The National Association of Realtors (NAR) is pushing lawmakers — yet again — to expand the first-time homebuyer tax credit. NAR hopes that lawmakers will make the tax credit available to everyone, rather than just first-time homebuyers — among other things. For more on this, read the following article from HousingWire.
NAR today called for expansion of the $8,000 first-time home buyer tax credit to include all home buyers at all income levels.
The push for a broadened tax credit comes after US Department of Housing and Urban Developmentsecretary Shaun Donovan announced home buyers pursuing Federal Housing Administration-insured mortgages may soon use the tax credit as a down payment at the closing table.
An expanded tax credit, combined with HUD’s initiative to make the credit available at the closing table for down payment purposes — called ‘monetization’ of the tax credit in the industry — would make federal assistance available to anyone pursuing a government-insured mortgage.
NAR, from its legislative summit this week, also urged Congress to make the ‘08 loan limit increase formula and loan limit caps permanent, and to “fortify” mortgage giants Fannie Mae (FNM: 0.7867 +2.17%) and Freddie Mac (FRE: 0.8166 +2.08%) to ensure the continued availability of capital for mortgage lenders.
“Housing is the engine of economic growth, and real estate is the road to economic recovery,” says Charles McMillan, NAR president and Dallas-based broker, in a statement today. “With many of the country’s current problems resting on a wobbly foundation of declining home prices, rampant foreclosures and increasing job loss, our members will be asking Congress to pass further legislation that moves the housing market forward.”
More and more people are jumping on the housing recovery bandwagon, but the excitement is a little premature. There are many signs pointing to the fact that the bottom is still far off in the distance. For more on this, read the following blog post from Tim Iacono.
This report by Ben Rooney at CNN/Money takes a few rather ambivalent comments by impartial analysts and combines them with more drivel from a National Association of Realtors shill, interpreting it all as a hopeful sign for the housing market.
Despite last month's decline, existing home sales appear to be stabilizing, according to Ian Shepherdson, economist at High Frequency Economics.
"Sales are volatile month-to-month, but the trend appears to be flattening off," Shepherdson said in a research note.
Yes, and they flattened out last year too before falling off a cliff (see chart from previous post), back when distressed sales accounted for a much smaller portion of overall sales.
By the way, what's with the characterization of distressed sales accounting for "just over half of all transactions in March" in the latest report? In the past, the NAR has cited percentages or a range of percentages, last month putting that figure at between 40 and 45 percent.
The phrase "just over half" could be anywhere between 51 and 60 percent, perhaps higher....
Here's the comment from the realtors' trade group:
First-time buyers made up 53% of existing home sales in March. Charles McMillan, NAR's president, said first-time buyers are "crucial" to a recovery in the overall housing market.
"The housing market always heals from the bottom up, and with large numbers of first-time buyers entering the market it will become a little easier for sellers to trade up or down," McMillan said in a statement.
Between this sort of optimism and word of bidding wars on foreclosed properties (discussed here yesterday and reported again in the Wall Street Journal today), this is probably a very good indication that there is much more pain to come in the housing market.
It is no secret that millions of Americans have put themselves in an unmanageable debt situation thanks to easy credit over the past few years, and while it is unfortunate, hopefully we all can learn from this. Tim Iacono talks about some of the lessons we should have learned, and offers additional insight in his blog post below.
Since credit cards were first issued and automobiles were first financed, bankers and car salesman have been more than happy to assist individuals in realizing their full borrowing potential. Realizing their full potential, that is, by borrowing more money than they really should.
For young adults, perhaps living independently and with their first full-time job, this could lead to important life lessons about managing debt and living within their means. After many months or years of credit card and automobile payments, the initial thrill having long since worn off leaving only the payments, valuable lessons about borrowing too much money have often been learned - lessons that are not quickly forgotten.
When purchasing homes, on the other hand, it used to be quite difficult to take on more debt than would seem reasonable - there, the bar was set higher. Years ago, couples would walk out of their mortgage broker's office disappointed and dejected because their dreams had been thwarted by a loan officer without a heart.
These too were valuable lessons about debt.
Maybe it seemed unfair, but someone who was presumably older and wiser had determined that the dream home so coveted by the young couple was simply beyond their means. Maybe when the couple later reflected on their denied attempt to purchase their dream home, they realized that the lender probably knew best.
But, the financing of real estate purchases has changed dramatically in recent years. Now that home financing has become as easy as getting a credit card or buying a car, valuable lessons about debt learned early on, are being unlearned later in life - this is probably not a good thing.
Credit Cards
Everyone has stories of their first credit cards or a friend’s initial experience with credit cards. It is probably still fairly common for young adults to get a new VISA or MasterCard with a $1000 credit limit, immediately go out and spend the $1000, then begin paying $20 per month to service this debt. Of course the debt never seems to get paid down - but, initially at least, it is easily serviced.
After a while a new credit card would be acquired - You're Pre-Approved!
The process would then be repeated. Another $1000 in debt and another $20 debt service. Many young adults have ended up going back to their parents when this process had been repeated many more times - when the debt service rose much more rapidly than their income and the funds to service the debt began coming up short at the end of the month.
The debt service payment had been multiplying along with the number of credit cards, and was now in the hundreds of dollars per month. Then an emergency arose, and it was game-over - back to the parents, a little groveling, some stern warnings, a few promises, and problem solved.
A valuable lesson was learned.
Automobiles
The purchase of a first automobile can result in a similar learning experience. This one, however can be much more personal - the memory of the car salesman may accompany the monthly payments. Many years ago, a roommate car salesman would occasionally come home and announce, "We buried this guy!” This was invariably a reference to some poor schmuck that came in off the street, and despite his best effort to resist, ended up driving off the lot with a car that he really couldn't afford.
Apparently, there is something both magical and legal about driving the vehicle off the dealer's lot - even if the paperwork was not quite right or the loan wasn't quite approved, you just bought a car - one way or another. You've just made a multi-year commitment to repay many thousands of dollars in both principle and interest in return for that shiny new car that maybe you really can't afford.
Missing too many car payments carries serious consequences - this could be an excellent learning experience if a new car owner needs to be taught this lesson. However, most borrowers who buy more car than they should just live with the strain of seemingly never ending monthly payments until the loan is paid in full. Then they can look back and reconsider the decision that was made on that fateful day. Was it a good decision? Was it worth it?
Another lesson was learned.
[Unfortunately, automobile leases today have given many people the impression that it is completely normal to make car payments forever. Individuals who will never experience the joy of owning automobiles outright and not having any car payments - these people do not know what they are missing.]
Houses
That brings us to today's wild world of home mortgage finance and housing appreciation. If either of the above two lessons about debt were learned earlier in life, it is understandable how they may be quickly forgotten when confronted with a force as powerful as today's global real estate boom.
With lending standards relaxed and home prices rising, debt has taken on an entirely new character - monthly payments now have a much friendlier air about them. Much friendlier in that the underlying asset seems to rise in value at a rate many times the debt service payment.
That never happened with credit cards or automobiles!
If you pay $2000 per month in debt service, and the home value rises by $5000 or $10,000 during that month, and this gets repeated month after month, and you also get a nice place to live in - this seems like an excellent kind of debt.
What lessons are there to learn here? Maybe the lesson is that more debt would be better.
But we are reminded that these are not normal times. We are living in what The Economist magazine calls "the biggest financial bubble in history" - the global real estate bubble. What happens if current trends do not continue? What happens when real estate appreciation regresses to the mean - slowly with stagnating prices or quickly with price declines?
Would there perhaps be some valuable lesson about debt to be learned at that time?
Is the entire Anglo Saxon world about to be taught a valuable lesson about debt?
[This was originally written and published almost four years ago...]
The new mark-to-market rule changes are very controversial. On one hand they have the potential to help stem some of the mounting losses being reported by financial institutions, but on the other hand there is the potential for some ambiguity in relation to the use of “judgment”. For more on this, read the following post from Mark Thoma.
John Berry likes the recent changes in the rules for valuing distressed assets:
Mark-to-Market Rule Gives More Clarity, Not Less, by John M. Berry, Commentary, Bloomberg: Mark-to-market accounting rules are being brought a little closer to economic reality -- accompanied by misplaced howls of outrage. ...[T]he standards have forced many financial institutions to overstate losses on trillions of dollars worth of assets, intensifying the global financial crisis.
Defenders of the rules say they protect bank investors and changing them will allow institutions to hide future losses. To the contrary, they have helped drive down the value of bank stocks, made shorting the shares much easier and caused bank stockholders to lose hundreds of billions of dollars in such companies as Citigroup Inc. and Bank of America Corp. ...
The problem with mark-to-market accounting is that it officially has presumed there’s a functioning market in whatever asset is being valued -- and that means a deal between a willing buyer and seller that isn’t being forced to sell. Actually, no such market exists for many mortgage-backed securities.
Nevertheless,... accountants have required many banks to calculate values based on distressed sale prices. That has meant large writedowns even on mortgage-backed securities that the institutions intend to hold to maturity.
Take the case of the Federal Home Loan Bank of Atlanta. Following the mark-to-market rules, it wrote down the value of its portfolio of mortgage-backed securities by $87.4 million in last year’s third quarter. Its actual projected loss on the securities: $44,000. For the fourth quarter the bank recorded a further $98.7 million loss on the securities.
That result makes no sense when the bank doesn’t trade such assets. ... A writedown might still be required under the changes FASB approved yesterday. Yet auditors can now use “significant professional judgment” when valuing illiquid securities. That’s what they should have been allowed to do all along. ...
The key points in this example are that almost all the mortgages involved are still performing and the bank plans to hold the securities to maturity -- and yet large writedowns were required. ...
Now accountants are supposed to use their judgment... That’s a big improvement over just using the last transaction price, as many auditors have been doing. ...
According to a couple economists our present financial crisis looks like a recipe for a depression. The main difference they see between a normal recession and a depression, is that a depression originates in consumer debt. If these economists are correct in their theory, the recent positive market movement will only be a suckers rally. Tim Iacono looks closer at the recent article published by these economists, and adds some of his own thoughts, in his blog post below.
In this commentary in today's Wall Street Journal, economists Steven Gjerstad and Vernon Smith offer a theory about why we could again be going from a bubble into a depression.
Over the years, there have been quite a few bubbles, but not all of them cause the sort of economy-wide damage that was seen in the 1930s or over the last year or so. Why?
Why does one crash cause minimal damage to the financial system, so that the economy can pick itself up quickly, while another crash leaves a devastated financial sector in the wreckage? The hypothesis we propose is that a financial crisis that originates in consumer debt, especially consumer debt concentrated at the low end of the wealth and income distribution, can be transmitted quickly and forcefully into the financial system. It appears that we're witnessing the second great consumer debt crash, the end of a massive consumption binge.
Most people forget that it wasn't just a stock market bubble in 1929 that led to America's last lost decade. There was an enormous housing and credit bubble in the mid-1920s during which Groucho Marx and others lost a good deal of money on Florida swampland.
As has been the case thoughout history, you can't get a really good bubble going until you get broad participation from the public - preferably lots of people at the lower end of the socio-economic scale levered up courtesy of a banking system that is gushing with easy money.
That pretty much described the situation in the 1920s and in the 2000s.
The entire piece is worth a look as they go through the recent history of financial bubbles in the U.S., a sequence that really accelerated about 20 years ago when you-know-who started sitting in the big chair at the Federal Reserve boardroom.
Interestingly, they touch on one of my all-time favorite subjects since this blog began a few years ago - how owners' equivalent rent duped the Fed.
During the 1976-79 and 1986-89 housing price bubbles, the effective federal-funds interest rate was rising while housing prices rose: The Federal Reserve, "leaning against the wind," helped mitigate the bubbles. In January 2001, however, after four years with average inflation-adjusted house price increases of 7.2% per year (about 6% above trend for the past 80 years), the Fed started to decrease the fed-funds rate. By December 2001, the rate had been reduced to its lowest level since 1962. In 2002 the average fed-funds rate was lower than in any year since the 1958 recession. In 2003 and 2004 the average fed-funds rates were lower than in any year since 1955 when the rate series began.
Monetary policy, mortgage finance, relaxed lending standards, and tax-free capital gains provided astonishing economic stimulus: Mortgage loan originations increased an average of 56% per year for three years -- from $1.05 trillion in 2000 to $3.95 trillion in 2003!
By the time the Federal Reserve began to slowly raise the fed-funds rate in May 2004, the Case-Shiller 20-city composite index had increased 15.4% during the previous 12 months. Yet the housing portion of the CPI for those same 12 months rose only 2.4%.How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.
With home price increases out of the CPI and the price-to-rent ratio rapidly increasing, an important component of inflation remained outside the index. In 2004 alone, the price-rent ratio increased 12.3%. Inflation for that year was underestimated by 2.9 percentage points (since "owners' equivalent rent" is about 23% of the CPI). If home-ownership costs were included in the CPI, inflation would have been 6.2% instead of 3.3%.
Yes, "an important component of inflation remained outside the index" - that sort of thing almost always ends badly as noted here on many occasions before.
There are a lot of people who deserve blame for the housing crisis, but who are these people exactly? Dateline recently took it upon themselves to expose the key individuals that they feel are behind the mess. Some are easy to see, while others are a little more abstract in their involvement. Scott Wilson looks closer at the Dateline piece, and adds some of his own input in his blog post below from Your Mortgage or Your Life.
Sunday March 22, 2009, Dateline NBCaired a piece called “Inside the Financial Fiasco,” in which Chris Hanson finally takes a break from exposing sexual predators to take a closer look at the current housing mess.
NBC attempts to assign blame for the mortgage meltdown, and also tries to make it seem like they have finally identified the handful people who were the “only ones who knew” what lay in store for the economy when Wall Street embarked on the derivatives end-run that fueled the crisis.
So let’s go down the list of people that are prime candidates in the vicious circle of blame, and what their role where in the making of this fiasco.
Let’s start at the top. Back in the mid ‘90’s, The Government loosened credit guidelines and required lenders to make mortgages available to more to minority buyers.
By doing this, they gave the lenders an open check book to write questionable loans, all the while knowing that they would be able to sell them on the secondary market (Wall Street).
This was the creation of the infamous “Subprime” loans which later morphed into Alt-A and Expanded Approval loans.
Next, let’s look at the Product Managers who wrote the underwriting guidelines for the toxic loans known as SISA’s and NINA’s, which required little or no documentation of income and assets. The SISA loans are highlighted in the Dateline piece.
Do you think that these product managers had no idea that these types of loans may be misused, or did they only see the underlying profit that was possible from billions of dollars of loan fees collected by creating millions of loans that were virtually just ticking time bombs?
Yes, there are some cases where these loans were appropriate, such as for the business owner who had a lot of write offs, or the borrower whose spouse may not have the best of credit, but will nonetheless contribute towards the monthly mortgage payments.
But the types of borrowers who where actually put into these loans were completely unqualified, as mentioned in the NBC piece.
People like Delores Parker Jackson, who took out multiple loans on four condos totaling over $1.3 million with a negative (-$6000) shown on her tax returns.
Mrs. Jackson, who claims to have run a profitable daycare, and says that she is not to blame, but is actually the victim of predatory lending.
REALLY? She took out multiple mortgages on four different properties totaling over a million dollars with a payment of more than $10k a month, and she claims she had no idea that she could not afford the terms. Now she wants to pretend that she is not culpable, and that the mortgage company committed fraud?
Come on, do seem we that stupid?
Thirdly, let’s look at another “innocent” party: The CEO’s of all the banks and mortgage companies.
These people should have overseen the product managers and acted as the final line of defense by looking out for the company’s long term interests by saying “Hey, stop! These loans may be too risky.”
But the CEO’s saw only a “pot of gold” in the form of billions in loan fees, and where slaves to the corporate bottom line.
Do you think that Angelo Mozilo, the former CEO of Countrywide who earned over $400 million during his last five years at the company, had absolutely no idea that SISA and NINA loans with zero money down would backfire?
Chris Hansen attempts to talk to Mr. Mozilo, but to no avail.
Since he quit Countrywide and the mortgage mess started to blow up, Mozilo has been hiding out at his palatial estate in Southern California, ala Howard Hughes. Chris tried to get the guard at Mr. Mozilo’s gate outside his house to let him in, but was turned away.
Also to blame are the former CEO’s at places like Bear Stern’s and Lehman Brothers, who ended up driving their companies into the ground by buying up these toxic securities. And none of these guys saw the writing on the wall?
I think they did, but also saw big dollar signs in the racket, and choose to ignore the hazards.
Next up for their heaping of blame are The Borrowers. I was an LO for 15 yrs, and used Countrywide as a purchaser for many of my loans.
I knew that some of my borrowers were “less than qualified,” but the underwriting said to “make the loan.”
Like when I would be working for a builder, and a borrower would come to me and asked what loan amount they qualified for, my reply often was, “How much can you afford?”
I told them that I could tell them all day how much they can and cannot get approved for, but only they could tell me how much they really afford.
I could tell them on paper or with calculator that you could qualify to pay, but only the borrower could tell me if they could actually maintain that payment.
I cannot tell you how many times I was told by borrowers, “Don’t worry about me affording it. You just write that mortgage.”
This is where I move on to include the next culprit in this mess, The Loan Officers.
How many LO’s wrote loans for people that they knew would end up in foreclosure?
Many borrowers who I turned down for a mortgage would come back to me later to say, “See, I knew I could get approved. Thanks for nothing.”
At the height of the bubble, there were so countless mortgage brokers who were willing to do anything to write a loan and collect a fee.
They would falsify the numbers to make them work if they had to.
In the Dateline piece, they showcase a woman who was employed as a personal trainer, and who claimed to of told the LO at People’s Choice that she only made $1600/mo.
She was approved for a $259k loan.
Even after she was told that the payment would be over $2100/mo, she figured that she would just have her sister move in and help with the payment.
Do you think that the LO at People’s Choice had any idea that she may NOT be able to make the payment on this house? When Chris Hansen looked at the original paperwork, it stated that she made $7300/mo, which surprised the woman.
She claims she never provided that figure to the LO.
How many LO’s committed fraud because the commissions that they were going to make on each loan they closed could be well into the tens-of-thousands of dollars?
Even though my job was commissioned based, I only made loans if I had some degree of certainty that the borrower had both the ability to pay the mortgage payment and that they completely understood why I was giving them a SISA or NINA loan product.
I did not want a former borrower hunting me down in the parking lot some night after work because I put them in a loan that that left them flat broke.
Next in line is a major player, one who no one seems to put much blame on or even mention much, The Appraiser’s. I believe these guys had a huge impact on the housing explosion, and no one seems to want to bring them up.
As the appraisers continued to inflate the values of the properties, the mortgage companies continued to write mortgages to cover the obscene appraisals.
I knew that if a borrower told me that they were short on funds to close, I could call the appraiser and ask him to “bump up” the value of the property a bit, so that I could give the borrower the money cover closing costs.
This was considered a legitimate practice because real estate only increases in value, remember? But in reality, the value of that house did not go up $5k in the 2-3 weeks since they had done the actual appraisal.
I also found out the hard way how much of an “opinion” an appraisal really was.
Prior to working for the builder, I worked for a short time as a mortgage broker. I only did one loan at the place. , and it was for a gentleman who was doing some renovations on his house, but did not have enough money to finish the project.
Less than a year earlier, the value of the house came in at $85k. When he wanted to do another cash-out refinance a year later, but the new appraisal came in again at $85k. So when I went to my boss and told him that I did not have the value to support the loan, he handed me a business card and said, “Call him.”
Two weeks later, I had an appraisal for $115k, enough to cover the loan.
Was there that much movement in the values of the house? Did it really go up $20k in three weeks, or did the new appraiser just want more business?
What do you think? I know when I worked for one of the big mortgage companies and did a ton of refi’s, every time I had to put an initial value of a home on an application (which typically came from the borrower) nine times out of ten, the appraisal came back with the exact same value.
Curious.
Another big part of the mess, the people who were supposed to catch any fraud or mistakes, were The Underwriters.
They were the final check points in the mortgage process, and when they were presented with a SISA loan that showed that a “house cleaner” made $12k/mo, they should have sounded the alarm.
Like the appraisers, the underwriters are merely mentioned in the piece on Dateline.
Ilene Lanacano, who worked for “People’s Choice,” says that when she brought up some of these problems with the questionable loans, she was often overruled by the CEO of the company.
She states that she was often offered “incentives” by loan officers (money, jewelry, even a car) to approve loans. Ilene says that she never took any of these incentives.
She also claimed that there was harassment and intimidation if you did not approve loans, such as flattened tires and physical threats.
Ilene finally left “People’s Choice” for a consulting firm whose business was to analyze the loans to be pooled in Mortgage Backed Securities (MBS’s). When she raised some flags, she ended up getting in trouble by management.
Next, let’s look to good old Wall Street. You would think that one of the supposed guru’s of Wall Street could have seen the possibility that at least some of these loans were destine fail. But they too, only saw the bottom line, and they sold these MBS to everyone: investors, pension funds, municipalities and other countries.
And then there is China, who bought up trillions of dollars in MBS in an attempt to control the US. By owning all these MBS, China has a huge stake in our mortgage meltdown.
They were only briefly mentioned in the “Dateline” piece, and no real repsonsibility was levied on them. If China had not been so greedy, there wouldn’t have such a demand for MBS, which would have cut down the toxic loans being written.
And the Chinese are smart, shouldn’t they have seen some of the signs?
Next ones to heap some blame on are the Bond Rating Agencies, such as Standard and Poors, who was also briefly mentioned in NBC’s piece.
As Dateline explained, they were hired to give credit ratings to these MBS, which are supposed to indicate their level of risk to investors. “AAA” was the highest rating that they could give a security, and 80% of MBS received that top stamp of approval.
They suggested that most MBS would perform well, despite the fact that the agencies did not have any historical data to back the ratings up. Richard Gufliota of S&P, stated that they were so over inundated with securities to rate that most were not examined to the extent that they should have been.
It should also be mentioned that they made their money in volume too. More quantity over quality.
Finally, a lesser acknowledged culprit of this financial fiasco is The Media itself.
If it wasn’t for the greed of the media (TV, Radio and Newsprint), rolling out with advertisement after advertisement for these mortgage companies and their products, borrowers would not have been so encouraged to accept some of these toxic loan.
In years leading up to this mess, there wasn’t a commercial break that did not produce a mortgage ad.
Often advertised were the No Closing Cost, Stated Income, No Income Verified, and so forth.
There wasn’t a Radio host in the nation who didn’t have at least one mortgage company in their back pocket paying them to be their spokesperson.
Did any of them look into the products that they were pitching to their listeners? Nope. I think they just laughed all the way to the bank.
And what is strange about the media’s role, is that I have yet to see anyone try to add them into the equation. Now, all you hear out of radio talk show hosts spewed crap about how everyone else is to blame. None have come forward to say, “Hey, I guess I had a hand in it too.”
All in all, it is going to be a vicious circle of blame.
There is plenty of blame to go around, and I think when it comes down to it, we can sum it all up with one little word: “GREED;” the Greed of the Government, the greed of the Product Managers, the greed of the CEO’s, the greed of the borrowers, the greed of the Loan officers, the greed of the Appraisers, the greed of the Underwriters, the greed of Wall Street, the greed of China, the greed of the Bond Raters, and greed of the media.
More and more people are starting to pay attention to the economy, and specifically the actions the government is taking to rectify it. One problem that many people are running into, though, is that things in the financial world are getting pretty complicated. We have these things called toxic assets that are destroying banks, but how did they get to be toxic? Furthermore why are they causing so many problems? When most Americans hear about the plans to fix the toxic asset problem, their heads are probably spinning. Economics professor Mark Thoma to the rescue. In his blog post below, Thoma does a great job of breaking the problem — and several of the proposed solutions — down into layman's terms using a car analogy.
Imagine a car lot that has 100 cars on it. However, some of these cars have problems. Half of them will have engine troubles that total the cars - the engines blow up and the cars are then worthless - and this will happen just after purchase. The other half are perfectly fine. Unfortunately, there is no way to tell prior to purchase which type of car you will get no matter how hard you try. Thus, half of the assets on the car dealer's "balance sheet" - the cars on its lot - are toxic, and lack of transparency makes it impossible to tell which ones are bad prior to purchase.
If all the cars were in perfect shape, they would sell for $20,000 each. Thus, there are (50)*($20,000) = $1,000,000 in assets on the books according to one way of doing the accounting, but that doesn't necessarily represent the true value of the cars on the lot.
The town where this dealership is located relies upon this business for jobs, it is essential, but, unfortunately, business has fallen off to nothing. Nobody is willing to risk losing $20,000 by purchasing a car that might die just after purchase, so the price has fallen. The expected value of a car is $10,000, but it's an all or nothing proposition, the car runs or it dies, and since people are risk averse nobody is wiling to pay the $10,000 expected value. In fact, the highest price they are willing to pay, $6,000, is lower than the minimum price the dealer is willing to accept (I've assumed a reservation price of $7,500 for illustration, and a horizontal supply curve to make the illustration easier):
So how could the government fix the problem?
1. Government purchases of toxic cars
The government could buy the cars itself, say at $7,500 per car, or $750,000 total for the lot, drive them around a bit (stress test them), wait for the bad ones to blow up, then sell the 50 good cars back to the public (who will no longer be fearful since the bad cars are out of the mix). If they can get anything more than $15,000 for each good car, they will make money on the deal (well, there would be overhead and other costs to cover, but let's abstract from minor details). But if cars end up selling for less than $15,000, they will take a loss.
(In the graph, the government intervention shifts the demand curve outward until it intersects at the kink in the supply curve at Q=100).
The problem with this option is knowing what price to offer for the cars. There is no market, and the firm's reservation price may be too high, i.e. paying the reservation price will eventually lead to a loss. And it's worse. In this example the percentage of bad cars is known, but the percentage of bad cars would also be unknown in a more realistic example, so there's no way to know how many good cars there are for sure, and what price they will sell for after the defective cars have been culled out of the herd. If the government pays $7,500 per car, and more than 62.5% of them go bad (not that much more than the 50% estimate), then taxpayers will lose money even if they sell for $20,000. With the percentage unknown, there's no way to know for sure what the breakeven price will be.
This is, in essence, the original Paulson plan. The only twist is that the price - the $7,500 in the example above, would be determined by an auction among many dealers with the government accepting the lowest bid (which could be $7,500 in this example since that is the price the firm is willing to accept). As you can see by thinking this through, there are questions about what price such an auction would reveal.
One danger in this plan is that if you overpay for the cars, e.g. give $7,500 when the breakeven price was, say, actually $5,000, then you have given the owner of the car lot $250,000 more than the cars were actually worth (this will be the loss to taxpayers). The dealer may need this money to stay solvent and stay in business, but, nevertheless, it is a windfall.
There are a lot of uncertainties here, and lots of ways to lose money. But it's possible to make money too.
2. Subsidies and Public-Private partnerships
Here, the government offers a subsidy to private sector buyers. Suppose that the demand curve intersects the vertical line in the graph (at Q=100) at a price of $4,000. Then in order to sell 100 cars, the government must subsidize buyers by $3,500 so that the $4,000 offer is raised to the $7,500 the firm is willing to accept (notice that the buyer willing to pay $6,000 gets a $2,000 windfall, so, except at the margin, this plan gives surplus to people purchasing the assets - as with the first plan, this shifts the demand curve out until it intersects at the kink in the supply curve).
However, once again, the government will not know if it is getting this right or not. Suppose it offers a $1,000 subsidy thinking that is generous enough. In this example, that won't bridge the gap between the highest offer of $6,000, and the reservation price of $7,500. Thus, the subsidy would be too small to restart the market and the plan would fail. So the answer is to make the subsidy large enough to encourage buyers, but the problem is that if it is too large, the government will be giving money away unnecessarily.
And there's another problem. If there's a large gap between what people are willing to pay and what dealers are willing to accept(the gap between $6,000 and $7,500 in the example), this would be problematic politically since it would require subsidies that are unacceptably large.
And I should note that it doesn't have to be a subsidy. That's one way to do this - as a giveaway - but another way is through a no recourse loan (what is being called a partnership). Suppose that the government gives (up to) a $3,500 loan to a private sector buyer to purchase the car for $7,500. If it's a good car and the value rises above $7,500, say to $15,000, then government will get paid back (with interest) since the asset can be sold profitably (another option is for the government to demand a share of this profit through warrants or other means). But if it's a bad car, the price falls to zero and the loan is forgiven - it does not need to be repaid. So the private sector agents only have to put up a fraction of the price to control the asset, and their losses are limited to the amount they put up while the gains are potentially large.
This is, in essence, the Geithner Plan. If many of the loans are not repaid, or if the subsidy is too large, it could lose a lot of money, but it could also make money too.
3. Nationalization
Now for the Saab story. Another option is for the government to simply take over the car dealership. The dealership is essential to the economy of the town, without it people will struggle, and the government - for that reason - might consider temporarily taking over the dealership to prevent failure. In doing so, it would make an evaluation of the company's assets, pay off the people who loaned the business money up to this amount, which may require having them take a haircut, i.e. accept some percentage of what they are owed on the bad loans they made, and the owner would simply be wiped out (which is a benefit since the business is insolvent and this allows the owner to escape the loans that cannot be paid through liquidation).
After taking over, the government would stress test the cars it now owns, put the bad ones in the junk pile, and sell the rest back to the public. So long as it didn't pay the creditors too much when it took over, i.e. the haircut is sufficiently large, it ought to make money on the deal. But it could lose money here too.
The Point
But, and I want to stress this, the point of these plans is not to make money, the point is to keep the economy of the town going, to keep people employed. If people place a large value on security, then even if the government takes a loss on paper, it may not be an economic loss. That is, we must put a value on the jobs that are saved and the security it brings (simply imagine that the utility function has risk as one of its arguments - by lowering the risk of job loss and the associated household disruption, you have made the agent better off, and this must be counted against any loss from any of the programs above). There is value in economic stability and security over and above whatever the government makes (or loses) on the actual financial transactions, and this must be factored into the evaluation of the policy.
Thanks to a recent TV spot on Good Morning America (along with other press exposure) banks are going to be hearing these words a lot, "Produce the note." A new movement is under way that is causing banks a lot of pain and grief. Essentially how it works is that a homeowner in foreclosure will submit paperwork requesting that the bank produce a copy of the original note. Sounds easy enough, but with the number of times these notes have been bought, sold and transferred, the paper trail can be hard to follow. Desperate homeowners are finding that if nothing else this tactic is buying them a little more time in their home. Tim Iacono looks at this new tactic in his blog post below:
The little guy fights back by making a simple request - prove that the borrower owes the money to the bank before foreclosing.
It really is hard to have much sympathy for the borrower, at least in this case - the lady borrowed $140,000 against a house for which she paid just $39,000.
It does, however, add great irony to the situation.
It appears that we finally (hopefully) will be able to see where our tax dollars are going, thanks to a recent court ruling. This court order will force the Treasury to release some of the information that they have been concealing from the American public in regards to the massive bailout of the country's financial system. Anthony Freed provides us with more information on this development in his blog post below:
Advocates of an open Government and transparent allocation of taxpayer funds celebrated the news late Friday afternoon (2-20-09) that the U.S. District court has moved to enforce a Freedom of Information Act (FOIA) request to release more details about exactly how TARP bailout funds have been and are being used.
The TARP was passed in early October, 2008, in an effort to stem the damage to the nation’s financial industry incurred during a decade of lax risk-abatement that pervaded the banking culture after the legislative emasculation of the Glass-Steagall Act.
FOX Business sued Treasury on Dec. 18 over failure to provide information on the bailout funds or respond to FBN’s expedited requests filed under the FOIA.The initial request, filed on Nov. 25, sought actual data on the use of the bailout funds for American International Group (AIG) and the Bank of New York Mellon (BK), and an additional request, filed on Dec. 1, sought similar data on the bailout funds for Citigroup (C).
FBN asked the Treasury Department to identify, among other issues, the troubled assets purchased, any collateral extended, and any restrictions placed on these financial institutions for their participation in this program.
The Treasury Department - along with the other banking regulators like the FDIC, OTS, and the Federal Reserve - are notoriously secretive concerning the data they collect and their subsequent analysis of the viability of any particular institution, preferring to operate instead behind closed doors.
This tendency often leaves investors in the dark, which generally tends to work in the banks’ favor. Regulators would argue that they are not in the business of moving markets, and that some data may be misinterpreted and inadvertently cause a run on funds at named institutions, evidenced by Schumer’s now infamous disclosure of details that may have led to the collapse of Indy Mac Bank in 2008.
That argument may have held some water until the TARP bailout effectively made the U.S. taxpayer a shareholder in any number of as yet identified institutions, and the owner of any assortment of exotic financial instruments which have proved toxic to Global capital markets.
Judge Richard J. Holwell of the U.S. District Court for the Southern District of New York said in a decision Friday that the government is directed to comply with FOX Business’s request under the FOIA “within 30 days and to produce a Vaughn index with 45 days.”That means Treasury must comply with FOX Business’s request by Monday, March 23, and must produce a Vaughn index by Monday, April 6.
The Treasury will have the chance to withhold some documents and information they deem too sensitive, but now have to provide an itemized “Vaughn index” of which documents and information have been redacted, and for exactly what reason.
“A Vaughn Index must: (1) identify each document withheld; (2) state the statutory exemption claimed; and (3) explain how disclosure would damage the interests protected by the claimed exemption.”
This may open the door to further FOIA challenges to release the remaining information if the Treasury fails to convince the courts that their vetting of information was reasonable.
I don’t think Treasury has realized that they are not the only ones who have new powers and responsibilities in the implementation of this historic bailout - the courts have yet to weigh-in on much of this, including who is ultimately going to be held responsible for the mess that is the economy, even if it is still taxpayers who have to foot the bill to clean it all up.
My guess is that the courts feel very differently about full disclosure than does the insider Wall Street elite who regulate themselves from Washington D.C. in seeming perpetuity.
Frank Rich of the New York Times wrote a good op-ed piece called What We Don’t Know Will Hurt Us, which helps further the argument that it is time to get to bottom of exactly what is going on with our economy, and why their seems to be so little consequence for the perpetrators of so much devastation.
Americans are right to wonder why there has been scant punishment for the management and boards of bailed-out banks that recklessly sliced and diced all this debt into worthless gambling chips. They are also right to wonder why there is still little transparency in how TARP funds have been spent by these teetering institutions. If a CNBC commentator can stir up a populist dust storm by ranting that Obama’s new mortgage program (priced at $75 billion to $275 billion) is “promoting bad behavior,” imagine the tornado that would greet an even bigger bank bailout on top of the $700 billion already down the TARP drain.
Remember, the fundamental point of the TARP bailout is to funnel incredible amounts of taxpayer money - debt, actually - to the very institutions and people who are responsible for driving the markets off the cliff in the first place.
And they got paid handsomely for doing it.
It is time for our nation’s financial machine to drop the self-righteous arrogance they have cloaked themselves in for too long, for all of those paper-pushing money lords to release their false sense of entitlement, relinquish their ill-gotten wealth from the last 10 years, and to return to their proper place in the economic landscape as facilitators of capital creation, not the creators of capital.
Accountability in the largest disbursement of public funds in history is not only a good idea, it is essential to our democracy, as is ending the revolving door between corporate boardrooms and the regulatory offices of our government.
The Fox Business FOIA request and the court’s decision to release more information should serve as a warning to the Wall Street good ol’ boys that their orgy of omnipotence is truly over, and that the era of accountability is in.
It appears the government is ready and willing to do whatever it takes to fix the housing crisis, but there is one little problem: They can’t. As part of the new stimulus package, there will likely be a $15,000 homebuyer tax credit, and not just for first-time homebuyers, but for all homebuyers purchasing a primary residence. In addition, the government will likely attempt to drive mortgage rates down to around 4.5 percent and work particularly hard to modify troubled loans to keep homeowners out of foreclosure. With these new measures in place the housing market will surely recover…right?
The answer to that question depends on your definition of recovery. Will it be enough to stop prices from falling, and possibly even help them start going up again? It’s definitely possible, but the problem won’t be fixed even if prices do turn around. Artificially inflated prices caused the housing crisis in the first place. Homeownership became an attractive option for more people than ever before through financing options that were cheap and widely available—a little too widely available, we are now discovering. ARMs, interest-only and other creative loan programs kept monthly payments low, and people could suddenly afford a more expensive house—or so it appeared. When interest rates started rising and ARMs reset, housing values stopped climbing and all hell broke loose.
So why would we believe that artificially boosting housing values will be sustainable this time? What do we think will happen when mortgage rates rise again and the tax credits expire? We won’t have to worry about ARMs resetting this time around because they are now shunned by banks for the most part, but the fundamental problem remains that housing is just too expensive compared to income. Interest rates can’t stay this low forever, and the tax credit will expire after the end of the year. Then homebuyers will only have their personal income to rely on to pay for their homes. This is how it has always been (minus government intervention), and it is how it should be. People making $50,000 a year shouldn’t be living in a $400,000 house—It’s that simple. People need to live within their means, but the government doesn’t seem to grasp this and keeps pushing measures to modify home loans. We can try to modify people’s loans all day long, but if they can’t afford their homes, then they can’t afford their homes. According to the Wall Street Journal, over 40 percent of borrowers were at least 60 days past due eight months after their loan was modified. It seems to me that these loan modifications are just delaying the inevitable and costing banks and taxpayers more money.
Before the housing crisis can truly end, housing prices must come into balance with incomes. When this happens, the problem will solve itself. When buying a home starts to make more sense than renting, people will start buying again. It isn’t that hard to figure out. Spending taxpayer money to prop up housing is not only a waste, but an unethical perpetuation of the problem. It is completely unfair to renters as well as our youth. Unfortunately, those groups represent the minority, so their voice isn’t likely to be heard. If these measures are passed, expect to pay handsomely for it and to see another bubble burst a few years from now. At least this time no one should be able to use the excuse that they didn’t see it coming.
There has been a lot of talk this morning about the unexpected rise in existing home sales in December, and specifically whether or not it signals the beginning of the end. Unfortunately, we also saw a less positive statistic released: The median home sale price fell 15.3 percent in 2008—the largest drop on record since 1968, according to the Associated Press (AP). So what exactly are we to make of these statistics?
In my mind, this is positive news overall. First and foremost, property values are still too high and they will continue their decline until they reach equilibrium with income levels. That prices dropped so much means that we are ever closer to that point. Increased home sales in December is also a good sign, but one must wonder how much can be attributed to suppressed mortgage rates.
Most homebuyers do not look at the overall cost of the home, but rather focus on how much money they need to put down and the resulting monthly mortgage payment. When mortgage rates were under 5 percent, that dream home was suddenly within reach, and many people came down off the fence to buy. As rates rise again the opposite will happen.
Let’s also not lose site of the fact that thousands of people are losing their jobs every day, and as long as job losses and layoffs are on the rise, it is hard to imagine that the real estate market or any other sector of the economy will recover any time soon. And let’s keep in mind that although home sales increased in December, overall 2008 saw 13 percent fewer home sales than in 2007 and the lowest total since 1997, according to the AP.
This correction was necessary, and we are closer to recovery every day. I wouldn’t get too excited about it yet, as we should expect to see an over-correction before total recovery in this type of market, but as the chart below further illustrates, we are getting closer to what appears to be an historical equilibrium.
It is no secret that builders are hurting, and some experts predict that upwards of half of them will be out of business before this economic crisis is over. The tough real estate market plagued by indecisive buyers and oversupply, combined with the restrictive lending environment, means that even those builders who manage to stay in business are still going to be hurting. It should be no surprise then that new construction is reaching all time lows. Overall it is a good thing, and something that needs to happen in order to allow the market to recover, but it is painful for builders nonetheless. Tim Iacono from The Mess That Greenspan Made looks closer at the latest new homes report and offers his take in his blog post below.
The Census Bureau reports new home construction reached record lows last month, a fitting end to the worst year in the home building business since record keeping began in 1959. Housing starts fell 15.5 percent in December to a seasonally adjusted, annualized rate of just 550,000, worse than the previous low of 651,000 set in November.
In population-adjusted terms, the previous record monthly lows in the low-700,000 range set in the mid-1970s are about double the current rate of home building, an astonishing statistic.
For example, prior to 2008, the low-water mark was 709,000 in May of 1975 which would be just over one million after adjusting for the growth in the U.S. population.
During all of 2008, housing starts totaled just 904,000, a decline of 33.3 percent from the level of 1.36 million units in 2007. The previous low was in 1991 when 1.01 million units were started, a total that, after adjusting for the increase in population was actually worse than last year.
Building permits, a leading indicator for new home construction, dropped to an annual rate of 549,000 in December, a decline of 10.7 percent from November, and also a record low.
This follows yesterday's dismal report by the National Association of Home Builders that pessimism has reached new all-time lows. The monthly confidence survey dropped to just 8 in January, down from 9 in December. Recall that, not more than two years ago, this index was over 50.
There is a lot of momentum gaining right now behind the idea to create a so called, "Bad Bank." This bank would be set up by the government and would be used to take toxic debt off of the balance sheet of the banks like Citigroup and Bank of America. Paul Krugman thinks this "Bad bank" is simply a bad idea. Economics Professor Mark Thoma revisits Krugman's article in his blog post below.
Are policymakers about to take another wrong turn?:
Wall Street Voodoo, by Paul Krugman, Commentary, NY Times: Old-fashioned voodoo economics — the belief in tax-cut magic — has been banished from civilized discourse. The supply-side cult has shrunk to the point that it contains only cranks, charlatans, and Republicans.
But recent news reports suggest that many influential people, including Federal Reserve officials, bank regulators, and, possibly, members of the incoming Obama administration, have become devotees of a new kind of voodoo: the belief that by performing elaborate financial rituals we can keep dead banks walking.
To explain..., let me describe ... a hypothetical bank that I’ll call Gothamgroup, or Gotham for short.
On paper, Gotham has $2 trillion in assets and $1.9 trillion in liabilities, so that it has a net worth of $100 billion. But a substantial fraction of its assets — say, $400 billion worth — are mortgage-backed securities and other toxic waste. If the bank tried to sell these assets, it would get no more than $200 billion.
So Gotham is a zombie bank: it’s still operating, but the reality is that it has already gone bust. Its stock isn’t totally worthless — it still has a market capitalization of $20 billion — but that value is entirely based on the hope ...[of] a government bailout.
Why would the government bail Gotham out? Because it plays a central role in the financial system. ... Gotham has to be kept functioning. But how can that be done?
Well, the government could simply give Gotham a couple of hundred billion dollars... A better approach would be to do what the government did with zombie savings and loans at the end of the 1980s: it seized the defunct banks, cleaning out the shareholders. Then it transferred their bad assets to ... the Resolution Trust Corporation; paid off enough of the banks’ debts to make them solvent; and sold the fixed-up banks to new owners.
The current buzz suggests ... policy makers aren’t willing to take either of these approaches. Instead, they’re reportedly gravitating toward ... moving toxic waste from private banks’ balance sheets to a publicly owned “bad bank” or “aggregator bank” ... “The aggregator bank would buy the assets at fair value.” But what does “fair value” mean?
In my example, Gothamgroup is insolvent... The only way a government purchase of that toxic waste can make Gotham solvent again is if the government pays much more than private buyers are willing to offer.
Now, maybe private buyers aren’t willing to pay what toxic waste is really worth... But should the government be in the business of declaring that it knows better than the market what assets are worth? And is ... paying “fair value,” whatever that means,... enough to make Gotham solvent again?
What I suspect is that policy makers — possibly without realizing it — are gearing up to attempt a bait-and-switch: a policy that looks like the cleanup of the savings and loans, but in practice amounts to making huge gifts to bank shareholders at taxpayer expense...
Why go through these contortions? The answer seems to be that Washington remains deathly afraid of the N-word — nationalization. ...Gothamgroup and its sister institutions are already ... utterly dependent on taxpayer support; but nobody wants to recognize that fact and implement the obvious solution: an explicit, though temporary, government takeover. Hence the popularity of the new voodoo, which claims, as I said, that elaborate financial rituals can reanimate dead banks.
Unfortunately, the price of this retreat into superstition may be high. I hope I’m wrong, but I suspect that taxpayers are about to get another raw deal — and that we’re about to get another financial rescue plan that fails to do the job.
Recently a coalition of homebuilders, real estate agents and other housing stakeholders have come together to formulate a plan to fix the economy. For the purpose of making their plan known, they have even created a website: fixhousingfirst.com. They proclaim that the main reason that the economy is so down right now is because the real estate market is being battered. After all, the problems began when housing values started to fall and foreclosures mounted, which exposed troubled mortgage-backed securities. So naturally, if we hope to fix this financial crisis, then we must address the most glaring problem first and foremost, right?
“So what is their big plan,” you ask? To create another housing bubble of course!
Their plan, as written on the website, is outlined below:
Enhance the initial Home Buyer Tax Credit:
Eligible purchases: Primary residences between April 9, 2008, and December 31, 2009.
Credit amount: 10% of home price capped at 3.5% of FHA loan limits (geographically dependent) — ranging between approximately $10,000 and $22,000.
Eliminate the recapture — a true tax credit [Here they are referring to the repayment of credit described above. In the previous housing bill there was an interest free loan for first time homebuyers of $7,500.]
Monetization: credit available at time of closing.
Available to all home buyers and not just first-time home buyers.
Couple the enhanced tax credit with a below market 30-year fixed-rate mortgage for home purchases
2.99% rate available for contracts closed between now and June 30, 2009.
3.99% rate for contracts closed between June 30, 2009 and December 31, 2009.
Continue foreclosure prevention measures to keep people in their homes, help stabilize home prices and bolster the economy.
Restated, they want taxpayers to pay the down payment for homebuyers and subsidize their mortgage payments as well. What would the net effect of this be? Housing would all suddenly become much more attractive and people would buy, pushing prices up. This is exactly what they say will happen, and is what they are striving for. The trouble is that it is an artificial boost to housing prices, which will inevitably lead to another housing bubble. Housing just isn’t worth what it currently costs. That is the simple truth, and a truth that we all need to grasp. Once the subsidies are gone, housing prices will once again fall until they hit their true value point.
If we are looking for a solution to temporarily get us out of this mess, I think this is certainly one plan that will help with that. However, to me it seems like a waste of time and money when in the end we are ultimately going to return to the same place we were before. This plan is not sustainable in any way shape or form, and should not be seriously considered. Then again what did one expect to see from a plan constructed entirely by home builders, real estate agents and other housing stakeholders?
I was reading through some blog posts this morning and came across one on housingdoom.com that just reaffirms my anti-bailout position. The blog post is simply a rental listing that was posted on Craigslist in Tampa, and while a rental listing in itself is nothing to rant about, you really need to read this particular one.
Here it is:
I HAVE A 3 BEDROOM HOUSE THAT I AM LETTING GO, IT SHOULD BE ATLEAST ANOTHER YEAR BEFORE THE COURT WANTS THE KEYS, SO I AM RENTING OUT THIS HOUSE WITH NO CREDIT CHECK AND ON A MONTH TO MONTH TERM, SO NO ONE IS LOCKED IN, IT IS A CHEAP WAY FOR YOU TO SAVE MONEY. THE HOUSE HAS NO APPLIANCES BUT YOU CAN GO TO CRAIGS LIST AND GET FREE ONES UNDER THE FREE STUFF. CHECK OUT THE LINKS BELOW. IF YOU ARE INTRESTED PLEASE E-MAIL ME. ALSO THERE IS NO SECURITY DEPOSIT AND THE HOUSE IS ON A 1/4 ARCE. YOU CAN E-MAIL ME DIRECTLY AT JOEYCARLO@******** FIRST COME FIRST SERVE.
This guy Joe is asking $499 a month for this house, which is ridiculously low, so I’m sure that he won’t have a problem finding a tenant to take him up on his offer. Obviously he has no intention of using the rental proceeds to pay his mortgage, and is planning to take full advantage of the system for as long as he can.
This is one of the reasons why I am so adamant that a foreclosure moratorium is a bad idea. Sure a lot of homeowners really want to stay in their homes. However, many have no intention of staying in a house that is thousands underwater, and a majority of those homeowners who do want to stay in their homes probably can’t afford it, so they would just be delaying the inevitable. Then you have guys like this, who plan to milk the system for every dime they can get. He already stole the appliances, and now he plans to take advantage of the lenders some more. Since taxpayers are basically on the hook for many of these lenders, he is also taking advantage of taxpayers.
If we can figure out a way to limit the bailout to only those homeowners who actually want to stay in their homes and who can afford to do so, I might be more inclined to support it. But any bailout, or other measure, that supports guys like this, will never get my backing. This guy may be an extreme example of the potential problems at hand, but I can’t help thinking that there are tens of thousands of people out there doing this exact same thing. They probably just aren’t disclosing the situation outright like Joe here. Just reading this listing makes me angry. If Joe isn’t going to live in the house or at least try to make the payment, then he needs to return the keys to the lender. Anything short of that should be illegal, especially when taxpayers are ultimately on the hook for the bill.
If you thought we were almost done with the collapse of the mortgage market, you are sadly mistaken. Last night 60 minutes did a piece about the looming wave of mortgage defaults, Alt-A and option ARMs. While, as Scott Wilson outlines below in his guest post on Your Mortgage or Your Life, 60 minutes did not do a fabulous job on this story, they did reveal some very interesting facts and figures. One that was especially scary occurs 3 minutes and 40 seconds into the video. This shows how most of the subprime mortgages have already reset, but what is looming over the next few years is a huge number of Alt-A and option ARMs due to reset. The graphic will definitely make you change your tune if you think this carnage is almost finished.
by guest author and good friend Scott J. Wilson
I know that I am just smart enough to get by, and I know am not a genius by any stretch of the imagination. I have just been in the mortgage industry - working everything from mortgage sales to secondary markets - for more than fifteen years.
I happen to be watching CBS’s 60 Minutestonight (12-14-08) and they had a piece called Mortgage Meltdown: Where’s the Bottom? with Scott Pelley, who did the story, and not a very good job of it. Either he or his writers need to better research their topic before they to such a report.
Mr. Pelley failed to note that POA’s qualified borrowers with “teaser” interest rates, and not the actual “payment” interest rates. But that is not what I am griping about. My complaint lay in Pelley’s false assumption that no one but a few sage individuals could see these consequences of poor lending standards coming.
All of my experience is in the explosive Orlando, Florida area, so I know a thing or two about exotic mortgage products like the soon to be infamous Pay Option ARM (POA), ticking time-bomb of the mortgage world, and the subprime’s little brother ALT A.
During the bubble from in 2004-2006, I worked for one of the biggest lenders in the nation (one of the survivors thus far) and I doing a truckload of Condo-conversions. I sold a hell of a lot POA’s to borrowers during that period, and most will all be recasting over the next two years.
I tried to always do one thing when I did sell a POA, I tried to explain to the borrowers exactly what these loans were intended for - people with season variances in income like construction and tourist trades, or for those whose income is mostly delivered from quarterly bonuses like sales people.
I did my best to point out to the borrower advantages and traps in POA’s. That being said, I am no “expert” by 60 Minutes standards, let alone “one of (only) six experts in the nation who saw this (tsunami of foreclosures) coming,” as 60 Minutes called Mr. Eagan in tonight’s story.
I knew way back when in the bubble, as did most of the loan officers that I worked with, that these were potentially bad products if they were sold to the wrong borrowers, and that most would probably fail if they allowed more than 80% loan to value (LTV), or made them available to speculators and subprime borrowers.
I also know that most of these loan officers were not geniuses either. Could we have been the only ones to know? I doubt it. So to say that the banks that offered them had no idea that POA’s had a high risk of potentially failing is just completely incorrect.
The bank’s own greed got the best of them; all they saw was the dollar signs in their eyes, as fees and points that filled their coffers.
The borrowers were really no less greedy- like I said, I did my best to explain, even tried to talk some borrowers out of using a POA to buy the property that they were interested in. But most times, it was to no avail. They either didn’t care about the risks or worse yet, their Realtor “over talked” me and told them that I did not know what I was talking about, and that the POA was their best choice:
Real estate always goes up, remember? It’s different here! No need to worry about that negative amortization loan if you stick with the only payment you can really afford, the one with the 1% teaser, your house will be worth double what you paid for it in a year or two!
But, unfortunately, the problem as the banks saw it wasn’t that these loans were going to fail in droves, nope.
The problem the banks saw was that the people were using these loans as short-term real estate investment loans with a really low initial payment, giving the investors time to remodel the property in order to “flip” the house and then move on to the next investment without having to sink so much capital into principle and interest with a higher interest commercial loan payment.
The banks were not making enough money, so they started tacking on prepayment penalties, which investors took as a cost of doing business and the banks thought of as a new revenue stream.
So the big banks and mortgage lenders had to have done some sort of analysis of these POA loans (I know Anthony did when he worked for them, whether the executives ever really read them I don’t know).
Did they not anticipate that the loans would be bad? That if someone who was taking this completely unaffordable loan out for a long period of time they would get burned, especially if the borrower had a two or three year pre-pay penalty on it and the market took a quick downturn, leaving them unable to refinance - just like it did.
Come on though, everyone can’t be so smart that we all saw this coming, but the leadership at Corporate of these mega-institutions did not - especially when they were offering No Income/No Asset options as well - now commonly know as “Liar-Loans” for their lack of any documentation in exchange for a higher interest rate.
Again, profit driven.
At one point, I told people that it was not a matter of if you can qualify or not for an Option ARM or not, if you had below-average or sub-prime credit, you would qualify , with no problems. All I had to do, was run their credit and if they had a 620 credit score (below average credit at the time), then I told them that they were approved with out even having an underwriter look at it.
Underwriters could approve even lower scores with the advent of “risk-based” and “exception” pricing add-ons, basically charging more for the additional risk posed by a riskier borrower, hence the birth of the ALT A loan, among other expanded approval products meant to sell more loans to more people.
So to have Mr. Pelley and 60 Minutes do this completely un-researched and absolutely baseless story that has little or no semblance to the truth is a more than a shame - lots of people knew this crisis was headed our way.
Hell, I wouldn’t be surprised if close to a million people knew that these loans were problems and a lot of them were going to fail. Do you think that any of them just might have worked in upper management of a these now failing banks?
Or are we really all just geniuses after all?
Well in that case then, I’d say my superior intellect makes me really doubt it.
So which city was hit harder by the real estate collapse, Las Vegas or Phoenix? To be sure they both have taken serious hits, but only one will go down as the winner. Tim Iacono from The Mess That Greenspan Made looks at the latest reports and gives the latest update on the markets. If your city is not in the top spot, don't fret because there is still lots of time to play catch up.
The September report(.pdf) for the S&P Case-Shiller Home Price Indices shows the 10-City and 20-City Composite Home Price Indices at new record annual declines of 18.6 percent and 17.4 percent, respectively. Price indices for all 20 cities are shown below. To aid in viewing this graphic, the order of the legend (upper left) reflects the top-to-bottom position of all 20 cities for the current month (far right). As such, the legend order indicates which cities have managed to hold onto the largest real estate price gains since 2000.
Congratulations New York!
You've just surpassed Washington D.C. as the metro area that has held onto home price gains the best in this decade. The bad news is that, with all the recent troubles on Wall Street, this may not last that long.
Not surprisingly, Phoenix and Las Vegas continue to lead the way down, year-over-year home price declines in both areas pushing past 31 percent in September as indicated in red in the table below - the death match continues.
A few other areas are also threatening to crack the 30+ percent annual decline threshold as indicated in blue, notably, San Francisco, an area where the annual price decline worsened to 29.5 percent. Two areas showed month-to-month improvement - Cleveland and Boston - while home prices in Dallas were unchanged from August. Cleveland was the only region where the annual home price decline improved from a year ago, from -6.6 percent in August to -6.4 percent in September.
David M. Blitzer, Chairman of the Index Committee at Standard & Poor's, noted:
The turmoil in the financial markets is placing further downward pressure on a housing market already weakened by its own fundamentals.
All three aggregate indices and 13 of the 20 metro areas are reporting new record rates of decline. Looking at the returns of the U.S. National Index, prices are back to where they were in early 2004. As of September 2008, the 10-City Composite is down 23.4% from its peak, the 20-City Composite is down 21.8% and the National Composite is down 21.0%
You'd think that things couldn't get any worse for home prices, but they probably will.
This article has been reposted from The Mess That Greenspan Made. The full post can also be viewed on The Mess That Greenspan Made.
Many people were excited about the Hope for Homeowners program that was recently rolled out to help curb the growing number of foreclosures, and keep people in their homes. Unfortunately, as Anthony Freed points out in his blog post on Your Mortgage or Your Life, things did not quite turn out as planned.
It’s reassuring to know that our dedicated civil servants are willing to put in the long hours required, on nights and weekends, to make sure their banking buddies and colleagues don’t have to suffer the same fate as many banking executives of late, having to retire with hundreds of millions of dollars that were fraudulently paid out as options and bonuses as reward for investing long and naked, and exposing their companies to tremendous risks.
By the way - none of those profits from the ‘boom’ are being appropriated in order to reimburse those now failing companies, and none of that money is going to be recovered in order to soften the blow to taxpayers.
That money is considered to be lawful compensation for a job poorly done. What is on the table is just exactly how much more bonuses they should get before their companies are declared illiquid then subsequently sold off to the lone bidder for pennies on the dollar, and how much of the bailout money they will use to buy up competitors instead of lending it out as promised.
And for the lowly taxpayer on whose backs both the illicit corporate profits as well as the cost of the bailout are borne? What has this unprecedented dash to action by the bureaucrats, political appointees, and elected representatives of the people wrought in the way of sanctuary from the economic tempest that has engulfed their citizenry?
How about the dandy “Hope for Homeowners” program, designed to help more than 400,000 homeowners avoid foreclosure by making as much as $300 billion dollars available for the effort. What a fantastic idea, it would seem at first glance. Of course, the Devil really is in the details.
As of today, October 27, 2008 - nearly four weeks since the program was unveiled - a remarkable 79 people have applied for the program (Fox News 8-27-08).
Yes, 79 homeowners have been accepted (Fox News 8-27-08).
There are at least 77 banks participating in the program. I am not going to try to do that math in my head, but my best guess is that each of those banks has only helped about one homeowner avoid foreclosure on average in that 27 day period.
With all of the poorly underwritten loans Countrywide booked - and the tens of billions of dollars in profits they made in the process - one would think they might be on the list of participating lenders. Not surprisingly, they are not. Although a unit of Bank of America now, there has been no indication they will assume the responsibility for modification of existing Countrywide loans.
My first impression was that this had to be due to a simple lack of awareness by the public that such a program was available to them. Not the case at all I have found. The program has generated a great deal of interest from distressed homeowners since it was unveiled.
Lenders have been deluged with inquiries from interested borrowers, and the Congressional Budget Office has estimated that this program could help as many as 400,000 homeowners through September 2011, when the program ends.
“Our phones have been going crazy,” said Anthony Logan, president of Group Capital Mortgage in Cerritos, Calif, a participating lender.
What’s the hold up? Why, it’s the program itself, which was designed almost certainly to fail. First of all, the program is completely voluntary for both the lenders and the participating banks. It also requires the lenders to forgive a portion of the original loan balance in an effort to bring the mortgage in line with the market and affordability for the borrower to enter a long term fixed mortgage.
It allows certain borrowers at risk of foreclosure to refinance into a 30- year fixed-rate loan insured by the Federal Housing Administration (FHA) if the current lender agrees to write down the existing loan to 90% of the home’s market value today. In plummeting areas such as California, if a lender holds a $500,000 mortgage and the home’s current appraisal comes in at $400,000, the lender would forgive $140,000 in all. Even before the program launched, lenders expressed concerns about the potentially enormous write downs they would face.
Incredibly, in the face of receiving the largest publicly funded bailout of private industry in history, supposedly caused by nonperforming securities backed by rapidly foreclosing mortgages, the banks themselves are refusing to use a portion of that bailout money to help alleviate the very circumstances that had predicated the public bailout in the first place.
“Refinancinginto the new government-backed program requires your current lender’s approval. If the home’s value is less than the mortgage — which real estate data provider Zillow.com estimates applies to nearly one-third of American borrowers who bought in the last five years — the note’s owner must also agree to reduce the amount owed on the house to 90 percent of its current appraised value. If you owe $190,000 on a house that’s only worth that much, the bank would have to agree to reduce the loan to $171,000, giving up $19,000 in principal, plus interest.”
Meanwhile, two million families are expected to lose their homes to foreclosure in the next two years.
There is a serious leadership vacuum in this country, especially at the upper echelons of both government and business. Their priorities and policies are bankrupting our nation, and the close relationship between these private industries and our government regulatory agencies should be rigorously examined.
Heavy deregulation and the elimination of the safety barriers that had existed between the retail banks and investment banks, as well as the experimental distribution of risk to world-wide markets through untested financial vehicles, led to the erosion of the credit markets.
This system, partially conceived and enthusiastically advocated by Paulson, directly led to the current financial crisis that threatens the first worldwide depression since the 1930’s.
Now, for better or worse, we have handed the job of fixing this mess to the very people most instrumental in it’s cause, namely Paulson.
Is it any wonder that the phones are ringing off the hooks as desperate homeowners look for help and scramble to avert financial ruin by refinancing out of predatory loans, and yet only 79 loans being made to save them nationwide?
If it is not for lack of a program, and if it is not for a lack of interest on the borrowers part, that only leaves the failure of the program to the usual culprits - the banks.
“We know the interest from the public is there, and the next question that can’t be answered yet is are the lenders going to do this?” says Bill Glavin, special assistant to the FHA commissioner, who notes that it generally takes at least 45 to 60 days to complete the process for a regular FHA loan.”
Well Bill, here is your answer from them banks: “No.”
This article has been reposted from Your Mortgage or Your Life. The full post can also be viewed on Your Mortgage or Your Life.
First-time buyers made up 53% of existing home sales in March. Charles McMillan, NAR's president, said first-time buyers are "crucial" to a recovery in the overall housing market.
How could this happen? In 1983, the Bureau of Labor Statistics began to use rental equivalence for homeowner-occupied units instead of direct home-ownership costs. Between 1983 and 1996, the price-to-rental ratio increased from 19.0 to 20.2, so the change had little effect on measured inflation: The CPI underestimated inflation by about 0.1 percentage point per year during this period. Between 1999 and 2006, the price-to-rent ratio shot up from 20.8 to 32.3.
Housing starts fell 15.5 percent in December to a seasonally adjusted, annualized rate of just 550,000, worse than the previous low of 651,000 set in November.
Two areas showed month-to-month improvement - Cleveland and Boston - while home prices in Dallas were unchanged from August. Cleveland was the only region where the annual home price decline improved from a year ago, from -6.6 percent in August to -6.4 percent in September.