating contracts and we still don’t get much out of it!” is thinking the wrong thing, in my view. It’s more like “Gee, we don’t get much out of it when we don’t violate contracts.”
The full post has more explanation than any sane person can follow, also see the NYT coverage. I don't understand many of the details of the plan, but it seems like a push in the right direction, namely encouraging settlement within the previous contractual framework. That said, I don't expect it to have a major positive impact.
Many critics would like to see more of a debt jubilee, but I keep thinking of two quotations reproduced over at Megan McArdle's blog:
There are many nuances related to mortgages. For instance, if you default, what are your rights in foreclosure? How can you redeem, and when? But it wasn't any nuances that tripped people up. "The monthly payment is more than I can afford" is not a "nuance."
. . the lesson here appears to be that if you see everyone else borrowing well beyond their means, you should too, since the government cannot credibly allow large numbers of homeowners to go into foreclosure.
There are two main arguments for breaking the loan contracts. The first is that we could limit human suffering. The second is that we could forestall macroeconomic catastrophe. Put together, these arguments have captured many hearts and minds, but neither is very strong on its own.
On the first, there are many better ways for our government to help poor people. Maybe you respond: "The perfect should not be the enemy of the good," but I am sorry: keeping lower income people in homes and out of apartments is too far down the list of efficient transfers for that rhetoric to succeed. Can we now allow the perfect to be the enemy of the not-good? Contract-breaking is not an especially fair way to help the poor, given that the very poorest probably never borrowed any mortgage money in the first place, and the most responsible of the poor won't get anything either. Should we also reimburse the non-wealthy for their unlucky investments in dot.com stocks? Go back to square one.
On the macroeconomic issues, there is a real chance of a cascading credit crunch in the next few months. Having the federal government arbitrarily rewrite legally binding loan contracts will, if anything, make that problem worse rather than better. It will hurt bank capitalization, plus it will weaken confidence that future loan agreements will be left intact. Uncertainty is the enemy of lending. Further side effects include the savaging of the subprime loan market (currently most subprime loans are being repaid without incident, thus putting deserving borrowers into homes) and seriously curbing floating rate lending in the future.
If you think that the macroeconomic skies will fall from future
mortgage interest rate resets, I am willing to listen. But your case
had better be really really good, given the macro problems of the debt jubilee. Aid as you will, but don't make it a tax on the lenders.
The foreclosures story combines a few popular memes: lower income people suffering, possible macroeconomic catastrophe, and a fair amount of misleading salesmanship (can I get my money back for having bought a computer with Vista?). But if we adopt widespread contract abrogation as the intended solution, I truly fear for the future of this republic.
Addendum: Here is testimony by Randall Kroszner, via Greg Mankiw. And Arnold Kling has a very good and lengthy analysis.
Posted by Tyler Cowen on December 7, 2007 at 06:44 AM in Current Affairs | Permalink
Comments
I'm starting to feel like an idiot for not buying a house I couldn't afford....
Posted by: chug at Dec 7, 2007 8:04:34 AM
Ha, I am very confused. The government cannot interfere with private contracts, can they? The government's job is to ensure contracts are followed! And I am happy I did not buy a house at all, because now I have more savings and can afford a decrease in growth(or improbable recession).
Posted by: brainwarped at Dec 7, 2007 8:17:41 AM
If Bush wanted to do something, he would accept that he let this situation get out of control, and use our tax dollars to buy up these sub-prime loans, then turn their homes into a type of section 7 housing for all those people who can not afford to pay their loans.
Posted by: brainwarped at Dec 7, 2007 8:25:16 AM
The subprime briefing that I posted at econlog.econlib.org has more info.
Posted by: Arnold Kling at Dec 7, 2007 8:31:59 AM
I'm concerned that this is less about "the poor" than the middle class calling for aid to help themselves.
Posted by: odograph at Dec 7, 2007 8:53:27 AM
BTW, two of my (orange county, high tech) co-workers are out of their homes from this, and another co-worker did himself some serious damage by being caught "flipping."
Posted by: odograph at Dec 7, 2007 8:57:57 AM
The government cannot interfere with private contracts, can they?
The States can't, but the federal gov't can. Under the contracts clause of the constitution (Art I, Sec. 10), "No State shall . . . pass any Law impairing the Obligation of Contracts." Notice the "No State" part. This clause does not apply to the federal gov't, the Supreme Court has ruled.
Posted by: JWR at Dec 7, 2007 9:02:29 AM
If the crooks in Washington had maintained control over the banking/savings/loan industry, Jane/Joe Schmo, wouldn't be on the brink of disaster. "Back in the day," there were limits lenders could charge borrowers and the rates were "fairly reasonable," like 5-8 3/4% 30 year fixed mortgages, under 12% interest on credit cards, etc.
"Back in the day," we weren't bombarded with commercials urging us to try to "keep up with the high & mighty," and just buy, buy, buy. Don't worry about your credit rating -- ad naseum.....
Posted by: mary ann larssen at Dec 7, 2007 9:08:11 AM
Six months ago, I acted according to the neoclassical model when I purchased my condo: like a rational optimizer, I waited until I could afford both the 20% deposit and the monthly payments, and waited until price/rent ratios became acceptable before buying. But upon hearing about this plan, I suddenly turned into a behaviorist: I'm morally outraged that people should be rewarded for their own frivolity even though I'm largely unaffected by the plan.
I'm so confused.
Posted by: Independent George at Dec 7, 2007 9:08:36 AM
Oh, and then there's the point that disregarding contractual obligations debases culture and morals.
Posted by: Daniel Klein at Dec 7, 2007 9:35:32 AM
The Bush plan is synonomous to putting a band-aide on a broken leg.
What is needed is an immediate halt to all sub-prime foreclosures.
Lending institutions who used 'teaser' rates to lure buyers into buying over their heads should be required to refinance these mortgages at 3-4% for 40 years. Additionally, all those late fees, attorney fees, fees for addding fees, are gone. They just get to refinance the principle.
Entire neighborhoods are decimated by boarded up homes. Massive foreclosures hurt the entire economy.
Posted by: Linda Iwaniw at Dec 7, 2007 9:36:18 AM
You write: "keeping lower income people in homes and out of apartments..."
An apartment is a home too!
Posted by: Andrew Gelman at Dec 7, 2007 9:37:05 AM
Having the federal government arbitrarily rewrite legally binding loan contracts will, if anything, make that problem worse rather than better.
Am I missing something? Isn't the plan voluntary on both sides? If so, both sides of the contract are simply deciding to change its terms, something that happens every hour of every day in this country.
Posted by: david at Dec 7, 2007 9:38:29 AM
This really seems like a win-win. Some of the more responsible people are being helped out and it helps the lender, too, who does not have to eat the 50k loss associated with a forclosure. All without federal money. Debt restructuring happens all the time because it is win-win. This is not the feds "arbitrarily rewrite legally binding loan contracts". This seems to be a negotiated deal that some of the lenders could not make on their own because of regulatory restraints.
The flippers are not involved with this, so they get what they deserve. Same with fraudulent loans.
The biggest winners are those who were never involved. I would think this removes uncertainty from the home sales market. A big flood of foreclosed homes on the market would wreak havoc on existing home sales and prices.
Both parties involved, the lenders and borrowers are paying a price and benefiting from this deal. Looks like a good way out.
Posted by: Tom at Dec 7, 2007 9:40:55 AM
As a Realtor who works almost exclusively with repossessed homes, I can tell exactly what is going on here. Lenders abandoned all standards in 2005-06 and started handing out no-documentation, zero-interest and adjustable-rate loans, etc., left and right. These loans were then bundled into securities and sold on the secondary market as collaterized debt obligations.
Problem is that when a lender sells a loan on the secondary market, he's supposed to write and have signed an assignment designating the investor as the "holder in due course." But these lenders didn't do that, probably because they didn't want to bother with all the paperwork. They just bundled up thousands of loans and sold them.
There have been several court cases recently, the first out of Ohio, in which the judge ruled that the investor did not have the right to foreclosure, even though the borrower was in default, because without the assignment the investor could not prove he was the holder in due course of the note. That's the problem right there.
It's going to cost a whole lot of money to write the assignments on all of these loans before the investors can have the right to even begin the foreclosure process, which is in itself expensive. This is why the lenders and investors are willing to make a deal with the government now. It's not to stave off foreclosures. It's because at this point no one, not the lender who made the loan and not the investor who bought the loan without an assignment, has the right to foreclosure. And thus neither has any way to repossess the properties for resale at market value, which has been declining by the way, to recover their losses on bad loans.
This whole thing is a mess. Welcome to the wonderful world of 21st century financing, where apparently no one has any idea of what to do with money other than how to lose it.
Posted by: GawainsGhost at Dec 7, 2007 9:42:10 AM
I'm starting to feel like an idiot for not buying a house I couldn't afford....
It's still not close to a free lunch for the debtors. Among other things, they really aren't going to be able to move from these homes for years, until they build up enough equity and the true home valuation recovers. They're still going to have mortgages based on the original home value. And since they bought too large houses and didn't put enough down to build equity, it's going to take them a lot longer to reach that point than people who were cautious. That's bad for the economy, of course, with the reduced labor flexibility.
Of course, regardless of whether the government stepped in or not, a lender faced with an enormous amount of potential defaults would still have the incentive to refinance many of them. A few foreclosures are acceptable to a lender, but too many are a huge problem that they'd rather deal with by forgiving some of the debt in order for the payments to be made. So there's still the incentive to borrow crazily when everyone else is doing it. Reminds me of the idea that when you borrow $500,000 from the bank and can't pay, it's your problem. When you borrow $500 million and can't pay, it's the bank's problem.
Posted by: John Thacker at Dec 7, 2007 9:53:59 AM
Just like the US can sometimes use a Strategic Petroleum Reserve it should offer to buy outright 2.000.000 of the houses currently involved with subprime loans; at a price below the current outstanding mortgage, 90%; financed by the current mortgage holder at government rates; and giving the current debtor a option to repurchase his house in a couple of years at a price that would keep the tax-payer from being harmed. That's what I would do… but then again I am no PhD and so I could be wrong.
Posted by: Per Kurowski at Dec 7, 2007 10:20:55 AM
"Entire neighborhoods are decimated by boarded up homes. "
"A big flood of foreclosed homes on the market would wreak havoc on existing home sales and prices."
Those factors are good enough for me.
Bonus points come from the indisputable evidence that lenders were eager to contract with those whom they knew to be in precarious financial positions. Sure, both lender and borrower "should have done the math" - but given that lenders are obviously better situated to do the math and to infer likely outcomes given those calculations, I'll go with a plan that puts the most pressure on them, not the borrower.
Posted by: meg smith at Dec 7, 2007 11:16:20 AM
Look, the moralistic arguments here are just misplaced. Consider:
1. The subprime loans in question were typically written with terms like a 5% rate for 2 years,
resetting to L+500, or a rough doubling of the payment. They were underwritten at ~ 40% of the
borrowers monthly pretax income. Both the borrower and the lender/investor could see full well that
the borrower couldn't afford to pay the reset interest, and everyone went into the transaction
expecting that the borrower would refinance after 2 yrs. Everyone in the home eq market priced the
bonds on prepayment vectors reflecting this. Both sides in the deal bet that home values and market
liquidity would remain high enough to permit refinancing.
2. Further, the investors (by the rating agencies as their proxies) specifically limited any loan
modifications to a de minimis amount in the PSAs, in order to make the deal fit their statistical
models more easily. It is generally not possible to amend deal documents even if it is to the
overall net benefit of the investors (trust me on this, I know of what I speak).
3. The parties' assumptions on home prices and market liquidity were not borne out, and now they're
screwed. The PSAs do not really allow any alternative to foreclosing and liquidating the homes.
The borrowers lose their investment and incur moving costs. The lenders/investors are in a worse
spot, as this course of action further reduces the value and liquidity of their collateral. They
will typically lose half the value of the house, whereas the borrower's investment was typically
under 10%.
4. The administration proposal as I understand it allows the servicer to waive the PSA limits and
extend the teaser rate only if in its determination the borrower can afford the lower payment and
not the higher one. The loss in interest income and retention of a full principal claim is a much
better outcome for the lender/investor than a foreclosure in a distressed market.
5. So: the government is helping the investors overcome their own error in building deal structures
that worsen their outcome in a distressed market. It has the side effect of letting the borrowers
continue to "rent" their houses at the current mortgage payment. I say "rent" to the extent the home
value is so far underwater in this market that their equity option is of minimal value.
6. The argument that this somehow disadvantages the responsible is silly. They do not bear any out-
of-pocket cost for this and, to the extent this reduces pressure on home prices and increases liquidity,
they benefit. If the fire department spends 50 man hours putting out the neighbor's house, ought I
complain that this rewarded their carelessness, or punished my responsibly upgrading my wiring? Ought
I demand the firemen spend a like amount of time fixing up my yard to compensate?
7. To the extent the government is creating a framework for renegotiating contracts in an environment
where both borrowers and lenders bet heavily on a wrong assumption, this is not terribly unlike Chapter 11
bankrupcy for corporations. When the airlines and their lenders bet wrong to the tune of tens of
billions in 2001, they took 2+ years in BK to sort it out and renegotiate their claims. Given the
diseconomies of scale in consumer renegotiations, a simple template of teaser rate extension makes
sense here. The government is just giving investors a tool to unscrew their own mistakes.
8. If one wants to complain about the government making a massive transfer of wealth from lenders to
borrowers, it ain't happening here, but exactly what else do you think a Fed rate cut is?
Apologize on length but have had this screed building for a while.
Posted by: mkl at Dec 7, 2007 11:21:06 AM
The biggest winners are those who were never involved. I would think this removes uncertainty from the home sales market. A big flood of foreclosed homes on the market would wreak havoc on existing home sales and prices.
The argument that this somehow disadvantages the responsible is silly. They do not bear any out-of-pocket cost for this and, to the extent this reduces pressure on home prices and increases liquidity, they benefit.
Why do people assume that higher home prices are automatically a good thing? For the 30+ percent of americans who aren't homeowners that's not the case.
The way for me to be a winner here (aside from my HGX put options) is for house prices to crash. Go crash!
I'm not worried about the GDP hit from reduced MEW. That had to happen sooner or later, anyway. A reduction in domestic demand ought to improve our trade balance, too.
Posted by: Mitch at Dec 7, 2007 2:35:15 PM
Everyone in the home eq market priced the
bonds on prepayment vectors reflecting this. Both sides in the deal bet that home values and market
liquidity would remain high enough to permit refinancing.
I'm in the home building industry. I saw this bust coming 4 years ago. Ray Charles could have seen this bust coming. That people in the biz were making bets that this day of reckoning wouldn't come is absurd. They should get what they deserve for such recklessness.
In 2005 when my best friend told me that she and her husband were buying a house with no money down and a 2-year ARM, I told her that was foolish because she was betting on future conditions that she couldn't control. She didn't listen to me and now the house is going into foreclosure. It's too bad for her, but in my mind it's a great thing. Now housing prices are coming down from the stratosphere and prudent people can actually afford to look to buy.
Anything that interferes with this is wrong.
Posted by: Christina at Dec 7, 2007 2:36:38 PM
All,
Nicole Gelinas just wrote a devastating piece about one "feature" of the Bush bailout plan. Apparently, the Bush bailout allows state and local governments to issue tax free munis to fund replacement subprime mortgages.
See "W'S DISASTROUS MORTGAGE 'FIX'" (http://www.nypost.com/seven/12072007/postopinion/opedcolumnists/ws_disastrous_mortgage_fix_767611.htm?page=0)
The bottom line is that Wall Street gets paid in full using tax free munis (at the expense of the Federal taxpayer) and state/local governments get stuck with the bill when these subprime mortgages (re)default.
A wonderful version of "heads Wall Street wins, tails the public looses" thinking.
Note that this article is worth reading for other reasons as well. I quote
"By encouraging people to stay in homes they can't afford, the plan keeps the housing market artificially high. When a bank forecloses on a home, conversely, someone else can buy it at a much cheaper price.
Politicians in New York and elsewhere have been complaining about a lack of affordable housing for years now; you'd think they'd be happy to have the opposite problem. Yet the bailout plans use government money to keep the market from finding its true price. This, when first-time homebuyers benefit immensely from falling home prices"
So the public interest is served by (more) affordable housing. A remarkable idea.
Posted by: Peter Schaeffer at Dec 7, 2007 2:49:27 PM
The basic underlying point is that contrary to the rhetoric this plan is not really intended to help out homeowners. The fact that it does is largely incidental, though convenient for speech-making and PR.
The only loans that will qualify are loans which would very likely default if the rate increase occurred, but which are now current and will hopefully remain current as long as the rate doesn't change. Down the line, unless something changes for them economically, these folks may still lose their homes if they made the sort of foolish investments they are being pilloried for (ie. buying a house that they can't afford on the assumption that it will continue to increase in value by 20% every year leaving them an easy out when they need it).
For now they are being encouraged to hold on and continue making their payments, which is really about stopping the bleeding in terms of the value of these loans and the bonds based on them in the secondary market. Moreover, this is an attempt to slow the unwinding of the housing bubble and hopefully reduce the depth of the fall in prices and the likelihood of it sparking a recession.
While its probably a good idea to avoid recession (I have my doubts, since it seems to me that trying too hard to avoid a recession is what got us into this situation in the first place- you have to prune the rosebush to get good roses in the spring), the rest of it seems to me largely aimed at keeping the investors from paying the full price of their mistakes, while leaving the rest of us to make up the shortfall as we continue to live with the consequences of those mistakes for a longer time.
I tend to feel that even homeowners who would lose their homes would be best served by a fairly severe and rapid adjustment to the housing market. Certainly those whose "irrational exuberance", both among the buyers and lenders, created this bubble in the first place would pay a price, but that's kinda the point. If we don't let them feel the consequences of their actions, they're more likely to repeat the same sort of behavior in the future. Moreover, once the correction is over we can all move on and focus on the real growth of our economy, secure in the knowledge that it has once again been proven that asset inflation is not a good way to economic strength.
At the end of the day (decade?), even those who would lose their homes today would probably be better off being able to buy a home at a rational price in a few years than keeping the mortgage they got at an inflated value a year and a half ago. It's really only the investors that are served by trying to stave off the correction.
Posted by: sdl at Dec 7, 2007 3:50:19 PM
Interesting perspectives. The truth of this matter is a typical Baptists and bootleggers scheme. "Help the poor homeowner!" goes the cry, while the lenders who made these loans are backing, backing, backing it. If it goes the good way, then the losses get to be recognized over five years. Investors are screwed, but gently. If it goes the bad way, then the public pays those losses. If it goes the REALLY bad way, then this plan hasn't worked; the losses get recognized all in the coming year; many banks go out of business as holders withdraw their funds; the economy collapses.
Posted by: Russell Nelson at Dec 8, 2007 9:45:01 AM
People are missing the hidden agenda. The proposed band-aid solution isn't a band-aid at all. What it is designed to accomplish is to coerce homeowners that were probably meant to be renters, because of their lack of ability to save, into morally upstanding savers. The savings is disguised as loan amortization. They become so saddled with making their house payments along with the fear of going into default that they develop the moral character that was not instilled in them by their parents. What "the plan" is saying is "hey" grow up!!" and here's a cover-up to get you on track. Unless they are terminally financially hopeless, when they see their equity build-up, they will become responsible and get with the program so they won't become wards of the state when they are too old to work. Isn't that what the American dream (home ownership) is really all about.
Posted by: Mike at Dec 8, 2007 2:37:30 PM
