Why the Foreclosure 'Rescue' Bill is Insane
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Voluntary Refinancing, Mandatory Bail-Out
The US Congress is passing a foreclosure rescue bill in a big hurry this week because President Bush announced he would not veto it as he had stated earlier. The bill has been languishing in Congress for almost a year, as Democrats and Republicans battle over lofty issues like 'moral hazard'.
Meanwhile, Rome burns.
The reason Bush suddenly dropped his opposition to the possibility of helping a maximum of 400,000 homeowners in trouble (right now we're looking at 3 million foreclosures and that figure is widely expected to hit 5 million), was that the federal bail-out of Fannie Mae and Freddie Mac was tacked onto the bill last week, and Bush and Congress wanted that part passed pronto.
Here's what really bothers me:
The terms in the bill for refinancing a select group of people facing foreclosure (only about 8% of the total amount of foreclosures expected by the end of this year) are totally dependent on the lending institution's willingness to write off 10% of the amount financed. So far, lenders have rarely been willing to do this, preferring to let the homes go into foreclosure instead, and then buy them back themselves for pennies on the dollar, which by some trick of accounting makes their books look not quite so catastrophic. These lenders can't be forced to cooperate, bill or no bill.
On the other hand, the Fannie and Freddie bail-out clause puts taxpayers on the hook for as much as 5 TRILLION dollars in bad loans immediately.
Again and again we hear that "Fannie and Freddie can't be allowed to fail."
Why not?
Why is it that individuals can be allowed to fail and lose their homes, their jobs, their children's futures, and more, but gigantic irresponsible corporations have to be rescued just so Wall Street doesn't wet its pants?
Inept Help in a Hurry
Most people who are facing foreclosure will not even qualify for help under the new bill. First, you have to actually live in the property in danger of foreclosure and you have to have a mortgage payment that is at least 31% of your gross monthly income. Second, you have to verify your income for the refinance, even if the subprime loan that is tanking is one of those 'stated income' loans that required no verification. And last but by no means least, the lender has to agree to rewrite your (now federally backed) loan at no more than 90% of the home's current value.
Those conditions exclude a huge number of subprime loan foreclosures right off the bat. Especially troubling are the verification requirements (if the borrowers couldn't get a loan by verifying their income in the first place, it's not likely they have adequate income now that they are in foreclosure, so they won't be getting a refi that requires verification, will they?), and the stipulation that the lender accept the terms of financing only 90% of the property's current value.
In areas like California, Nevada, and Florida, where home prices have fallen by as much as 50% over the past year, 90% of a home's current value can easily equal a loss of 60% or more for the lender. I don't see why lenders will agree to it, and the main reason I say this is that so far they've been loathe to agree to lesser concessions. Why would this new bill change their minds in any way, especially when they are already losing truckloads of money every single quarter?
On the flip side, the bail-out of Fannie and Freddie demands almost no accountability, ever. I would like to see some executives on trial and at least fined heavly if not imprisoned or publicly beheaded. That isn't part of the plan. But the most problematic part of all is that the US doesn't have the money to back these failing giants. We don't have it, period. There's been lots of talk about how its likely taxpayers will never actually pay a penny because everything is going to work out.
That isn't the point. I also think it isn't true.
The worst case scenario goes something like this:
Home values continue to drop, causing even more trouble in the housing market and even more pressure on households as people who are NOT in subprime mortgages suddenly find themselves 'upside down' on their loans; that is, owing more on their homes than their properties are worth. As this downward spiral continues over the next one to two years or even longer, the value of even the 'good' mortgages held by Fannie & Freddie decline rapidly, causing both giants to be undercapitalized and in need of massive doses of government funds. Those funds have to come from somewhere, and that somewhere will be your pocketbook and mine. When times are hard, the last thing we need is more pressure on taxpayers AKA 'consumers'. That kind of pressure causes further economic downturn.
Down and down we go, where we stop, nobody knows.,
A Hard Solution, Don't Hold Your Breath
Months ago, right before Bear Stearns tanked, Bernanke put forward a solution that involved individual lenders reworking their problem mortages to bring the amount owed in line with realistic property values. This would necessitate the lenders declaring huge losses, but on the up side, there would be an instant correction that would stabilize the markets by making the debt held in line with the real values behind the debt. He said he knew this would not happen, because it would cause turmoil and bank failures, but he acknowledged it would in fact correct the problem.
In other words, the banks that bought up or sold bad, highly-leveraged loans would take the brunt of the punishment and might fold.
What we are doing with this bill is the exact opposite of that: We are promising to borrow more public money to back the privately held bad debt. In other words, we are promising to back bad private debt with our bad public debt. That's insane. I just don't know how else to say it. Insane is the kindest way to describe it. The other thoughts I'm having aren't printable.
It's a popular form of insanity because Wall Street and the people who were making money in the heady days of the boom have a lot to lose if they have to suddenly face some kind of reality. The government would like us to believe that if Fannie and Freddie aren't bailed out, the worldwide financial system would collapse and the consequences would be too terrible to contemplate.
What no one is saying is that a financial collapse could happen anyway if Fannie and Freddie are bailed out. In fact, from where I sit, it looks like there's a very good chance that is exactly what will happen. So why not do the hard, right thing to begin with? Why not actually fix the actual problem?
"Wall Street got drunk," Bush quipped the other day off the record.
OK. What's his excuse?
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The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It
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Confessions of a Subprime Lender: An Insider's Tale of Greed, Fraud, and Ignorance
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Subprime Mortgage Credit Derivatives (Frank J. Fabozzi Series)
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Financial Shock: A 360ยบ Look at the Subprime Mortgage Implosion, and How to Avoid the Next Financial Crisis
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Comments
Wow.it seems that when ever congress comes up with a way to help they make things worse like No Child Will Be Left Behind. The Lenders really screwed things up. I sold my house 5 1/2 years ago just ahead of foreclosure. We would have been able to have sold it 10 months earlier if the subprime lender hadn't kept adding fees, and extrea charges just at closing time. No stmpathy for lenders. All my sympathy goes to those homeowners losing their homes.
These rescue bills are getting way out of hand! At some point there has to be some kind of owning up from companies. They made their bad, so they should have to lie in it.
Thanks Rob! I see it from the other end at my job at the bank, and it is truly frightening, as you say. Many, many middle class people are dependent on home equity lines to pay for their childrens' educations and their cars and often, sadly, just daily expenses. Those lines are now frozen, with more lines being frozen every day as the value of their homes drop. When mortgages and helocs go upside down, people default. Defaults drive home prices down even more, and so on and so forth. I just don't see this measure fixing anything at a fundamental level. Even the most optimistic estimates put a correction in home prices out into 2010, so we are not even near the bottom.
I'm just a person, I'm not an expert. It just looks nuts to me. Hope I'm wrong.
Thanks for your kind comments Rob. Hang in there!
Hi 02SmithA and Georgiakevin,
I think you are right, the rescues are getting out of control. To my mind, it just makes our government look incompetent, like we are just flying by the seat of our pants--because I think we are. We're just making it up as we go along. It's nuts.
Driving with your eyes closed means you WILL hit something. Welcome to the brick wall. I'm really getting tired of being so cynical but a spryte I'll never be. Every day that passes leaves me more convinced that nothing good can come of this. But keep it to yourself Pam! Stop spouting venom!!!
Hi ColdWarBaby! What was I thinking?? I meant to write, "Happy days are here again!" I'd sing it but it's so hard to sing on paper! Now I am feeling so warm and fuzzy, I think I have to go hug myself. Thanks for getting me back on track. (I am happy and carefree, I am happy and carefree, I am happy...)
NCE WRITEUP
As a real estate agent and investor in this market - even in one of the "only good markets" for real estate - the situation is truly sad. Houses are taking forever to sell (think more than 6 months), no matter how great or what kind of incentives there are. People who bought houses less than 5 years ago can't afford to sell.
Adjustable rates have knocked people completely out - they were promised they'd be able to refinance within two years (after the pre-payment penalties wore off) - only to find chaos in the lending market at the exact time their rates are being almost doubled!
I have a client who is a truck driver. He is getting a double whammy because gas prices have tripled, so even if he works twice as much, he can't afford his mortgage whose rate has gone up more than 5% - and is going up again next month! His payments have gone up more than $2,000/month. He's tried for MONTHS to work with the bank - no dice. They just seem to be blind or stupid, or hoping to take as many properties away in foreclosure as possible (I'm sure they have their reasons).
When the market was actually good, I used to be able to help people out of foreclosure with forbearances and loan modifications, as well as short sales (although I know it's not the preferred way). Now that the market has turned, it's like the banks just decided to make it worse! There is SO little help, I am totally discouraged, as the time spent to try to help seems wasted now!
Hi zadken,
My experience had been very similar to yours--I know our bank does not work with people at all, no matter how irrational it seems to take the larger loss, and some of the really big lenders like Countrywide--good luck even getting a live person on the phone let alone a live person who knows what is going on or can help. In some parts of the country, realtors are getting up at 3 AM just to get a message on an answering machine for a return call because if they wait until office hours the machine is already full and they can't get through to the lender at all.
So why this new 'rescue' package should change that I can't say. It does seem to me that it only passed to get the Fannie & Freddie bail-out in place. And now, as if things weren't already bad enough, mortgage rates are rising. What a mess. It won't be boring, but I think it will get a lot uglier before it gets better.
Well, I think it is unjust to bail out BOTH lenders AND individual homeowners. This is greed that put former and later into this situation, and it is fundamentally wrong to use somebody's taxes to pay for somebody else's greedy mistakes.
If my personal finances are looking wobbly, I look to see where the money is haemhorraging and try to plug that first. Might that not work for a national economy too? Do we think it's conceivable that the US Government is spending taxpayers' money rashly, anywhere in the world? Perish the thought!
Seriously though, even from the outside, this one's looking bad and the ripples are already washing other shores.
Hi Misha and Paraglider,
Yes it seems wrong and wrong-headed at the same time. Maybe someone who likes the bill can post an explanation of why its a good idea. I would read that carefully, I really would, because I've been reading and reading about this and I still don't understand how it can work. Most of the explanations I've read so far count on it working by not having to use it (at least the Fannie and Freddie part) and just restoring confidence in the market. But the thing is, now we have this in place, this was to push the debt to 9 trillion if we have to. It seems crazy to me.
More great work,pg. A friend of mine called the government's behavior "privatizing profit and socializing loss" and I think that kind of sums it up. Very foolish in the long run. Just prolongs the agony. Notice that the the CEO's of Fannie and Freddie make 12 and 13 million respectively--good pay for running things into the ditch, dontha think?
Right you are, Wall Street got drunk and Washington is the big enabler while we the people are going to pay the ultimate price. Sobering up is not going to be a pretty picture--but it's gonna happen one way or another.
I agree, Roberta. I think Wall Street might feel better for awhile and then things will begin to get ugly again. I think it's telling that the motivating factor in the rescue was Fannie and Freddie's fall in stock prices. If you and I can't afford gas or heat or food so what? But if Wall Street starts to lose money, oh no. Can't have that.
Hey, I enjoy reading the Truth, great article. I hate to have to grasp this reality, but the hole in the ship seems to big to plug.
Realistic hub. However, I don't think that the actions of those in control of the government are insane - - actually, the objective is to tape and rubber band government's actions together until those people can make graceful exits with taxpayer-paid pensions intact.
Also, that comment that Robie noted, "privatizing profit and socializing loss" is not wholly accurate. As you undoubtedly know, any capital gains are taxed and any losses over a kilobuck are not deductable. That sounds like "socializing gains and privatizing losses". But then, if you are too big to fail, then the policy is reversable.
On another site, there was a comment that congressional approval was 9% but 95% of the congresspeople will be relected - - WHY?! The reason is that we "got'ta vote"! To paraphrase Marx, "Voting is the opiant of those who think that they can make a difference".
Thanks Bud for the astute observations. I do think there was a healthy dose of self-interest in the Congressional vote. I also think they are scared. I honestly think no one really knows what to do, and then when you combine that confusion with political expedience and self-interest this is what we get. It's a little scary.
My wife and I were responsible and waited knowing that we couldn't afford a house. We just bought a small well priced house last year. Now everyone that was irresponsible racking up credit card debt, buying big cars and huge houses they couldn't afford get to be bailed out. How are we supposed to teach responsibility to our kids when our government bails out all of the irresponsible people. Our consumer driven society will eventually givce us more debt than we can handle. I guess the governmet thinks it can just write IOU's. Last night on the news it mentioned how the governmet gives huge loans to foreign companies and fortune 500 companies while small businesses that we should be helping get denied. I am starting to regret not buying a mansion and getting a clean slate when the government decides to foot the bill.
Hi Jim, I know what you mean. Being a responsible person you probably wouldn't be able to stand the stress of overspending though, it would drive you nuts. It's going to be painful at some point, all this shuffling the debt around. It can't go on forever. Thanks for your comments and congrats on your new house!
Hi, I have a radical solution to the housing problem. Why can't we get our legislators to pass a temporary ban on foreclosures, except for the cases where the homeowners cannot make their original payment amount. Not only that but the homeowner should be obligated to keep and pay for that home; except in certain circumstances, moving for employment etc. Any shortfall in the payment of the original interest rate should be added on to the back end of the loan.
That's far from a complete discription of the plan I have in mind. Obviously it would take many pages to even outline a complete plan and a far better brain than mine. It just seems to me that the fault for all these forclosures is wide spread. Not just the lenders, not just the borrowers or the loan officers or the Feds rapid rise in interest rates, which is the breeze that started this house of cards to start collapsing. What is needed is a plan that would make those responsible pay for getting the economy out of the mess they've gotten it into.
I do not understand why anyone is surprised by what has happened. It was obvious this was in the cards for several years. I was just getting into real estate when the big price increases started. I kept asking people, what happens when prices stop going up and start to come down. Noone wanted to talk about that and I wasn't very popular when I brought it up either. By the way none of my clients have gotten into trouble with their loans as far a I know.
Lenders wanted the loans so they could make lots of money on the interest. They don't want to keep these current loans because they have some way to make their company look better on paper if they take them back and because they want to make new loans. Most of the interest is made and paid in the first two years.
Buyers wanted the homes at any cost. They saw people making double the price of the home within a year or two and wanted in on the action. Many lied about their ability to pay to get them. Lenders didn't require they prove it. Well they got them. Let them keep them and let them keep paying for them.
In the end the lenders will still be making money if not as much as they wish. The home owners will still have their homes and eventually the home will regain it's value all be it over many years. It's not that things can't be worked out. It's that noone wants to work it out. So, make them.
Hi Lynn,
Interesting idea. I don't see why it couldn't work in a lot of cases. The problem is no one is compelling the lenders to do anything. I find this unconscionable. That's how the problem got started in the first place--lenders doing insane things without anyone stopping them. If Congress could grow a spine that would help, but in an election year don't hold your breath. Bush would only veto anything the finance industry didn't like anyway. Hopefully the next President and the next Congress can make some hard decisions and clean this up, but who knows how bad things will be by then.
Thanks for your thoughts.
Congress grow a spine? Yea, that is the one gigantic snag in the plan isn't it. How can we make them. Write your congressman or congresswoman. Sometimes it actually works.
My husband always jokes that congress is the opposite of progress. How nice of them to not prove him wrong.
Hi RGraf--What is really astonishing is that even now, after spending almost half of the $700 billion rescue package, the problem of homeowners losing their homes and the downward spiral in home values caused by foreclosures has not been addressed. No, they're just throwing more money at the top. I think your husband is right. It's really crazy.
Rob Jundt says:
17 months ago
Wow! It's a privilege to be the first to comment here. You're so spot on it's scary. Scary in the fact that you're right. Home prices continue to fall, foreclosures seem to escalate every month, and many credit worthy buyers are being handed not now cards. I make my living, albeit not a good one right now, in the housing industry. As of last month, there was a 73%, yes a 73% DROP in new housing permits from a year ago. And 2007 was a BAD year. Thank goodness I still have some credibility in this market and can obtain other employment if needed. But good gracious, these money hounds who got us into this mess by selling loans to gophers and squirrels with no credit, should be allowed to fail no matter what the fallout. So much for accountablility where it counts. You have done great justice to this topic. Excellent.