Too LIttle Too Late? The Money Party at Work

Too Little Too Late?

The Money Party at Work

 

By Michael Collins

Wash. DC, Feb. 19 -- President Obama announced a $75 billion assistance package to address home foreclosures yesterday. He also promised a $200 billion infusion into Freddie Mac and Fannie Mae, the nation's underlying lenders. That's exactly $275 billion more dollars than the previous administration committed to citizens to help ease their very human crises surrounding foreclosure.

Is this enough to stem the tide for those losing their homes? Will those "who have played by the rules," as Obama calls them, be salvaged the indignities and financial oblivion that begin in earnest if they're thrown onto the street? Or will those who broke all the rules profit immeasurably?

In order to understand the current situation, it's necessary to take a hard look at some really ugly numbers from 2008 summarizing the "nonprime" home lending situation. (The data in this article is from Federal Reserve Bank of New York Dec. 2008 summary of "nonprime" lending).

The nonprime home lending market consists of 2.2 million "Alt-A" home loans to those with good credit who chose "innovative" adjustable rate mortgages plus 2.7 million subprime home loans to those with marginal credit who, often times, used funds to purchase a first home. The total 4.9 million nonprime loans were used to purchase homes that house around 12 to 15 million people.

The total balance due for the five million "nonprime" loans is $1.2 trillion as of December 2008. The loans at risk (60 days overdue) have a balance due of $160 billion (40% for Alt-A's, 60% for subprimes). Preserving home ownership for those at risk in just the nonprime financed homes will eat up the proposed $75 billion package and reduce the Fannie-Freddie funding increase from $200 to $115 billion dollars.

That presumes every cent pledged today was used for these 714,000 loans. What about the six million additional home foreclosures anticipated over the next two years? More will be needed or a comprehensive approach like a national cramdown may gain the attention of our public servants.

To understand how the future will look, let's examine what happened in the nonprime market in 2008. The following graph shows the risk in just the nonprime loans. Traditional fixed interest loans are less vulnerable at the moment but when GM and Chrysler implode and as small businesses disappear, traditional loans will show up at risk in droves.

The nonprime lone market has 1.2 million loans at risk of entering foreclosure due to substantial arrears in payment. What will change to allow these people to catch up? There's no credit line left, in most cases, and no room for a "second" in a home loan where the current value is less than the loan value.

If anyone tells you that we're finished with the "subprime" crisis, recall these figures above. Over 800,000 subprime loan holders are currently at substantial risk for defaults and foreclosure.

The next wave of loan defaults and eviction risks will come from the Alt-A loans. They are, "typically higher-balance loans made to borrowers who might have past credit problems-but not severe enough to drop them into subprime territory--or who, for some reason (such as a desire not to document income) chose not to obtain a prime mortgage" (NY Federal Reserve) These are often borrowers who took Alan Greenspan's 2004 advice seriously when he pitched borrowing through a "mortgage product alternative," (e.g., ARMs), take some cash out, and spend that money (all to "help" the economy).

Small business owners, professionals, and corporate employees from generation X forward used the ARMs, and interest only loans to move into more suitable homes. Why not? Home prices were increasing exponentially. It looked like a good investment. And "the man" Greenspan said so.

The advice and loan programs have turned sour and many are now trapped in loans that will soon change dramatically. In the first few years of an Alt-A or subprimes, interest rates are kept low. In fact, some loans allowed substantially reduced "interest only" payments. It was all about getting people in homes to fuel a housing boom. The "affordability" of new homes pushed the market up in general and created artificial wealth. Now the party is over and these Arthur Geeenspan specials are "resetting."

When a nonprime loan "resets," it adds an average of three to six points to the loan payment for Alt-A's and subprimes respectively. It's quite a shock.

"Average Margin" is a specified amount added to the rate of the mortgage when it "resets" a few years into the loan.

This chart shows the percent of nonprimes resetting in the coming years. In 2009, 630,000 combined nonprime loans will reset to a substantially higher interest, 320,000 in 2010. By 2011, all but 3% the subprimes will have reset. However, starting in 2011, nearly 40% of the Alt-A's, 850,000 in all, are scheduled to reset. Families and individuals in these homes will have a home loan well over the assessed home value and a substantial increase in interest payments. They'll be in a recession economy.

The loss of homes is not the sole manifestation of rampant fiscal mismanagement and systemic corruption. It's a symptom of an economy going in to a steep decline after years of looting by insiders.

Why are we going through all of these gyrations and special programs to prop up a financial system that clearly created this exposure with full knowledge of the substantial risks? Why are we diverting funds to cover bad loans by U.S. banks and bad investments in securities based on those loans by financial interests overseas?

 

A partial answer is that the U.S. banks that knowingly made these bad loans must be preserved and have their investments preserved. Overseas banks and others who invested in special stock offerings based on this high risk housing bubble must see their investments preserved in some profitable form. (See the next installment of "The Money Party at Work" for a broader explanation.)

We may not know how this crisis will end but it's clear how it started. Despite warnings from some of the most respected housing experts in the public and private sector, the die was cast by failed financial guru and Wall Street promoter Alan Greenspan in 2004 when he offered uncharacteristically clear advice to home buyers.

From Money Party to Citizens: Drop Dead! Feb.1, 2008

In 2004, Greenspan told a credit union association crowd that "the refinancing phenomenon" had been supportive for the economy and that the use of home equity "helped cushion" declining stock prices. Then Greenspan showed his supposed genius with this advice to home buyers and owners:

"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home." Understanding household debt obligations, Federal Reserve Board, Feb. 23, 2004

END

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The Money Party Series

Information Sources: The Federal Reserve Bank of New York Nonprime Loans Dec. 2008 Subprime Home Loan Market as of Dec. 2008 xls Alt-A Home Loan Market as of Dec. 2008 xls Interactive Maps of Loan Status Data by Zip, County, State, Nation

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There's truth in what you write, and that is how things look. In the interests of discussion though, I'd like to ask you to think about this, and perhaps comment further if you think it would be useful.

Though there is discussion about write-downs and de-leveraging, the Big Bad Banks (BBB) have not taken losses yet, and actually insist that if they hold mortgage-backed securities, and the associated derivative paper, to maturity, they will make money. It is not clear how they will do this. Wikram Pandit from C has said this perhaps most clearly. As long as (BBB) can say that they will continue to hold, then the homeowners are carrying the can for them, and so are we all through the cost of foreclosures on government at all levels and reduced economic activity.

If FNM and FRE can be revived as a secondary market (that needs elaboration, but not now, they were never simple, subsidized competitors against private banks, which was why Richard Baker did what he did) then conforming loans (where borrowers income and stuff are verified to exist etc, and the payment is like 28-32% of income) can be packaged and sold. These securities, collateralized against properties their owners can afford at reduced prices, would create a quality standard against which the stuff Pandit intends to hold can be judged as to value and marketability. The 30-year time frame of the new securities will massively exceed what (BBB) calls holding to maturity. Given a choice investors will go for the FNM and FRE product and leave Pandit et al high and dry.

If one looks at what Obama et al seem to be doing, it is not so different than the Roosevelt stretch-out of balloon notes into 30 yr self-amortizing fized rate notes. He too gave the money world a fair choice.

These thoughts were also prompted by what is going on to set up a clearing exchange for certain classes of derivative products. Purists will say "they are encouraging speculation, it just proves they're part of the bankers' conspiracy, I told you so all along." Practical minded people might look at the proposed arrangements and say "they're organizing a byob party, won't it be interesting to see who shows up, who brings what and who drinks what other participants have brought. Oh, and don't forget the party poopers!" Practical minded people are not just going to want to get out of the mess as rapidly as possible. They are concerned with getting out of the mess in the right way for the right reasons by restoring what is due to those who are suffering unjust losses and taking away from those who have made excessive gains. This means establishing ways to determine fairly and transparently what the unfair losses are and what the unfair gains are.

Since government is now involved in these matters as the primary player it is more than ever key, I think, to attempt to sort out the politics, and whether the politics involves these issues of fairness and unfairness, and if so how, from what are all too often emotion driven reactions to the pragmatic technical interpretations of what the proposals seem to be advocating on the surface.

The housing measures do not seem to be trying to set a price floor, but rather to find a section of buyers who can be supported to float a new class of security against which to compare the old ones. If this approach works it  will affect the whole thing. In the same way the clearing exchange idea provides a forum for valuing the existing mortgage backed assets and derivative products in a what may be a more transparent way than what we have now.

I think the spreading groundswell for nationalization, without considering too much what's involved in nationalization, reflects the financial community's unease at the potentials embedded in these approaches (Greenspan, Lindsay, King, Naked Capitalism, Arianna Huffington Nouriel Roubini and many others). There's food for thought there too probably.

 

You asked where the most distress can be found. The NY Fed's data is extremely useful but it has it's limitations. However, here's some interesting stuff. The worst of the worst, in terms of collapsing subprime and Alt-A loans would be the co-occurrence of high credit risk rate, which I define as 30+ days over due in this case. AND the presence of more than one state a region or contiguously. in a region or contiguously. Here it is:

Louisiana and Mississippi struggle economically in a good economy. When you've got a recession-depression and the presence in the top tier for risk in both nonprime loan categories, you have a problem. Georgia is with them in suffering and Alabama has a very high credit risk profile for subprimes but not Alt A's. That section of the Southeast is going to get hammered.

Maryland, Virgnia, and West Virginia are each twofers for subprime and Alt-A risk factors. The states are contiguous and very much a region.

Massachusetts and Rhode Island are merged at the hip and they each have double trouble.

Michigan stands alone with its significant credit risk, default, and foreclosure problem. This is a wild card. A large state with heavy unionization, the retrenching of GM poses a special problem. In Michigan and surrounding states with GM or GM supplier plants, the picture could change immediately.

Here's a chart of the most serious credit risks for the top tier states. The risks for Alt-A loans are much less as a percentage of total loans, 13% and up. The risks for subprimes are much higher 30% and up.

This is a serious mess.

More on your reply later.

"Furthest from him is best, whom reason hath equaled, force hath made supreme above his equals." Milton

There are two members of the White Family that post here. That post was from CHRIS White, my esteemed husband.

carol

Duly noted. Thanks. It's another example of "small print" conspiracy, which I've noticed for the past 3-4 years. Incrementally, print sizes are reduced leading to confusion like this. Of course, I could also carefully read the author line too but then the error would be my fault;)

"Furthest from him is best, whom reason hath equaled, force hath made supreme above his equals." Milton

Duly noted. Thanks. It's another example of "small print" conspiracy, which I've noticed for the past 3-4 years. Incrementally, print sizes are reduced leading to confusion like this. Of course, I could also carefully read the author line too but then the error would be my fault;)

"Furthest from him is best, whom reason hath equaled, force hath made supreme above his equals." Milton

That this housing plan is a beginning which in reality serves more than one purpose. By reinstating Fannie Mae and Freddie Mac (backed by government credit) as the agencies who will issue mortages based on sound principles such as the long-standing requriement that mortgage and interest not be more than one-third of the borrowers income, this is creating the basis for recovery. Obama said yesterday that Fannie Mae and Freddie Mac would have leeway to reneogiate principle on interest on loans of people presently living in homes which are at risk of becoming unaffordable by two criteria -- 1) the actual present market value of the home rather than the sales price and in an artificially inflated market; 2) renegotiating so that the final payment meets the criteria of not exceeding a third of the borrower's income. If the implied craw-down would be too great, ie a family has nothing link a sufficient income to afford the house they ostensibly own, then their debt could be forgiven as part of a bankruptcy settlement so they could work to reinstate their credit worthiness and put their lives together.

One consequence of such a process would be to place an actual value on bank-held mortgage-backed securities and de facto take care of some of the toxic assets now in the system.

I think that they way forward is not necessarily one grand plan that will solve everything but a series of pragmatically steps in the right direction. That is in fact what happened in FDR's famous first hundred days.

carol