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Friday, December 5, 2008

The Near Total Socialization of Mortgages

Right now, there is no industry more on the brink of being totally Socialized than is the industry of mortgages. Currently, the government controls or subsidizes nearly all end of the business. Furthermore, the government is about to subsidize or control give away programs to just about every portion of the business. The ramifications are not only dramatic but full of unintended consequences.

1) Fannie Mae and Freddie Mac

Both these two were always extensions of the government, but now they aren't merely extensions but owned by the government. You need to be in the mortgage business to understand just how much reach these two have. By securitizing loans, they control the entire process. It is in fact, Fannie/Freddie that underwrites each of their loans and prices them. The only thing that individual banks do is verify that all the information is accurate and collect the money. Any important decision is in fact made by these two. Since the federal government now owns them, in fact all important decisions are now made by the federal government itself. Yesterday, I made the case that mortgage rates for Fannie/Freddie loans are being manipulated so that there is no incentive to give any rate above 5.875%. This is something totally new, and not something I had ever seen while these two were private. It's exactly the sort of thing that happens when we have government control however.

Furthermore, besides Fannie/Freddie, there is currently only one other option for a residential property ( a home, a condo, or any multi unit up to four units) and that is FHA. Well, FHA is also a government sponsored mortgage program. As such, it is the government making any and all underwriting and pricing on any and all residential loans.

2) Loan modifications

This is the process by which banks create a new loan for borrowers that are struggling to pay their current loan. Terms and rates are set not by credit worthiness but frankly by credit unworthiness. In such cases, borrowers have loans they can't afford. Banks adjust the loan and make the payment something they can afford.

Because there is a startling number of defaults and delinquencies on mortgages, the government has been aggressive in trying to find ways to curb this phenomenon. One of the ways is to encourage banks to do loan modifications. In this process, borrowers struggling with their payments get brand new more affordable payments. In this process, it is no longer credit worthiness but rather hardship and need that qualifies. To encourage banks to do this, the FDIC has announced plans to insure millions of these loan modifications. Furthermore, the state of California has passed into law a mandate that no property is allowed to be foreclosed unless the loan is first modified. As such, loan modifications are about to explode with the subsidizing and mandate of various branches of government.

3) Barack Obama will give out billions to struggling homeowners.

President-elect Barack Obama signaled a clear desire Wednesday to use a significant portion of $700 billion in financial bailout funds to stanch foreclosures by helping struggling homeowners with their mortgages. "The deteriorating assets in the financial markets are rooted in the deterioration of people being able to pay their mortgages and stay in their homes," he said.

Now, if you are struggling not only will you have the government subsidize a new loan, but the government will also just give you cash.

4) Dodd/Frank

This is a bill that will have a very similar effect to loan modifications. Under this law, the federal government has assigned $350 billion to FHA to buy up mortgages from struggling borrowers, lower their rates, and even lower the balance if necessary. (both of these options are currently available on modifications as well) Under this program previous mortgage lates are disregarded and strict debt to income guidelines are enforced. Because most borrowers applying for this program would never normally meet these strict guidelines, they will often have their rates and balances lowered artificial to qualify.

5) The Treasury's plan to manipulate mortgages lower.

The head of the government's financial system rescue effort said Thursdaythe Treasury Department is considering a program to encourage banks to makemortgage loans at low rates to help revive the battered housingmarket.

Under the proposal being pushed by the financial industry, Treasury wouldseek to lower the rate on a 30-year mortgage to 4.5 percent by purchasingmortgage-backed securities from Fannie Mae and Freddie Mac. It's unclear exactlyhow much the plan would cost.

Until two days ago, all the government handouts and intervention were only directed at those that were struggling. Now, the government is even willing to interfere to help those that aren't struggling. The government is planning on buying hundreds of billions if not trillions of Dollars worth of Fannie/Freddie mortgages in order to drive the rates down to a target rate of 4.5%. This manipulation means that not only will the government own Fannie/Freddie but they will own the bonds that Fannie/Freddie issues. In other words, each and every portion of Fannie/Freddie's business will now be controlled by the Federal Government.

6) the bailout.

All of the bailout money is going to banks and other financial institutions in the hope that they will lend. So, they will be lending into government programs with government money.

Now, who benefits from this? The first beneficiary will obviously be anyone working in mortgages. The business will soon be transformed from a total depression to a massive boom and it will happen through government subsidies and manipulation. Whereas 2008 was characterized by a total lack of loan possibilities, now borrowers of all shapes and sizes will soon have the opportunity to have their loans changed. Mortgage brokers have already transitioned into loan modifications, and now they will be able to do both ends. Banks, title companies, and appraisers will be the recipients of a massive amount of new business.

The borrowers of all shapes and sizes will soon also be significant recipients. Soon, it really won't matter what your credit profile is because you will have a new loan at below 5%. Furthermore, all borrowers about to get into the market with perfect credit will be the recipients of a depressed real estate market combined with artificially reduced rates will get the deal of a lifetime.

The only folks that won't benefit are those not in real estate. That accounts for about 25% of the population. As such, 25% of the population are about to pay for a trillion Dollar Socialist boondoggle.


Anonymous said...

I'm not sure your conclusion, that the 25% of Americans who aren't invested in real estate are the ones who will end up paying for this socialist boondoggle, is accurate.

I suspect that a vast majority of the people who don't own a home, renters, are also in the 45% of Americans who don't pay any taxes, because their income is below the minimum threshold for a tax burden.

I think the people getting hit the hardest are the very people that Obama wants to tax more anyway: the very wealthy who pay the most in taxes. Their payout on this fiasco will be the largest, and unless they are actively investing in more real estate than just their primary residence, they will also gain the least.

Unknown said...

It's very interesting to see how others feel about mortgages and what the market is doing.