Guest Commentary: Ramsey on the Bailout Proposals

Submitted by Rich Toscano on June 30, 2008 - 1:32pm

Sporadic guest pigg Ramsey Su is back with some thoughts on the current housing bailout packages making their way through Congress. Executive summary: he's not a fan. Read on for Ramsey's take on why the bailout proposals are a waste, at best, and likely to do more harm than good.

“Housing and Economic Recovery Act of 2008"
Ramsey Su

http://dodd.senate.gov/index.php?q=node/4462/print

My 2 cents:  They should rename this The Totally Wasted Effort Bill.  We do have a crisis that could have devastating consequences.  The emphasis should be on how to erect a safety net to prevent systemic failure.  This bill accomplishes nothing, which would be the best case scenario.  The worst case scenario is that it will incentivize default, compounding the effects of the death spiral that is in process now. 

Congress, stop wasting time on the debates and go back to the drawing board.

There appears to be three sub Acts:

  1. Federal Housing Finance Regulatory Reform Act of 2008
  2. HOPE for Homeowners Act of 2008
  3. Foreclosure Prevention Act of 2008

The third act is of minor consequence and will not be discussed here.

Federal Housing Finance Regulatory Reform Act of 2008 - The “Federal Housing Finance Regulatory Reform Act of 2008" establishes a new, independent, “world class” regulator for Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, the housing government-sponsored enterprises (GSEs). 

What about OFHEO?  If you read the mission statements, it sounded pretty much like what OFHEO (Office of Federal Housing Enterprise Oversight) is supposed to be doing right now. 
http://www.ofheo.gov/about.aspx?Nav=55
or in super detail
http://uscode.house.gov/download/pls/12C46.txt

The GSEs and FHA cannot fail.  FRE, FNM and FHA are now the life line of the real estate market.  Without them, there will be no financing.  It is unclear how this reform act is going to strengthen these three entities. 

Crossroad.  FHA is a government program.  The GSEs are implied.  We are now at the crossroad.  Are the GSEs going to be truly privatized or completely nationalized?  It appears the first step is leaning toward nationalization. 

The fate of the GSEs.  In hind sight, it was fortunate that the accounting problems during the early 2000s prohibited the GSEs from fully participating in the toxic loans.  That said, they still made a mountain of loans during that era and are not without problems already.  The chart below shows the current REO inventory of three lenders (FRE and FNM considered one).  CFC has a combination of all types of mortgages.  The GSEs had limited participation.  BAC, in comparison, did not have any toxic programs and the results are obvious.  (Why on earth do they want to buy CFC?)

REO Inventory of BAC, CFC, FNM and FRE

At the moment, the loss severity of the GSE portfolio is most likely not as high as CFC portfolio.  Furthermore, the majority of the GSE loans should have some credit enhancements in the form of mortgage insurance.  However, if property value continues to decline and foreclosures escalate, it is unclear how much more damage the GSEs can sustain. 

Raising the loan limits.  For some strange reason, there seems to be an obsession with raising the loan limits for the GSEs as well as FHA.  The NAR May 08 existing homes sales averaged $253,100.  The median is even lower at $208,600.  Even the higher priced West and Northeast were only at $327,200 and $309,300 respectively, far below the old $417,000 ceiling.  What a waste of time!

HOPE for Homeowners Act of 2008 - The “HOPE for Homeowners Act of 2008" creates a new, temporary, voluntary program within FHA to back FHA-insured mortgages to distressed borrowers.  The new mortgages offered by FHA-approved lenders will refinance distressed loans at a significant discount for owner-occupants at risk of losing their homes to foreclosure.  In exchange, homeowners will share future appreciation with FHA.

I'd like to ask the genius who drafted this how it works?

Eligible Borrowers. Only owner-occupants who are unable to afford their mortgage payments are eligible for the program.  No investors or investor properties will qualify.  Homeowners must certify, under penalty of law, that they have not intentionally defaulted on their loan to qualify for the program and must have a mortgage debt to income ratio greater than 31 percent as of March 1, 2008.  Lenders must document and verify borrowers’ income with the IRS.
Moral hazard, redistribution of wealth, socialization of housing, you name it.  What are they saying here?

New Loan AmountThe size of the new FHA-insured loan will be lesser of the amount the borrower can afford to repay, as determined by the current affordability requirements of FHA; or, 90% of the current value of the home.  Loans must be 30-year, fixed rate loans.          
If I had just been laid off, my new loan amount would be zero?  What if I had been working 2 jobs, as well as my spouse, to make payments, I would be a fool not to stop working immediately.  How many lenders are going to voluntarily write down their loans to some unknown level?  Can you imagine the staffing needs to make that determination?  This is supposed to be a cheaper alternative to foreclosure?

Equity & Appreciation Sharing. In order to avoid a windfall to the borrower created by the new 90% loan-to-value FHA-insured mortgage, the borrower must share the newly-created equity and future appreciation equally with FHA.  This obligation will continue until the borrower sells the home or refinances the FHA-insured mortgage.  Moreover, the homeowner’s access to the newly created equity will be phased-in over 5 years.
Equity participation programs had been tried many times before and I have yet to see anyone succeed in coming up with a workable structure.  I will highlight a few obstacles.  What if the occupant wants to update the kitchen, how is that expense shared and pro rata profits determined later?  What if the occupant is neglecting the property, resulting in excessive wear and tear, does FHA have recourse?  What if the occupants decide to rent out the property temporarily due to job change, would FHA be a co-land lord?  I can go on and on but I think you got the message.

Existing Subordinate Liens. Before participating in this program, all subordinate liens must be extinguished.  This will have to be done through negotiation with the first lien holder. I have no idea what they are suggesting here, probably neither do they.  Who is extinguishing the junior liens, the first lien holder?  May be the junior liens voluntarily extinguish themselves?

There really is no reason to analyze any further. 

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Submitted by Eugene on June 30, 2008 - 2:14pm.

If I had just been laid off, my new loan amount would be zero? What if I had been working 2 jobs, as well as my spouse, to make payments, I would be a fool not to stop working immediately. How many lenders are going to voluntarily write down their loans to some unknown level? Can you imagine the staffing needs to make that determination? This is supposed to be a cheaper alternative to foreclosure?

The new loan amount must be agreed upon by the lender and FHA. If "the amount the borrower can afford to repay" is lower than the amount that the lender can recover via foreclosure, they will foreclose instead of participating.

The only thing I don't understand is why they need to involve FHA in all this, and why they can't just let banks write down mortgages on their own.

Before participating in this program, all subordinate liens must be extinguished. This will have to be done through negotiation with the first lien holder. I have no idea what they are suggesting here, probably neither do they. Who is extinguishing the junior liens, the first lien holder? May be the junior liens voluntarily extinguish themselves?

They expect FHA to act as a middle-man in this negotiation. Maybe to offer cash in the amount of 10-20% of balance to every junior lien holder in exchange for signing off on the deal.

Submitted by Bugs on June 30, 2008 - 4:25pm.

It's an election year and the media always likes to trot out the old/mentally impaired/weak/ESL borrowers who will lose it all as justification for spreading their pain around to everyone.

Submitted by barnaby33 on June 30, 2008 - 8:57pm.

Esmith the whole point is to keep the banks from going under. None of these types of proposals will do so. They don't fundamentally alter the fact that millions of people cannot afford the mortgages they took out. This is just more lipstick on the pig. If debt cannot be paid back, it must be defaulted on. Its that second part thats the bitch.

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