Foreclosures and bailouts
December 22nd, 2007, 12:01 am · 7 Comments · posted by Mathew Padilla, Reporter
Are federal politicos on the right track with their steps to combat rising foreclosures?
To shed some light on that question, I quizzed Kurt Eggert, a law professor at Chapman University in Orange whose three-year term as a member of the Federal Reserve Board’s Consumer Advisory Council is just ending.
The Federal Reserve has proposed new rules on higher cost loans, including limitations on prepayment penalties and allowing borrowers to state their income without providing proof.
Meanwhile, President Bush and Treasury Secretary Henry Paulson have backed a plan with some loan servicers and investors in securities backed by mortgages to extend teaser rates on some subprime adjustable loans for five years.
By the way, I hope everyone enjoys the interview, since Eggert will become an occasional guest blogger.
Q. Many readers of this blog hate the idea of any government intervention in the mortgage mess. From their comments, I deduce they see intervention as A. anti-capitalist and B. they see house prices as overblown and they believe the market needs to correct itself to bring affordability back within reason. Your response?
A. Whether intervention is “anti-capitalist” completely depends on the form of the intervention. For example, the Bush/Paulson loan modification proposal is completely voluntary, both in whether servicers follow the program and in what modifications they give borrowers. Those of your readers who prefer unfettered capitalism should embrace this plan, since it has no fetters attached. Servicers would be modifying loans only if it makes sense for the investors who bought into those loans. By doing the loan mods in bulk, they would be able to do them more cheaply.
Because it is voluntary and there is no way to measure or monitor whether it is working, the Bush/Paulson plan also will likely have a smaller effect than some might hope. It’s impact on housing prices will be, I think, limited. Unfortunately, a lot of homeowners are going to lose their homes to foreclosure. And remember, foreclosure has more effects than just driving down housing prices. It can also drive down neighborhoods. A neighborhood with a lot of foreclosures becomes a less attractive place to live.
Q. Will the plans have the unintended consequence of blocking credit access to some lower-income folks or others with wobbly credit histories?
A. There are two new federal plans out there, the Bush/Paulson loan modification plan to deal with existing loans, and the Federal Reserve Board’s plan to change the rules for new loans going forward.
The Fed proposal should affect whether subprime loans are being offered, but not in the way that you might expect. Before the subprime meltdown this year, underwriting standards had so fallen by the wayside that lenders were making loans to borrowers who could not make the loan payments once the loans reset from an initial teaser rate. Because so many loans were going into default and foreclosure, many investors stopped buying securities backed by subprime loans and lenders couldn’t sell their subprime loans and therefore stopped making so many of them.
It was the lack of regulation and the resulting ridiculously loose underwriting that caused the restriction of credit. If we regulate subprime so that investors know what it is they’re buying, they may come back into the market, start buying securities backed by subprime again, and get the market fully restarted.
Q. Does Bush’s plan do enough to help current borrowers and hopefully avoid a housing-led recession?
A. The Bush/Paulson plan to lock in introductory rates is completely voluntary, and helps only a subset of borrowers. Some estimate that as few as seven percent of subprime borrowers could be helped. While this plan is better than nothing, I do not think it will be enough to head off a recession, if that’s where the foreclosures are leading us.
Q. Again, I have to ask if Bush’s plan is going to do more harm than good by blocking access to credit, say if investors lose even more faith in securities backed by subprime mortgages? And will it prolong what some readers of this blog see as a necessary housing correction?
A. The Bush/Paulson loan modification plan should help investors, because they lose big-time when loans they invest in are foreclosed unnecessarily. The average foreclosure can cost as much as $50,000 or more. Often, it is better for investors to modify the loan and avoid foreclosing. Because many loans are securitized, investors turn over foreclosure and loan modifications to servicers. However, servicers have not been making enough of these modifications, and so a loan modification program that encourages more of them could help investors.
The Fed proposal could also help investors by allowing them to see the value of what they are buying. Before, investors were buying a pig in a poke, with too little idea how many borrowers would default. With more consumer protection in place, investors should have a better idea what they’re buying, and so be more willing to invest in subprime.
December 22nd, 2007 at 9:53 am
Interesting interview. One other angle of the anti-intervention sentiment about mortgage bailouts that wasn’t really mentioned is the fact that, by the government stepping it, it is implicitly promoting the bad/ignorant behavior that led to the necessity of bailouts, while punishing others who either kept saving or took out more responsible loans.
December 22nd, 2007 at 10:50 am
Q. Many readers of this blog hate the idea of any government intervention in the mortgage mess. From their comments, I deduce they see intervention as A. anti-capitalist and B. they see house prices as overblown and they believe the market needs to correct itself to bring affordability back within reason.
And many readers have shorted their house or are repeat speculators looking for cheap investments properties.
December 22nd, 2007 at 4:00 pm
Professor Eggert says several times that the Bush/Paulson plan is completely voluntary. A completely voluntary plan is one where lenders, investors, and borrowers re-negotiate terms on their own. Why is government involved? Other than possible behind-the-scenes arm twisting, one alternative is that government is using its “good offices” to inform or encourage confidence in the exercise conducted among investors, lenders, and borrowers.
Here I think is the rub. Either government is bringing benefits to the table that must be removed from somewhere else (i.e. taxpayer money — I accept that this is not happening currently), or they are conducting a distributional role, helping one of the actors in the transaction at the expense of another. The Bush/Paulson plan is not hurting lenders, or they would not participate. It may be harming investors, who lose some of their returns. It is CERTAINLY harming borrowers. The borrowers who will be “saved” are really being harmed. In most cases, they would be better off defaulting on their loans and buying a cheaper home or renting. Future borrowers will also suffer to the degree that this intervention increases uncertainty about the terms of contracts. Investors are risk averse.
So, “completely voluntary” is a bit of spin. Power relations such as that between government and investors, or informational asymmetries between borrowers and the government make it hard to claim that all are better off in this situation. The government has really become the debt consolidator for foolish banks, unwise investors, and boorish borrowers. This _is_ a reduction in capitalism, since it increases the moral hazard, encouraging everyone to think that they will not be held accountable for irresponsible actions.
Rational expectations
December 22nd, 2007 at 6:55 pm
Ahh, Yes! We are witnessing a real estate version of Holland’s “Black Tulip”
huge price run-up and the resultant burst-bubble disaster. House flippers, other
speculators and just plain overoptimistic home buyers of limited means courted
price levels that were impossible to sustain.
I am always sorry for anyone who loses his/her home for any reason: fire, flood
earthquake, or financial insecurity. But the bitter truth is that the speculators
made a very poor investment decision and will have to suffer the consequences.
The non-speculators who simply took on a lot more debt than they could reasonably afford made an equally poor decision. They have my sympathy but the consequences can only be regarded as unavoidable.
The only good thing to come of this looming fiasco is that real estate lending will be returning to more sane practices. So the guy who can’t afford a house in the first place will have to be a renter until he can afford to buy. And the spec buyers
will more likely find less hospitable behavior from banks and mortgage firms.
So, someday, the real estate market will return to sound values. And, no doubt, a lot of real estate agents will be turning to other pursuits until recovery is achieved.
December 26th, 2007 at 10:18 am
Fed should stay out of subprime melt down. let the market correcting it own overprice real estate sooner the better. Fed will prolong the suprime melt down longer than it need to be. In addition it is not subprime loan resetting that cause borrowers and/or investors cannot afford the mortgage payment. Instead these investors do not see incentive or financial gain in the near future (flip the property) and just walk away from their own mess. Financial institution (mortgage company,banks & etc) and investors(flippers) are in the financial gain when the market is up. When the market is down they want us to bail them out which is so unreal. What happen to Lassez fair financial policy.
December 31st, 2007 at 11:24 am
Harvey Tepfer wrote:
Harvey, I wish I could believe your words. I doubt seriously that this will happen. More serious regulation is in order and I just do not see it. Best FOMC regulations have done thus far is 95% loans vs. 100% loans. I believe we will continue to see 120% loans and loans. There is nothing stopping high risk investors to get back in the game. NOTHING!
As for the realtors: in my area have removed list dates and change dates on all listings in the MLS. NAR is paying for foolish commercials encouraging people to buy homes now or the opportunity will never come again. BS really. Hopefully there are not as many foolish buyers that buy into this BS. Hopefully, this mess will result in buyers becoming aware that there are many other options to purchasing a home than using a Realtor. I would like to see some laws protecting a buyer and seller from the shenanigans of the person who is supposed to be protecting them. The next home I purchase will be handled via a real estate attorney. Escrow companies are not objective third parties and the realtors on both sides and loan agents on the loan all “talk.” Deals are pushed through. The three parties mentioned all take advantage of the “emotional” nature of the home and a less than educated buyer will ALWAYS be screwed.
rational expectations is COMPLETELY RIGHT!
It is CERTAINLY harming borrowers….
I completely agree. There is nothing stopping these people from “walking away,” if not the former the latter should be phrased “taking the bait.”
WALK AWAY, REBUILD, and comeout the wiser.