Two quotes on the subprime problem:
From commenter David Nieropont:
There are many nuances related to mortgages. For instance, if you default, what are your rights in foreclosure? How can you redeem, and when? But it wasn't any nuances that tripped people up. "The monthly payment is more than I can afford" is not a "nuance."
Ryan Avent on the new plan to freeze mortgage teasers:
. . . the lesson here appears to be that if you see everyone else borrowing well beyond their means, you should too, since the government cannot credibly allow large numbers of homeowners to go into foreclosure.
This plan is by no means going to end the crisis; for one thing, many of the subprime borrowers who are in trouble seemingly can't make the payments with the teaser rates. But the market is currently in the grips of terror: how bad will it get when rates reset? This may allay those fears enough to ease the credit crunch.
But there are downside costs--we live in an imperfect world. One will be distortion of the housing markets; people with those artificially cheap subprime mortgages won't be able to move, and by stalling the decline of house prices, this may drag it out to ill effect. Another will be the moral hazard. Bankers and consumers just learned that no matter how stupid they are, the government will bail them out.
Overall, I'm pretty sure the cost is worth it. But I worry that if this works, and things settle down, we'll see the financial industry's appetite for risk grow even more voracious, and along with its tendency to mistake beta for alpha.
Bankers and consumers just learned that no matter how stupid they are, the government will bail them out.
A brief question-- the reports so far have been very unclear. Is the government paying for the lost interest income, or are they simply getting the mortgage companies to agree to keep the teaser rates on these mortgages? If the latter, isn't this something that hypothetically could have happened without government intervention-- or are mortgage companies unable/unwilling to lower interest rates so as to avoid foreclosures (which end up costing the bank money anyway)? Also, if the latter, it's not exactly a bailout.
The criticism that I've seen (e.g., here) from those (Democrats and others) who want to "do more" seems to focus on this only applying to the small fraction of loans of people who actually have a chance of paying off their loans with a lower rate but who couldn't with a higher rate, and that it mostly focuses on mutually agreed refinancing between the lenders and borrowers.
Mutually agreeable refinancing does seem like a reasonable idea at this point, not exactly a bailout. Banks made bad loans; if they accept slightly worse terms for them that the borrower can then actually pay off, both sides may be better off even without federal funds.
"This plan is by no means going to end the crisis; for one thing, many of the subprime borrowers who are in trouble seemingly can't make the payments with the teaser rates. But the market is currently in the grips of terror..."
Crisis? Terror? Isn't that something of an exaggeration. Maybe I'm just blind to the apocalypse we are facing but I feel perfectly serene.
Some people wanted to buy houses they couldn't afford. Some banks enabled them to do so by making risky loans. Now those banks and borrowers are in trouble. But more than 94% of mortgages are just fine right now, so this does not seem catastrophic to me.
The Federal Reserve will supply liquidity as needed and the market will move along just fine. The Treasury should stay out of it.
I think this is more of an attempt to come up with the biggest flash with the least effect, simply in an attempt to calm down the markets and convince the average-Joe-on-the-street that Something Is Being Done.
I bet you anything that all the real players realize there's not much they can really do, aside from wait for prices to drop enough that people are purchasing again, the backlog of houses to clear, the markets to start actually pricing CDOs accurately for risk, and the whole thing to unclog itself.
The real entanglement is that everyone is worried about where the next dodgy-debt-bomb-called-an-SIV will blow up next, no one knows that the risk of any of the stuff out there actually is, and everyone's terrified of correlations going to 1. And there's really nothing the government can do to fix any of this. So they're attempting a bit of a smoke-and-mirrors act to try to keep the naive-buyer market from panicking and give themselves a bit of a breathing period. I think they're more worried about system panic than anything else.
They're also starting to realize that even if they were to let the stuff go to foreclosure, there's a huge set of headaches out there. The collatoralization and financial slicing-and-dicing means that in a lot of cases, nobody knows exactly who owns some of these properties anyway. There have been a few foreclosures stopped (in Ohio, I think) because the paper trail was missing. Add into that chain a few CDOs that blow up, some escrow companies, a few mortgage companies that go bankrupt, and you can easily see how finding out who actually owns property X can turn into a court case that would drag on for years.
" Bankers and consumers just learned that no matter how stupid they are, the government will bail them out."
They didn't just learn that. This is a well established way of doing business. The bankers exert pressure by causing a lot of pain on wall-street.
They don't generally stop until it looks like they will get what they want. A bail-out.
As someone who just walked through the sub-prime tornado by buying a foreclosed house - I can tell you the some lenders (Countrywide) would rather have no business. Rather than someone who is a low risk buyer - if they can't charge you 12% interest.
Besides.. the people who thought they would pay such jacked up rates are the same people who run their credit cards to max, and then claim bankruptcy.
The other element in some areas - is non documented workers. I'm betting you'd be surprised at their affect on the sub-prime housing market. Since a lot of loans were pulled with no-docs.
John_Thacker: Voiding a debtor's valid debt *is* a bailout, just not of the creditor.
Everyone: how can these "freezes" even be legal? If the government orders it, it's voiding a contract. If the banks do, they're changing the terms without consideration from the borrower, which is a typical requirement for a contract. "But if you cut my rate, I'll pay you what I originally agreed to!" is not consideration!
The entire plan is laughable. (1) It won't work to help forestall the continuing meltdown- there are just too many people who took out loans they could never afford in the best of scenarios, and (2) when the recession comes, rates will fall anyway, and there will be even more people who can't pay even the teaser rates that are not resetting (upwards, that is) under the plan. All in all, this is simply a bunch of politicians and bankers playing charades, pretending they are doing something constructive and intelligent (which it wouldn't be, even if it actually worked).
Voiding a debtor's valid debt *is* a bailout, just not of the creditor.
Oh, certainly from the debtor's perspective it is. The post was, however, was describing both banks and consumers as being bailed out. I'm just wondering how the various chips fall. I suspect that if the plan largely consists of reducing debt that while debtors may well want more loans, banks will become more leery. So it won't help with fraud on the part of debtors, except so far as it makes banks do more due diligence. (And the burden falls on debtors who would not have cheated as well.)
how can these "freezes" even be legal? If the government orders it, it's voiding a contract. If the banks do, they're changing the terms without consideration from the borrower, which is a typical requirement for a contract. "But if you cut my rate, I'll pay you what I originally agreed to!" is not consideration!
From the articles I've read, the government got the lenders to agree, so no orders. Questions about how much arm-twisting went on can remain. It appears that they will require consideration from debtors-- but I suspect that many debtors will be willing to sign something that decreases their payments and debt.
The fact that people with high incomes will not be offered this refinances (according to the NYT) argues that this is intended to be a forgiveness of some of the debt in an effort to avoid foreclosures. It's not without merit as an idea, though obviously only a small portion of loans fall on the margin that would be helped.
I suppose one could argue that a large push was helpful, because there's a Nash equilibrium that discourages banks from being the first to write down loans. I'd need more convincing, though.
It appears that they will require consideration from debtors-- but I suspect that many debtors will be willing to sign something that decreases their payments and debt.
What consideration? Will they pay even-higher interest rates later? Will they become yes-recourse loans? Will they have to offer additional collateral? I didn't know these rocks even had much more blood that could be squeezed out!
Contract amendments do not require consideration to be legally enforceable, if the original contract was enforceable. This is Contracts I.
y81,
You obviously went to a different law school than I did, because my Contracts prof said just the opposite.
But I don't see the problem; if the bank wants to unilaterally stop trying to enforce its right to higher payments, who's going to stop it?
The smartest thing I've seen about this mess was from Calculated Risk a while ago. The essence of the argument is that the various banks have no where near enough staff to process the coming avalanche of foreclosures and defaults, or even enough staff to do the due diligence necessary to figure out which distressed mortgages can be saved (by a modification to terms of the mortgage), which are doomed right now, and which can be dealt with in the intermediate term.
To add further complications, there are covenants in the securities (RMBS, etc.) that hold these notes that have vague language that restrict workouts to distressed loans. What the guvment can do is to give a common definition to "distressed" to provide legal cover for the mortgage banks to do some serious triage in figuring out who to foreclose now on, and who to try to string along and perhaps foreclase later.
"The essence of the argument is that the various banks have no where near enough staff to process the coming avalanche of foreclosures and defaults"
Avalanche? Sometimes I think people just like to talk about stuff they aren't completely sure about.
Are there going to be more defaults? Probably. Real estate markets are not one whole entity. Some places will be bad. For instances, almost everywhere in California where they created too many new developments. In other areas it won't be as bad.
Also - having just bought I foreclosed property. I watch the Countrywide REO database like a hawk. And, I can tell you a lot of their inventory is being absorbed.
I'm betting a lot of the other lenders inventories are also being somewhat absorbed. Even - at the worst time of the year to move properties.
From the articles I've read, the government got the lenders to agree
The problem with this is that many of the loans are no longer owned by lenders. They're owned by investors who bought bundled loans after agreeing to specified rates of return. Change the rate of return without their approval, and there will be lawsuits. My guess is that they won't agree to voluntarily reduce their rates of return just because the lenders and borrowers in the situation were all reprehensibly irresponsible.
snarkolepsy--
Sometimes I think people like to talk about stuff without reading the other person thoroughly ;) Snark aside, I'll admit that I am just shooting the breeze here, but I don't think what I said was unreasonable.
The problem I was mentioning is NOT buyers for foreclosed properties. It is just the process of getting those foreclosures to market, and the ancillary work to figure out, among all the folks who may have problems making payments, which ones to try to workout a compromise, and which ones to just foreclose on.
Think about it-- up until somewhat recently, there weren't that many distressed mortgages that needed workout. So, the companies servicing mortgages didn't need that much staff to handle that sort of stuff. From what I read on Calculated Risk, the servicers have gone further than that and small, inexperienced staff in those departments.
Now all of a sudden, there is a big spike in "problem" mortgages. Do you think that these companies, who are now under financial strain, can just magically handle all of that volume?
This won't show up in slow to move REOs-- it will show up in REOs that show up later than they were expected to based on when the NOD gets filed. And it will also show up in greater "messiness" in trying to work with those customers who are in trouble but can be saved.
"Now all of a sudden, there is a big spike in "problem" mortgages. Do you think that these companies, who are now under financial strain, can just magically handle all of that volume? "
I'm not trying to be snarky here. Honestly.
Only point out that what the media is reporting doesn't coincide with what's happening on the ground.
Countrywide for example- has already hired a ton of people for their REO department. People hungry to work. Who used to work at title companies. Who were laid off. So yes... I do think they can handle that volume.
I use Countrywide for an example, because I just bought house from them. They are one of the biggest, and I'm familiar with how quickly they are managing their forclosure database.
They also tried to sell me a loan - so I'm also familiar with their current process.
I'm only saying that the media - and what most analysts are reporting is not very current information.
I just watched a segment a few minutes ago on this very topic. They are still speculating that lenders are going to have harsher lending requirements. Duh! Anyone who has bought a mortgage in the past few months knows this to already be true. This has been happening for several months now. Sometimes being so harsh they aren't lending money to almost anyone.
Isn't it their job to know this stuff?
The media is habitually 3 months behind what is actually happening on the ground.
snarkoelpsy--
That's good to know, and quite frankly it is pretty impressive that they can ramp up so quickly even with the financial troubles they've been hit with. Thanks for the perspective.
They're owned by investors who bought bundled loans after agreeing to specified rates of return. Change the rate of return without their approval, and there will be lawsuits. My guess is that they won't agree to voluntarily reduce their rates of return just because the lenders and borrowers in the situation were all reprehensibly irresponsible.
Of course, they might if the alternative is not getting paid at all, but yes, securitization does make it more complicated. One might even argue that the investors were irresponsible in not performing due diligence themselves and thinking that real estate was some magical investment with amazing returns without risk.
Anyway, I'm not sure that "we'll see the financial industry's appetite for risk grow even more voracious" from this if the solution mostly rests on the financial industry taking a loss by reducing the debts to a point where some debtors can pay. (Some loans, certainly were bad the moment they were made.) We will see, instead, stricter diligence and harsher terms for lenders (as we're already seeing.) The problem will fall on the person with bad credit who would have been able to pay back that loan anyway who will now be denied.
For instances, almost everywhere in California where they created too many new developments.
I agree with the rest of your comments, but I slightly disagree with this one, at least in a nuance. I still don't think that California has "too much" supply in an absolute sense. The prices are too high relative to the supply, but I don't think that the proper equilibrium is one of less supply and high prices, but of high supply and lower prices. They created too many new developments to justify the simultaneously raising prices, but pricing the middle class home buyer out the market is not my favored solution. I realize that there's a lot of personal preference there, but I agree with Ed Glaeser and Virginia Postrel on this one.
Is it possible that this will backfire, by discouraging investment in CDO's and discouraging banks from offering mortgages? After all, if you are the investor, you have one more uncertainty now -- that the government will step in and modify the loan after it's made.
If fewer mortgages are available, there will be fewer home sales, and prices will drop even faster.
Ryan Avent's comment overlooks the minor fact that lenders are not going to give people the opportunity to "borrow beyond their means" at teaser rates if they suspect the government may freeze the rates; instead, they will stop offering teaser rates. We are talking about "freezing teaser rates", not the general issue of making loans available to people with low credit ratings. Since teaser rates are con jobs targeted at people with poor financial judgment, there is no downside to this solution.
I would argue that in part, the California housing prices were due in part to the easy availability of credit offered to people who never should have been able to enter the housing market.
This increased the number of buyers, shifting the demand curve right. Yes supply increased as well, but supply is always lagging behind demand in housing, due to the time from inception to completion. It is in part why we have real estate bubbles. The lack of supply, results in even more demand, as housing (unlike most other consumer goods) has the added incentive of being an investment opportunity. Ironically, as housing prices rise, rather than damper demand, it can actually increase demand since you have both additional demand from speculators as well as people trying to grab their house before they rise any faster.
Grumpy realist at 12:40 PM sums it up best for me. I suspect a lot of the people who greatly need the help, probably won't get any relief, and the problem has too many moving parts. Politicians know that. So it's best to do something minimal, but broadcast it loudly for effect.
I doubt the plan will work in reality and I am betting that sometime next year, things go down a notch further.
Is Snarkolepsy (spelling adjusted) extrapolating an awful lot based solely upon his dealings with CFC (Countrywide) and buying foreclosed property?
Is this the same Countrywide that was inches from death without the mighty financial hand of BofA thrust strategically in their direction? The fact that that transaction even happened suggests things are bad.
And loan resets have not even begun in earnest, or so they say. It's not so much the problem of a small percentage of homeowners defaulting, but rather, how such defaults and the tightening of credit spread further and further out into the economy.
Whole areas, like Phoenix where I live, are greatly dependent on the employment created by home building, and we know almost all the major builders are busy writing down assets, freezing projects, and dumping inventory at lower pricing.
So if you are, say, Mohawk Industries, you might be seeing pressure on your carpet sales, or if you are Home Depot, people may not be buying.
It spreads and goes beyond the few people defaulting out of the whole pie of homeowners. The actions of the few have affected the decision processes and capabilities of a population sample several times their size.
"Is Snarkolepsy (spelling adjusted) extrapolating an awful lot based solely upon his dealings with CFC (Countrywide) and buying foreclosed property?"
There is other evidence that the market is starting to clear the after effects of the real estate bubble: Citadel taking E-Trade's MBS portfolio off of its hands for 27 cents on the dollar, Lennar unloading hundreds of millions of dollars of land inventor, etc.
Snarkolepsy, any chance you have a handy link to that CFC REO database?
"Countrywide for example- has already hired a ton of people for their REO department. People hungry to work. Who used to work at title companies. Who were laid off. So yes... I do think they can handle that volume."
What about the one year+ it takes to go through the court system? I will assure your the courts will not be nearly able to handle the onslaught.
"The problem with this is that many of the loans are no longer owned by lenders. They're owned by investors who bought bundled loans after agreeing to specified rates of return. Change the rate of return without their approval, and there will be lawsuits. My guess is that they won't agree to voluntarily reduce their rates of return just because the lenders and borrowers in the situation were all reprehensibly irresponsible."-Posted by mike
The investors did not buy the loans. They bought shares of funds that are based on the loans. They are in the same boat as any investor. If I buy stock in Ford, and don't like the way the company is run, I am most likely screwed. If I own enough stock, I can possibly agitate with other investors to shake up the board, or the executives, but unless I can do that, the company won't listen to me. There is always the possibility of a shareholder lawsuit, but that usually requires malfeasance of some kind, not just dissatisfaction with the way the company is run.
Good points, Njorl. I'm not familiar enough with the terms of those deals to know if changing the terms on the bundled mortgages is malfeasance. However, I would assume, whether they're successful or not, that investors would sue if they bought securities based on the understanding that the teaser rate would reset to prime + X% after a couple years, and then that doesn't happen.
As somebody else mentioned above, I'm not sure at what point investors would cut their losses and accept this deal, as opposed to facing a higher than anticipated foreclosure rate.
Since it's so rare, I have to publicly agree with brooksfoe that teaser rates seem to have no sound justification other than tricking people who aren't that bright.
I'm not as sure that freezing them has "no downside," but if it puts an end to teasers in the future, that would be good.
"Is Snarkolepsy (spelling adjusted) extrapolating an awful lot based solely upon his dealings with CFC (Countrywide) and buying foreclosed property?"
You don't go into this market - unless you have a good overall understanding of what is happening in real terms. I bought my REO a few weeks ago. At the scariest time on earth to be buying properties like this. Or any property for that matter. A person would insane if they hadn't done a ton of homework.
I have feelers in related industry tied to real estate. Plus, I had a pretty messy deal.. so I got a good view of what was happening in the industry and lenders overall.
Fred: http://www.countrywide.com/purchase/f_reo.asp
Tom: "What about the one year+ it takes to go through the court system?"
Takes it? what to go through the court system?
Rob_Lyman: Depending on the context, "teaser rate" can also refer to another practice that aggravates me to no end: referring to the *payment* rate as the interest rate. That is, the first year, you're obligated to pay 4% of the loan, after which the debt increases by 6%. In my book, that is an interest rate of 10%, yet virtually ever solcitation I've seen implies or says that 4% is the "interest rate".
How do they get away with that?
What I still can't uderstand is what idiot thought that tricking people into mortages they can't afford was a good financial decision for the bank.
Did they know they could sneak the bad risks under Moody's raidar by bundling them, or was this just the sales team run amok? It's particularly egregious because the people most likely to pick a mortage based on the up-front rate, rather than a consideration of total liability are by definition the worst risks for default.
"What I still can't uderstand is what idiot thought that tricking people into mortages they can't afford was a good financial decision for the bank."
The idea was that even an apparently bad loan was fine, because the property in question would undoubtedly rise in value to the point that the loan would become good. That was a good plan, until it wasn't. For years, banks made money on risky loans. If the housing market were still skyrocketing, they'd still be making money.
Obviously, the boom had to stop. But any lenders who got out long before the bust also lost money. There is an old saying, "The market can stay irrational longer than you can stay solvent."