Paulson's Plan Is Nothing But Lip Service

Barclays and UBS AG bond analysts say Paulson Subprime Plan Offers Little Aid.

Paulson's plan is aimed at borrowers with "steady incomes and relatively clean payment histories" who are able to repay adjustable-rate loans only if their payments don't rise, he said today at a conference in Washington. In a later interview, he wouldn't "put a number" on how many loans would be affected.

Few homeowners may qualify for the proposed aid and many are likely to default even before rates reset higher, Barclays analysts wrote in a report today.

"The subprime reset plan, as it currently stands, is unlikely to be a big help," New York-based Barclays analysts Ajay Rajadhyaksha and Sharon Greenberg wrote.

Most borrowers who would be helped by the plan would have their loans reworked without a coordinated effort, UBS's Thomas Zimmerman wrote Nov. 30. Details of the Paulson proposal haven't been announced.

Only 12 percent of all securitized subprime adjustable-rate loans in California would qualify for fixed payments under a similar agreement between the state and four mortgage servicers last month, the Barclays analysts wrote, based on an announcement saying the deal applies to borrowers who occupy homes, have been making on-time payments and can't afford higher rates.

Assuming that half of subprime balances default or are repaid before rate resets, another 30 percent of borrowers don't qualify because they've missed payments and 20 percent of modified loans eventually default anyway, the Paulson plan only eliminate losses of 60 cents per $100 of subprime loans, versus a total that may be as high as $18 to $20, they wrote.

"I think it's lip service and essentially not meaningful," said Michael Burry, president of Cupertino, California-based hedge-fund firm Scion Capital LLC, which manages about $1 billion. "It will only help those who don't need to be helped."

Industry Insider Email

I find the above article interesting in light of an email I received from an industry insider this weekend who wishes to remain anonymous. Here goes:

The homeowner bailout sounds a lot better in the headlines than it does when you dig deeper. For instance, HomEq reports that for every 5,000 resets that come in every month, only 1,000 meet standards to even begin loan modification, and of those only 10% of borrowers actually begin the process. That's 2% of all borrowers undergoing resets.

One of the problems is that in many cases, a W2 is required, and many of these homeowners are reluctant to provide one since they presumably lied about their income to qualify for a mortgage. Still others are in trouble not because of the reset, but because they can't even afford their teaser rate. Many in foreclosure won't pick up the phone when contacts are attempted from lenders.

And that's before we even talk about getting servicers to sign off on the proposal, deciding which of the millions of homeowners in trouble deserves help, and moral hazards of the plan on the part of borrowers who might stop making payments in hopes of getting a freeze and of lenders who might decide to shun the MBS market completely if the government is going to force them to modify contracts. And even for those who do get a government-aided freeze, all this will do is keep them in an underwater home for longer, making them permanent debt slaves on a bad asset.

Other bailouts don't inspire much confidence either. Citigroup, Freddie Mac and E*Trade had to offer extremely generous terms to get more capital. It's bad enough that we're at the mercy of Asia and OPEC countries for the treasury market, but now they're making inroads on our premier financial institutions too.

As E*Trade sold asset-backed securities at 27 cents on the dollar, will this put more pressure on other institutions to give more realistic marks on their portfolios, leading to more writedowns? How are institutions like Freddie Mac supposed to make any money when it now costs them over 8% to borrow? And how are rate cuts going to help anything when what the system needs is "more balance sheet," and there's none to be found, and in fact credit continues to contract?

Supposedly the terms of the deal are not finalized but details and discussion items seem to have leaked out. Whether or not any particular detail makes it to the final plan or not is irrelevant.

What matters is the plan is doomed to fail just as I predicted in "temporary" mortgage freeze is doomed.

The plan will fail because it is in the best interest of those underwater on their loans to make it fail. This is what happens when borrowers have no skin in the game. Hoards of people borrowed money with 0% down. If they had 20% down or even 10% down they would be reluctant to walk away from that loss. Instead, borrowers have a chance to walk away debt free after being 10's or even 100's of thousands of dollars underwater. Who in their right mind would not want to jump on that?

Oddly enough, the new IRS plan to not tax homeowners on forgiven debt actually encourages homeowners to walk away. Does any government scheme ever work? I think not, and Paulson's Lip Service will not fare any better.

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