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Slick Deal on Subprimes

posted by Elizabeth Warren

Later today George Bush will announce his administration's plan to deal with the subprime meltdown.  Instead of a change in the law, this is a voluntary deal negotiated with some large mortgage lenders and mortgage servicers.  If it works, it's a slick deal for the lenders.  But it may be too small to do any good.  The plan has two features that shape the whole deal: 

1) The lenders decide who gets the benefits and who doesn't. This seems to be the Goldilocks Game.  If the borrower is too cold (not credit worthy even for the teaser rate), no deal.  If the borrower is too hot (could pay on the reset), no deal.  Only borrowers who are just right (can pay currently, but can't pay more) will get the deal.  And the mortgage servicer decides who gets to be Goldilocks. 

2) No permanent solution.  People will have up to five years at teaser rates and then they are on their own. The only way this doesn't recreate the mortgage crisis down the line is if families can figure out on their own how to refinance into sustaintable (usually fixed) mortgages.  Refinancing means more people heading to mortgage brokers and more fees, etc. 

The no-stripdown aspect is crucial.  Lenders (actually investors now holding SIVs) will forgo interest increases for up to five years, but the homeowner remains liable for the full amount of the principle, fees and interest, regardless of the value of the property.  If this works, the lenders get much more than they would have gotten in foreclosure on these properties, they can ratchet up the value of their weaken portfolios of CDOs and SIVs, and they can declare the crisis has been averted.

A huge part of the subprime market offered 100% financing, which, in reality was more like 110% Loan-to-value because of fees that were also rolled into the financing.  Of course, those valuations were based on a rising market.  In a falling market, a huge proportion of subprime mortgages are now in the 125% LTV territory--"below water" in the foreclosure parlance.  The current "deal" will have homeowners paying off all the mortgage debt or facing foreclosure once again. 

Whether you think that homeowners ought to pay all of the debt or not, regardless of the value of the property, it doesn't make much sense from a families' point of view to do so.  Those who can, will walk away.  That means property values will continue to sink and foreclosures will continue to rise.  In other words, the crisis isn't over. 

One other note:  There's no talk about the infrastructure for this deal.  Those who live in the bankruptcy world know that estimating ability to pay through evaluation of debtors' income and expenses is tough.  Right now the mortgage servicers don't have enough trained people to answer the phones. I talked with someone from the office of a state attorney general yesterday who said that even when they call and explain that they are investigating, they can't get through.  Good luck for the average homeowner trying to get a workout. 

OK, one more note:  Investors--the ones whose interest payments are being negotiated away here--aren't all at the table.  This is a deal in which some lenders who hold some debt and some mortgage servicers are planning to give away their own collection rights along with the right of some third parties who have not consented. The lawsuits will fly thick and fast over this.   

And the last note: Much as I would like to see some sort of "fix" happen to the mortgage market, I find it ironic that the borrowers it would help most are those who are not already in default, i.e., the ones who have the least urgent need for relief. The lenders really need to address the problems of those whose rates have already re-set, and who may have already missed a payment or two.  These folks are still headed for foreclosure.

By making the reach of the deal too narrow and by not offering any permanent solution, this deal isn't likely to stop the slide in home prices or halt the wave of foreclosures.  Without that, the lenders' portfolios will still stink, and they will lose the benefits of their own slick deal.

Comments

This is also the "something will turn up," or "Micawber" deal. The deal will encourage some Goldilocks borrowers to remain in homes they can't really afford, hoping for prices to rise again. The deal will subsidize them at the expense of new home buyers, who really deserve to see prices fall to sustainable levels. Of course, the deal has only been formulated because lenders and servicers are hoping something will turn up-- they want investors to subsidize their crossed-fingers temporizing.

If the secondary market for mortgage debt stabilizes, watch managers at lenders and servicers scramble to diversify their personal portfolios into anything but mortgages.

I entirely agree that this is a weak proposal that will help few homeowners, and not the ones who really need it. Assuming that the interests who sponsor it genuinely want to prevent foreclosures, they have done a poor job.
A point that should be made more often is that the standard rule in bankruptcy reorganization is that undersecured creditors are entitled on the secured portion of the claim to a payment stream equal in value to the current market value of the collateral plus reasonable -- not necessarily contract -- interest. That is applied extensively in Chapter 11, and is even the default rule in Chapter 13, subject to the whopping exceptions for home mortgages dating to the 1978 Code and, more recently, many auto loans. Viewed in that context, the concern shown most recently at yesterday's Senate hearing for the plight of mortgage holders who could under such a scheme fail to benefit from future appreciation is not compelling. Whether or not altering the home mortgages exception is politically plausible, it should be emphasized that the described rule is not a radical idea but the normal method of reorganizing undersecured debts.

THE FEDERAL GOVERNMENT NEEDS TO GET THE H#!! OUT OF TRYING TO BAIL OUT PEOPLE WHO WERE STUPED ENOUGH TO TAKE OUT AN "ARM" ON A HOME THAT WAS BEYOND THEIR MEANS. LET THE FREE MARKET TAKE CARE OF THE PROBLEM AND MAYBE TEACH A LESSON TO THE IDIOTS HOME BUYERS WHO WEREN'T RESPONSIBLE IN HE FIRST PLACE AND THE STUPID LENDERS WHO TRIED TO PLAY VOODOO FINANCE. BUSH GET THE H#!! OUT OF THE WAY OF THE FREE MARKET SYSTEM.

Speaking of Goldilocks, there's actually a book called "The Goldilocks Game". Although it is admittedly a work of fiction, it deals with the very concept of an economy being "not too hot" and "not too cold". More information can be found at www.thegoldilocksgame.com or by searching Amazon.

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