Monday, December 10, 2007

More on Mortgages - Paulson's Priorities

I left the investor side of things out of my last mortgage post, but a number of sharp and interrelated articles have been posted in the last two days that highlights what is the real deal in Paulson's Plan.

It kicks off with Tanta of Calculated Risk with her post Bailouts and Bailins. Here are two key graphs:
So to get back to the "bailout" question: at the simplest level, what's going on here is that loans that were "insured" (or credit-enhanced) by the private sector are being refinanced into loans that are insured or credit-enhanced by the public sector. Therefore the risk is moving off the private balance sheet and onto the public one. The rewards--such as they are these days--are still firmly in the private sector. In that sense, you could call this a bailout: it's moving the risk of default.

On the other hand, it only works if investors are still willing to buy Ginnie Mae securities or municipal bonds. There has to be some capital supplied. The idea here is that nobody's stupid enough to buy high-risk mortgages right now without government guarantees. So far--and I do stress so far--not even FHA has been willing to go down the road of upside down loans to borrowers who can't qualify with income docs. That's why the whole Paulson Plan is about, in essence, what to do with those loans. So FHA is "taking out" some pretty weak loans, but it isn't taking the weakest ones. The weakest ones get "the freeze" or the foreclosure. That is why this Plan is usefully described as not a government bailout. If FHA or municipalities would take all the toxic waste, we wouldn't need this Plan; servicers would just be busy refinancing. The Plan exists because there is a big pile of loans that do not qualify for any of those refinancing opportunities.
So, what's the deal here? If there really isn't any bailout going on, either of homeowners or of security investors, why even bother? Is it just to look like the adminsitration is doing something? That's what I initially thought until I came across Elizabeth Warren's post on TPM Cafe, The Sandbag Plan. She gets into the law side of things, specifically, what modifications to the law this plan is intended to forestall:

So why trumpet a plan that doesn't do anything? CongressDaily (no link) found the answer: "'Totally will sandbag the bankruptcy stuff,' one lobbyist said of the White House announcement." That's what the plan is designed to accomplish--kill off the bankruptcy proposal to deal with home mortgages...

In a piece entitled, "Bankers Hope Bush Subprime Plan Will Scuttle House Bill," CongressDaily reports that "the mortgage industry hopes a White House plan designed to aid subprime borrowers at risk of losing their houses will help scuttle congressional efforts to refashion mortgages through the bankruptcy code. . . The announcement comes as Congress moves ahead with plans to make it easier for bankruptcy judges to refashion home mortgages that are on the verge of foreclosure -- legislation bitterly opposed by the housing industry. Bankers said they hope to use the White House approach as a prime example of why the bankruptcy legislation should not move forward, emphasizing that a voluntary effort can cover many of the estimated 2 million subprime loans that are scheduled to reset to higher rates over the next two years."

Bankers evidently dislike the bankruptcy proposals because they give borrowers some real power: they can write down the mortgage to the value of the property, and they can rewrite the mortgage into a fixed instrument. "Voluntary," according to the banks, is much better.

Ah, now we begin to see where the plan swings into action. The appearance of doing something is very much the point, in order to prevent something far more dangerous to Republican interests from taking root - changing bankruptcy laws to help the individual citizen out of crushing debt.

This point was taken up by Paul Krugman in this morning's NYT column, Henry Paulson's Priorities:

The plan is, as a Times editorial put it yesterday, “too little, too late and too voluntary.” But from the administration’s point of view these failings aren’t bugs, they’re features.

In fact, there’s a growing consensus among financial observers that the Paulson plan isn’t mainly intended to achieve real results. The point is, instead, to create the appearance of action, thereby undercutting political support for actual attempts to help families in trouble.

In particular, the Paulson plan is probably an attempt to take the wind out of Barney Frank’s sails. Mr. Frank, the Democratic chairman of the House Financial Services Committee, has sponsored legislation that would give judges in bankruptcy cases the ability to rewrite mortgage loan terms. But “Bankers Hope Bush Subprime Plan Will Scuttle House Bill,” as a headline in CongressDaily put it.

(Note - Krugman appears to have been alerted to the CongressDaily post by Prof. Warren.) . Krugman goes on to identify three very serious consequences to the mortgage meltdown: 1) Major financial instability as banks and investors are hit, 2) the human toll of millions of citizens losing homes and all of the economic and social upheaval that will cause, and 3) the issue of justice as the people hardest hit are those who were scammed in predatory lending schemes, which makes the previous two problems deeper and more tenacious because of the corrupting influence on finance, personal and institutional. Krugman casts a jaundiced eye at which of these problems is actually considered a "problem" by Paulson & BushCo:

So there are three problems. But Mr. Paulson’s plan — or, to use its official name, the Hope Now Alliance plan — is entirely focused on reducing investor losses. Any minor relief it might provide to troubled borrowers is clearly incidental. And it is does nothing for the victims of predatory lending...

But won’t the borrowers gain, too? Not if the planners can help it. Relief is restricted to borrowers whose mortgage debt is at least 97 percent of the house’s value — which means that in many, perhaps most, cases those who get debt relief will be borrowers who owe more than their house is worth. These people would be nearly as well off in financial terms if they simply walked away.

And what about people with good credit who were misled into bad mortgage deals, who should have been steered to loans with better terms? They get nothing: the Paulson plan specifically excludes borrowers with good credit scores. In fact, the plan actually provides an incentive for some people to miss debt payments, because that would make them look like bad credit risks and eligible for relief.

Sometimes, the venality of the current administraiton is hard for even me to grasp, but it is important to understand that the sole purpose of these goons is to make themselves as rich and powerful as humanly possible, and that immiserating others is a feaature, not a bug. Krugman's point about not pursuing or defending against predatory lending practices takes on a very bitter edge when you read this post of a set of emails from a San Diego foreclosure expert, Ramsey Su, posted with permission today by Rich Toscano of Professor Piggington's Econo-Almanac. Don't let the cutsey blog name fool you. Rich is a serious financial analyst and Mr. Su has a keen eye for the self serving nature of the mortgage industry.

In this post, The Big Mortgage Bailout - The Big Lie, Mr. Su goes in depth on the plan itself in the context of who worte it and what they were trying to do. To start with, this federal plan is not to be found on the US Treasury website. It is on the site of aprivate industry group, the American Securitization Forum. It is composed of companies like Countrywide, Washington Mutual, Deutsche Bank, and the other players deeply complicit in creating the mess in the fisrt place. Mr Su echoes what we first heard from Tanata:

On page 1, the scope of the bail out is limited to:

• were originated between January 1, 2005 and July 31, 2007;
are included in securitized pools; and
• have an initial interest rate reset between January 1, 2008 and July 31, 2010.

Any reasonable person may ask: if the plan is intended to help borrowers avoid foreclosure, why would a government plan be limited only to loans in securitized pools? ASF answered this question on page 5:

The modification maximizes the net present value of recoveries to the securitization trust and is in the best interests of investors in the aggregate,
because refinancing opportunities are likely not available and the borrower is able and willing to pay under the modified terms.

Now that I have laid out the background, the bailout plan is much easier to understand. Every word in the proposal is intended to maximize the net present value of recoveries, nothing else. If you are looking for the section as to how it will help borrowers, let me know when you find it because I sure can’t.

After going into more detail about the plan itself, Su sets down two scenarios to show how the borrowers - and the taxpayers - are left holding the bag:

This is a brilliant two part scheme. Here is how I believe the scheme is intended to work.

Scheme Part 1: Say the subject property was valued at $100,000 with an 80/20 financing package in place. Now the property is worth $90,000. Using only the 1st lien, the LTV is only 88.9% ($80,000/$90,000), far below the 97% LTV. The idea is to get these suckers (borrowers) to refinance into one of those FHASecure while the 2nd lien holder agrees to subordinate to a new 1st. The old securitized 1st is now home free with a FHA/government bailout while the 2nd, though still in an over-encumbered position, has just received a reprieve. How brilliant.

Scheme Part 2: If the property has dropped to approximately $83,000 or below, then Scheme part 1 is not feasible. So it is best to keep this borrower paying in a 120%+ CLTV property. As you can see, with the property value so low, they know with certainty that a default would be a total wipe of the 2nd and a severe loss to the 1st.

This two part scheme assures that there are no crumbs left on the table for the borrowers.

And now were are back to Tanta and the reason why the effort is to take the very worst loans and move them into FHA backed workouts. The taxpayers take on teh risk for the very liekly to fail workouts, the barely scraping by borrowers who are trying to be responsible are screwed over for a few more payment cycles until they, too, fall into the FHA whirlpool, the big lenders get first servings at the payout table, and true reform that migth actually help - Barney Frank's revision to bankruptcy law - is sandbagged for at least another year and the ability of the government to regulate greed hamstrung again.


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