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Sunday, March 9, 2008

More Housing Lunacy

Barney Frank, the man responsible for H.R. 3915 is ready for more action and he penned this piece outlining what he thinks needs to be done. In it, he largely echoes the thougths of the Fed Chairman, Ben Bernanke, that we need to save troubled borrowers by any means necessary. A few weeks ago, I analyzed this idea to resolve the mortgage crisis by Robert Kuttner. Here is one thing I said...

The way to save these borrowers isn't to reduce their rate but to reduce their loan amount. What actually needs to happen is for twenty or twenty five percent of the mortgage amount to go away. A 250k mortgage must be reduced to 200k. Now, I doubt politicians would ever suggest that because it is patently ridiculous, and yet no one seems to have a problem suggesting that rates be renegotiated in masse.

It turns out I was wrong. I never thought that politicians would go so far as to suggest that mortgage balances need to be reduced. In other words, if you owe 250k and that is too much, the government is now suggesting that your balance be reduced to a lower loan amount. Here is what Frank says...

In concept, we propose to tell those who either originated or purchased mortgages that are now extremely unlikely to be repaid that they should write down their existing obligations to a level that represents current market value. After -- and only after -- the loss is taken, the government would facilitate refinancing mortgages for homeowners who could meet repayment obligations at the new, written-down level. Of course, not all borrowers would be able to refinance, but the number of foreclosures could still be substantially reduced. This plan would use the Federal Housing Administration's authority to guarantee certain loans to induce a renewed willingness to lend by private entities that are either unwilling or unable to do so.

The problem is several fold. First, most of these folks would still not qualify for FHA loans. FHA loans have very strict requirements on debt to income (your monthly debt obligations over your gross monthly income). Even if the mortgage is reduced, the borrower would almost certainly still not qualify for FHA loans. Most of these borrowers got mortgages with so called stated loans. That means their real DTI's (debt to income) was sixty, seventy, and even more. They qualified because they lied on their application. Let me say that again, they lied on their application. There is no getting around that. Their incomes were marked on the application and they signed knowing full well that the income listed was a fabrication. FHA allows no such loan. FHA limits the DTI to 42%. This reduction will help almost no one get an FHA loan. Furthermore, most of these borrowers would still not afford their new mortgage even if it is reduced. At sixty, seventy, and higher DTI's, a mere 10-20% reduction in the mortgage is not enough to save them.

Here is what Frank wants to do. If we have a troubled borrower and they owe 250k, and their property is only worth 225k, their mortgage should be reduced to 225k. The first problem is that these borrowers would still owe a lot more than they can afford. That's because most of these folks initially bought properties that were more expensive than they could afford. Then, they added to the problem by using new found equity to artificially finance their mortgage by taking out against the equity. Furthermore, a reduction in equity would only solve one problem in their quest to get a better mortgage. Stated loans, and loans to people with poor credit scores, are no longer available, and they are certainly not available to people with loan to value (the loan amount compared to the value of the property) of 100%. Keep in mind, Frank wants to merely reduce the loan to the value of the property.

Frank not only gives away his lunacy but his obvious pandering...

Yes, some people borrowed imprudently. On the other hand, though, it is clear that many of the people in this situation were misled, were deceived or were in other ways the victims of unfair lending practices.

Refusing to respond to their plight would not only be lacking in compassion but would also be bad economics. Everybody -- homeowners, lenders, neighbors, indeed our entire economy -- is worse off when a foreclosure occurs instead of a prudent write-down and appropriate refinancing.

Like I have said over and over, mortgage brokers like myself haven't changed in the last two years. We are the same sociopaths we were five, ten and thirty years ago. What changed was a relaxation of the rules that allowed us to exploit the situation. Maybe borrowers were misled or more likely they fooled themselves into believing they could afford a mortgage they couldn't. It doesn't matter. These people are only going to be able to afford their mortgage for a few months more by merely reducing it to the cost of the property. These folks received mortgages currently not available in the marketplace. In fact, these folks shouldn't be in the mortgage market place at all.

That is the rub, as Shakespeare would say. Frank, and other misguided folks like the Fed Chairman, want to carry irresponsible borrowers thinking that is the only way to avoid crisis. Let me tell you something. We can't avoid crisis. We have millions of irresponsible borrowers that hold loans they can't pay. That is a crisis. Reducing their mortgages isn't going to avoid crisis. It will merely prolong the crisis. The reason that we have a mortgage crisis is because the mortgage market included millions of borrowers that had no business getting mortgages. The answer isn't to keep them in the market place artificially. These folks need to be removed from the market place as quickly and painlessly as possible. All politicians should be getting behind anything that gets these folks from out from under these mortgages. The way to do that is to get behind promoting short sales, where borrowers are allowed to sell their homes for less than the mortgage amount and avoid foreclosure. That is the only prudent thing to do now. Instead, they want to turn unaffordable mortgages affordable artificially. (Of course, they still won't be affordable, and those that will will become unaffordable when the same folks go out and spend new found money)

The problem for Frank and others like him is that they are hitching their wagons to folks that will likely let them down. That is one of many lessons of the Duke fiasco. Nifong hitched his wagon to an individual that he shouldn't have trusted. Frank thinks that after these mortgages are reduced artificially these borrowers will suddenly learn good financial management. My experience is that these borrowers will use this opportunity to attain more debt. If this plan is executed, these borrowers will borrow more and in the end most will still be foreclosed on.


Anonymous said...

Like you I am a mortgage banker and in general I agree with you.However it certainly would not hurt the mortgage companies and in effect the market to renegotiate as many of the mortgages as possible. Take the situation where the interest rate went from 7% to 10% and the payment went up $350 to $500. If these folks were able to make the payment at the initial rate, why not keep them out of foreclosure and maintain the old rate? Within 5 to 7 years or so that mortgage will be refied out and the problem not made worse by another bargain basement cost house on the market.
You are so right that Barney Frank does not have a clue.

mike volpe said...

There are several problems there. First, I believe that is exactly what the President has done by opening FHA up to all those folks that were on time but only late after their rate has been moved up.

the problem is you are re negotiating the mortgages of those that are irresponsible and leaving the responsible ones holding the bag. If you are going to re negotiate the mortgages of those that can't make their payments, what about those that can? If their rates stay the same, then you are punishing folks for being able to pay their mortgage on time. Do you really think you can punish responsible folks and reward irresponsible folks with no unintended consequences?

These mortgages didn't magically go up in payment. This is expressly set out in the documents the borrowers signed. In other words, they agreed to certain terms they can't meet. This is a contract, and a private one at that. The government wants to renegotiate private contracts en masse and reward those that couldn't meet their obligations with reduced payments. Again, there are all sorts of unintended consequences there.

Cliff Waldron said...

This goes beyond just a bailout. Frank is saying that congress has the right to alter the terms of private contracts. It doesn't. Not to mention that rates will skyrocket or be unavailable when investors see that US mortgage paper can be marked down by government force.

mike volpe said...

Correct, and you didn't mention the most important part. Frank only wants to alter the terms on those borrowers that can't make their payments. In other words, if you are responsible enough to make your payments on time, your terms stay the same. He is rewarding irresponsibility. To say that this is full of negative unintended consequences is an understatement.