A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Thursday, March 15, 2007

Issues Surrounding a Massive Subprime Bailout....

I think it is very important that such a program is not undertaken hastily (see “Katrina Cards”).... Below are some issues that need to be resolved (I don't think they can be resolved, but we'll see) regarding any sort of massive mortgage bailout...

1. How would Congress vet such a program to avoid abuse (see “Katrina Cards”)? What are the costs associated with vetting these loans, and how many dollars will be allocated to bail out consumers? Further, how can we stop any bailout money from going to people who fraudulently misrepresented themselves in order to get loans that they couldn’t afford (thinking they could cash-out at any time for a profit)?

There is at least $40 trillion in Mortgage Debt Outstanding (as of 9 months ago). An overall delinquency rate of 5% puts $2 trillion worth of mortgage debt at risk.

For the $2 trillion in endangered loans, that translates to approximately $170 billion in mortgage payments due just this year… a potential worst-case scenario balloons the Federal budget deficit from $250 billion over the next twelve months to $420 billion.

2. Further, do we segregate “subprime” borrowers from “prime” borrowers, and only help those in the subprime category, even though prime borrowers are in trouble nonetheless?

3. While a bailout can work as a stopgap measure, how do we solve the problem of the basic fact that these people still can’t afford a mortgage on their own? If we subsidize, “until they sell,” then what incentive do they have to sell in the first place? Are we going to subsidize these borrowers permanently? What will that cost? $1 trillion, $2 trillion? If we put a time limit on the subsidy, then we are just delaying the inevitable. This might be the worst case, where billions in tax dollars go to no good end.

4. Finally, the question of fairness… I don’t own a home, and refuse to buy irresponsibly (i.e. borrow more than I can afford to repay if things go south). Now my tax dollars will go to subsidize someone else’s poor decisions to keep them in a house, while folks like me are still renting? One could argue quite successfully that those facing foreclosure should not be, and have no right to be, in the homes they’re in.

Keep in mind, that the market will correct on its own… the glut of subprime loans will be wiped out through foreclosure, and the lenders will probably suffer the most (the borrower will be freed of the obligation, in the end).

9 comments:

Scott1405 said...

Wow,
I thought it was a good idea at first, but I don't see how it can be done in a meaningful way... It would be nice to save all those people from foreclosure, though... But I guess they made their own beds!

cinepro said...

Good points.

eternitus said...

Thanks cinepro... For anyone who reads this new blog... please feel free to weigh in... I'd like to stimulate a healthy (but respectful) debate on the issues.

Lance said...

Eternitus,

I think your making quite a leap to assume (1) 5% of all mortgages are going to be in trouble and (2) that a bailout would cost the entire amount of the mortgage assuming it occured. Even under worst-case scenario, the highest percentage of foreclosures on subprimes is something like 12% of all subprimes out there. The worst-case scenario for the non-subprimes (i.e., non-30 yr loans made to people with prime credit histories) is sure to be far less than 12%. So first your 5% turns into something far less than 1% in all probability. Secondly, I think even those pessimists predicting the worst and not agreeing with my #1 above will agree with this ... You've made a serious assumption error is thinking that any bailout would involve either (a)a complete payoff of the loan by the government/taxpayers or (b) a complete assumption of mortgage payments by the government/taxpayers. First, even under worse case scenarios, a sale of the properties would payoff at least 80%-90% of the "in danger" mortgaged amounts. Secondly, foreclosures are "insured". I.e., All these subprimes were issued with mortgage insurance for which the borrowers have been paying a premium monthly as part of their mortgage payment. This insurance gets re-sold various times but ultimately ends up in the hands of places like Llyods and the other "big guys" who also paid off on Katrina, etc. Yes, they wouldn't like taking this hit, but like in the case of Katrina, they would and just pass on costs in the form of future hiked premiums. But in any case, under any scenario, the taxpayer wouldn't be paying a dime ... Lastly, do some googling about what the investment bankers had to say yesterday about the effect of subprimes going belly up. I think you'll be pleased to learn that they are not worried. In effect, your concerns really aren't concerns to begin with. They are just unfounded fears instigated by "Housing Bubble" believers who are searching for an easy solution to making a hard home purchase ... Their easy solution is for the house prices to magically go bust like stock prices did back when they were impressionable youngsters.

eternitus said...

Lance,
Thanks for the post, an alternative viewpoint is always welcome...

I think you missed my point, though...I'm less worried about the problem in the subprime area than I am about hastily crafted government programs that end up doing more harm than good, which was the crux of my post.

To speak to your points...

For the record, I do say "worst case scenario" in point 1... The "worst case" (however unlikely) would be that the government picks up the tab for $170 billion in mortgage payments... and I use that example to give folks a sense of the magnitude of the numbers involved... "the worst case," by definition, is as much as the program could possibly cost us.

But, to play the Devil's advocate, if you were struggling and you knew that Uncle Sam would come to the rescue if you slacked off, you'd be tempted to find a way into this windfall, wouldn't you? All $170 billion of those troubled dollars would be very tempted to take advantage (and maybe some others aren't late on payments, too), I'm sure.

Which is why I brought up the point about what kind of screening process would be used.

I said nothing about the effects of subprime mortgages on the economy in my post, so I'm confused about why you are commenting on this. I believe exactly what you do... foreclosure won't cost the taxpayers a dime if the government stays out of it, and I think they should.

Any mortgage holders or insurers, just like the house-owners, know the risks when they enter into their contracts. Up to now, they willingly enjoyed the benefits of those agreements. Now, they are all equally at fault for the problem, and they should pay the price for their folly, not us.

eternitus said...

Merrill Lynch Quote... On Yahoo Finance today....

Reuters
Housing mess risks recession unless Fed cuts: Merrill
Thursday March 15, 3:15 pm ET

NEW YORK (Reuters) - House prices could tumble 10 percent this year and raise the chances the United States may slip into recession unless the Federal Reserve cuts interest rates to cushion the fall in economic growth, Merrill Lynch said in research notes this week.

If correct, the prospects of this scenario will prove troubling for equities investors, who could face a stock market decline of 30 percent or more as measured by the S&P 500 index <.SPX >, the brokerage said.

Merrill said the biggest concern is that tighter lending standards in the mortgage market, even if confined to lower-quality borrowers, will constrain overall housing demand and hamper recovery in the struggling housing market.

"It is not inconceivable (given what is happening now to mortgage originations) that we end up with something closer to a 10 percent decline in home prices this year," Merrill Lynch said.

MyTwoCents said...

Eternitus,

I believe predatory lending is a bigger crime than you're letting on. People being sold sophisticated loans that they didn't really understand by a "mortgage industry professional." A professional who knew precisely how craftily they could work the details to get the home buyer into a payment of their choice. Sure it's buyer beware but...

The true problem is the knowledge gap. The lender (who knows a lot) versus your average borrower (who knows a little). If the government were to regulate the disclosure of fees and who makes money and what happens to the mortgages after they're created, that might go a long way in helping the average consumer figure out what's going on.

Ie, if I offer you 50" Plasma for 50 bucks, you're probably going to surmise it's stolen.

With a little disclosure-type regulation, maybe someone can realize that a 2/28 with a teaser intro rate and negative amortization is the same thing because this lender isn't sticking around (he's selling it to the secondary bond market and driving his truck away fast).

I think it might have been either the WSJ or Money.CNN.Com that suggested perhaps Fanny/Freddie can morph their purview into an entity that not only educates consumers as to what is going on, but actively helps them refinance their current products into a more appropriate loan. And by this, I mean having the government pass regulations that allows Fanny/Freddie to pass a judgement on whether a lender took advantage of an unwitting buyer. If so, then allow them (Fanny/Freddie) to waive early termination penalties and have the lenders draw up more reasonable loan terms - something that makes the lender and the buyer split the loss and not the tax payer.

My $0.02.

eternitus said...

Good point, mytwocents.

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