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Friday, April 20, 2007 12:21 AM


The Fatal Flaw in Housing Bailout Plans


The CNN Money headline states Feds want 'prudent workout plan' for borrowers.

U.S. banking regulators urged lenders Tuesday to help distressed borrowers unable to make mortgage payments and to offer possible incentives to move homeowners to lower-cost loans.

The Federal Reserve and other agencies said they may relax some regulatory penalties for financial institutions that pursue reasonable workout plans with borrowers. Lenders may also receive favorable consideration under the Community Reinvestment Act, the regulators said in a statement.

"The agencies want to remind their institutions that existing regulatory guidance and accounting standards do not require immediate foreclosure on homes when borrowers fall behind on payments," they said.

U.S. banking regulators and lawmakers are exploring ways to help millions of borrowers with poor credit history who took out adjustable rate mortgages that start with low introductory monthly payments and then dramatically increase after the first two or three years.

The regulatory agencies said a prudent workout plan is in the long-term interest of both the financial institutions and borrowers and urged lenders to work with consumer groups to help borrowers avoid predatory foreclosure rescue scams.
Let's be realistic here. This has nothing to do with helping out distressed borrowers. This has everything to do with helping out lenders who are stuck in loans with increasing chances of default.

The prudent thing to do would be to stop risky lending practices cold. The way to do that would be to punish irresponsible lenders and borrowers both. Instead the Fed is attempting to prop up asset prices by the carrot and stick method of relaxing regulatory penalties for misbehavin'.

$1 billion rescue of subprime loans set

Neighborhood Assistance Corp. is announcing a $1 billion rescue of subprime loans.
A Boston-based national community advocacy group on Wednesday announced a $1 billion campaign to rescue predatory loan victims by refinancing their mortgages, as a new U.S. Senate report said such foreclosure prevention efforts are beneficial to communities.

Using its capacity as a nonprofit mortgage broker, Neighborhood Assistance Corp. of America will act as an agent for Citigroup and Bank of America Corp., the two biggest U.S. banks. The group will approve new loans for “subprime” borrowers — those with spotty credit — who are in danger of losing homes to foreclosure.

NACA will counsel the struggling borrowers, process loan applications and underwrite the loans, which the banks will fund before likely selling them to Wall Street investors in the form of securities and bonds. The 30- year loans will carry a fixed interest rate one point below the prime rate, putting it currently at 5.5 percent. There are no fees, and the banks pay all the closing costs.

“We have created a new program that is going to be out there to really save the thousands of people who are at risk of losing their home, just in the Buffalo area not to mention nationwide,” said NACA CEO Bruce Marks in an interview.

Using data from First American LoanPerformance, the report also looked at the percentage of subprime loans that were at least 60 days late in payments. Buffalo’s rate of 13 percent was the highest among New York’s large cities, though well below Cleveland at 24.1 percent. The national average is 12.4 percent.

“We need to redouble efforts to protect American families and communities who are at the losing end of this mess,” Schumer said in a press release. “The subprime mortgage meltdown has economic consequences that will ripple through our communities unless we act.

“It’s always the best deal out there,” Marks said. “Everybody would love to have a NACA loan, but we are prioritizing. The people who have a predatory loan, those are the people that we are going to assist.”
Ah yes, Priorities

"We are prioritizing. The people who have a predatory loan, those are the people that we are going to assist."

It's a brilliant plan. Let's reward the totally inept with 5.5% loans. Let's make everyone wish they got trapped in loans they could not afford. But what happens when this escalates from subprime to Alt-A to prime? Are we going to bail out everyone? Who is it we are bailing out anyway: the homeowner or the predatory lender? A better question is: Are we bailing out anyone at all or just padding the pockets of a new set of lenders? Questions, questions, questions.

By the way, who exactly are those 5.5% subprime loans going to be sold to? I suppose when push comes to shove the government could always pad another pocket and guarantee them.

"The report said foreclosure prevention efforts pay off, since every new foreclosure can cost up to $80,000 including the impact on homeowners, lenders, neighbors and local governments. By contrast, foreclosure prevention programs cost only about $3,300 per household".

Hells bells, why not just give everyone $3,300 and be done with it? To think we could have prevented this subprime blowup for a measly $3,300 per and we did not do it. Shame on us.

The Ohio Rescue Plan

On April 5th Reuters reported Ohio mortgage bailout plan gets off to slow start.
Struggling with one of the highest foreclosure rates in America, Ohio rolled out a rescue program for struggling home owners this week. Lenders have been lined up, a Web site developed and phone lines opened.

Trouble is, no one can quite figure out how to tell desperate homeowners about it -- and lenders say the ones who have heard about it may be too far gone to help.

"Even though it has been in the newspapers, it's really one of those referral type of things that gets around by word of mouth," said Patricia Kuether, a loan officer at Sibcy Cline Mortgage Services in Cincinnati. "We haven't experienced any phone calls asking about it yet."

The state-sponsored program, run by the Ohio Housing Finance Agency, is designed to refinance borrowers facing rising payments and looming foreclosure into a 30-year fixed-rate loan with a 6.75 percent interest rate. That's a huge discount for subprime borrowers who have seen rates rise to as much as 10 percent to 12 percent in recent months.

Housing experts estimate some 1.5 million U.S. homes will be foreclosed in 2007 as interest rates rise and borrowers fall behind on their payments.

Ohio hopes the program will help about 1,000 home owners struggling to keep up with rising interest rates -- if only they can get the word out.

"When we opened our phone lines on Monday morning, we received a lot of phone calls," said Rita Parise, director of programs at OHFA.

"But unfortunately we found that a lot of those people don't have Internet access, so it's a matter of walking them through the process to find lenders and nonprofit counselors in their community who can help."

Ohio had the highest rate of foreclosure in 2006. Nearly 7,500 households -- or one out of every 640 -- registered a foreclosure filing in February, nearly 30 percent above the national average, according to foreclosure tracking service RealtyTrac.

Lenders said the most desperate of borrowers also may not qualify for the program. There are minimum credit requirements, and applicants must have enough income and only a certain amount of debt to be accepted. All will have to undergo four hours of face-to-face financial counseling.

"Unfortunately, I think some of the people who are going to be interested in it, they are so close to foreclosure it's not going to work for them," said Beverly Pineault, a loan officer at Humphries Mortgage in Cincinnati.

"We've had a couple of phone calls, maybe three phone calls about it," she said. None look like they can yet qualify for the loan. "Once someone starts spiraling down financially, they get behind on their house payments, their credit scores drop, so it may be too late."
Note that the program can't reach the people they want to help because many of them do not have internet access. Is that funny or is that sad? Whatever it is, let's do the math. Ohio hopes to help 1,000 homeowners through this program. Now assume that every state came up with a similar program and lets assume each state saves 1,000 foreclosures. That's 50,000 total out of an expected 1.5 million foreclosures.

Washington Mutual announces $2B program to help subprime borrowers

In contrast to the piddly $100 million Ohio bailout program, Washington Mutual announced a $2B program to help subprime borrowers.
In the $2 billion program, the Seattle-based bank said subprime borrowers who are current with their existing loans but face payment increases may apply for "new discounted fixed-rate loans or other mortgage products," such as a 30-year fixed-rate subprime loan with the interest rate discounted by 50 basis points.

Washington Mutual also said it will offer "prime mortgage product options for borrowers who qualify."
The reason Wa-Mu is doing this is simple: Steve Rotella, Washington Mutual's president and chief operating officer, said there was "turmoil in the subprime sector," and told shareholders that Washington Mutual's subprime segment lost $164 million in the first quarter.

In other words this is an act of desperation by Wa-Mu hoping to cut further losses.

Freddie Mac ups the ante to $20 billion

Upping the ante even further is a Freddie Mac promise to buy $20 billion in subprime mortgages.
Freddie Mac says it will buy $20 billion in mortgages in a bid to clean up the looming mess in the so-called subprime lending business. The big government-sponsored mortgage company says that starting this summer, it will buy "fixed-rate and hybrid ARM products that will provide lenders with more choices to offer subprime borrowers."

Freddie, which made the announcement on a day when it appeared before Congress to explain its role in the controversy, says its new products "will limit payment shock by offering reduced adjustable rate margins; longer fixed-rate terms; and longer reset periods."
This will be interesting. The Fed wants to rein in Fannie and Freddie but they are bound and determined to expand business. This is another disaster in the works. Fannie and Freddie bonds trade as if there is a government guarantee even though there is none.

The Washington Post is also talking about Freddie Mac and Refinancing Loans.
Freddie Mac, one of the nation's largest mortgage investors, plans to buy about $20 billion worth of mortgages that would primarily refinance the loans of people in danger of losing their homes.

The McLean company is targeting the loans of subprime borrowers, who typically have blemished credit records or other factors that make them risky to lenders. Since the housing market softened, many such borrowers have missed payments and defaulted at record rates in parts of the country.

Richard F. Syron, Freddie Mac's chief executive, announced his company's plan at a Capitol Hill briefing yesterday. The goal is to buy fixed and adjustable-rate mortgages with more affordable terms, starting midsummer, he said.

The idea is that if more troubled borrowers could refinance their homes, they would not lose them, and if investors such as Freddie Mac are willing to buy these loans, lenders would be willing to make them.

Freddie Mac is allocating money to this troubled sector "because it's needed and because, quite honestly, it's a good business opportunity," Syron said in an interview. Considering that the average mortgage is $150,000, the $20 billion Freddie Mac has allocated would cover about 130,000 mortgages, he said.

Freddie Mac has not decided exactly what terms it will set for the loans it will buy. Fannie Mae's program, HomeStay, would allow lenders to refinance without having to wait until the borrowers clear unpaid bills on their credit reports. It also would stretch the loan term to a maximum of 40 years from the current 30-year limit. Fannie Mae has not placed a dollar amount on how many such loans it would buy.

Freddie Mac plans to keep the loans affected by yesterday's announcement in its portfolio, Syron said. That way, it can launch the program quickly and alter loan terms if necessary, which is difficult to do if the loans are sold to investors.

The loans Freddie Mac buys under this program would not be limited to refinancing, though refinancing is the initial focus now that millions of people have adjustable-rate mortgages with low teaser rates that will soon spike.
The loans under the program would not be limited to refinancing. Why not? After all isn't that what the program is for?

Wendy on The Market Traders is skeptical.
Quite honestly, if it was a good business opportunity, real banks, not government-sponsored organizations, would be offering it.

Many subprime mortgages have prepayment penalties of up to 6 months. With home prices stable or dropping, how will the new Freddy mortgages cover the transaction costs of refinancing?

If Freddy "cherry picks" only those mortgages that actually make sense to refinance, it will only be a fraction of the market. Will the government mandate a non-discrimination policy, and force them to take even bad mortgages (after all, if the people could pay, they wouldn't be in default)?

Taxpayer funded bailouts always distort the market.

Wendy
I'm right with you on this Wendy. This is a slippery slope we are on and it has nothing really to do with bailing out homeowners. For Fannie and Freddie it is a way to get Congress off their backs and start expanding again regardless of risk. For Wa-Mu it is an act of desperation. And it certainly is not a "good business opportunity" for anyone except perhaps someone with a government guarantee or government funds. Regardless, every one of these plans will fail because they all have a fatal flaw.

The Fatal Flaw in Bailout Plans

The flaw is these programs are all designed to keep people in their homes regardless of the value of those homes.

Who wants to be "bailed out" if it means owing $350,000 on a mortgage when their house is only worth $175,000? The last thing a rational borrower needs or wants is that kind of bailout. Essentially what is being offered is a sucker play to stop people from handing over the keys and walking away. It won't work.

Some might argue that it was irrationality that led to absurd prices in the first place so "why expect rationality now?" The answer is expectations are lower and few expect a return to madness any time soon. In short: Housing psychology has changed. The bottom will be formed when no one expects prices to rise again. Look at Japan. This can be many years from now.

A second reason is the slowing economy itself. Eventually the slowing economy will take a toll. The problems are already spreading beyond subprime into Alt-A. Eventually it will spread into prime. Finally, capital spending is slowing dramatically and with that will come rising unemployment.
More people will have a harder time making payments, and not just on subprime loans either.

The refusal to let this play out, first by Greenspan in slashing rates to 1%, now by Congress, and soon again by the Fed, all attempting to contain the uncontainable has a recent parallel. But no one sees it. Hidden in the shadows o
f rising commodity prices, the refusal to write off bad loans is following in the exact same footsteps as Japan.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

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