The Upcoming Financial Quagmire

By Pejman Yousefzadeh Posted in | Comments (6) / Email this page » / Leave a comment »

Regulation of the mortgage industry has suddenly become the cause du jour among the political class. Consider, for example, this article, which discusses Hillary Clinton's fire and brimstone condemnation of the mortgage industry and her solution to the subprime crisis:

Clinton repeated her call for a voluntary agreement that would call for a moratorium of at least 90 days on foreclosures of subprime, owner-occupied homes; a freeze on the monthly rate on subprime adjustable rate mortgages, with the freeze lasting at least five years or until the mortgages have been converted into affordable, fixed-rate loans; and an agreement by the industry to provide status reports on the number of mortgages it is modifying.

"If we cannot reach a voluntary agreement [with Wall Street], I will consider legislation to address the problem," she says in her text. "Mortgage servicers can work with borrowers to modify their mortgages. In the process, they can save families their homes, save investors from losses down the road, and help the economy. ... So I am prepared to consider giving legal protection to servicers and others who administer these loans and who do the right thing by balancing the interests of the homeowners, the investors, and our economy."

Read on . . .

Of course, the Bush Administration has gotten into the act as well:

The White House is working on a plan to freeze interest rates on certain subprime home loans, though it faces significant hurdles that could derail its implementation, according to industry executives and others familiar with the situation.

The plan, being discussed by the Treasury department and other regulators, along with mortgage lenders, servicers and investors, is des­igned to forestall a potential crisis when introductory "teaser" rates on nearly $400bn (€272bn, £194bn) of high-risk subprime loans reset higher over the next year.

Under broad terms of the plan being pushed by Hank Paulson, the Treasury secretary, lower interest rates would be frozen for borrowers who met certain criteria, including the condition that they could not afford higher rates but might avoid default if they kept their current rates. This group is likely to include people who have missed one or two ­payments.

The plan would exclude those able to keep making payments at higher rates and perhaps those unable to keep up even if their rates were frozen. However, no final details have been set.

The White House said on Friday it was "premature" to discuss details of the plan. Jennifer Zuccarelli, a Treasury department spokeswoman, said there was broad agreement to come up with a more standardised approach to helping homeowners. Mr Paulson has discussed the plan publicly in recent days but offered few details.

Ah, but there are problems. Let us call the following the "Distorting The Market Is A Bad Idea--Example # 274,916,583" portion of this blog post:

Industry executives, market participants and several analysts said implementing any plan would be complicated and riddled with technical and political problems, including possibly encouraging otherwise stable borrowers to miss payments. "If you are a borrower in the group that gets left behind by this scheme, you have a set of perverse incentives to default in order to get the break. It has moral hazard written all over it," said Don Brownstein, chief executive of Structured Portfolio Management, a hedge fund.

Several mortgage experts also said categorising borrowers would be difficult, given that their financial information might never have been collected before. Also, a large percentage of adjustable rate subprime loans have already been sold to investors who would have to accept lower payments as part of the plan.

Pretty worrisome, eh? It gets worse:

There could also be political backlash if any final plan did not help the most strapped borrowers. Any plan that did not include such help could face opposition from prominent Democrats including Barney Frank, a representative from Massachusetts, and Charles Schumer, a senator from New York.

In a statement on Friday, Mr Schumer said: "This is the first time that the Bush administration is working towards a solution that meets the magnitude of the problem. But there is a $64,000 question: will investors go along with this plan? And if not, can they be compelled to?"

Read that last quote again. As my RedState colleague, Jeff Emanuel, pointed out, "compelling" investors to go along with a particular financial solution is indicative of an entirely misguided mindset. And yet, it is a mindset that is particular to one side of the partisan divide.

I do not lack sympathy for those who are under pressure thanks to the subprime crisis. Far from it. These people should talk to their lenders, many of whom are eager to help them with a solution. But the proposed bailout plans on both sides of the aisle have a whole host of problems attendant to them and market distortions are no way to address the subprime crisis. Quite the contrary--they would only serve to make a bad situation far, far worse. Indeed, Stephen Green helps explain further why the Administration's approach could be such a bad idea.

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The Upcoming Financial Quagmire 6 Comments (0 topical, 6 editorial, 0 hidden) Post a comment »

Where is Ross Perot when you need him? Say what you want about Ross Perot, that guy single-handedly quadrupled the average voter's understanding of the economy. His little half-hour infomercials about the federal deficit were watched by millions of people, and they led to the amazing result that even tax-and-spend Republicans like Mike Huckabee [oh, you didn't -- ed.] have to at least pay lip service to fiscal discipline these days. Before Perot, warnings about "deficit spending" fell on deaf ears because few had the slightest idea what it meant, except that Republicans were meanies who wouldn't spend money to help the poor.

Politicians on both sides of the aisle are jumping on this because they know that most Americans haven't the slightest idea why the government shouldn't set all prices. Nothing in the average American's education would shine any light on this subject.

I'll bet Fred could do some bang-up infomercials on the economy that would rival anything Perot did. He should.

Drink Good Coffee. You can sleep when you're dead.

- especially when the "cure" is prescribed by the federal government, an entity which can barely account for what happens to the $3 trillion it extracts from the economy each year.

The market has a very efficient method of punishing those publicly-traded companies who behave recklessly. The resulting loss of equity often results in undervaluation of the companies in question, making them attractive targets for acquisition by firms with better management. The result is a more efficient and profitable industry in the long term, even if there is some short term pain.

All of the suggested "remedies" punish the lenders while bending over backwards to insulate the borrowers from any consequences when it is THEY who have defaulted upon their contractual obligations. It makes no economic sense whatever, and can only prolong the problem and make it worse.

So if I read this correctly:

The Federal Govt is proposing to abrogate mutually agreed upon, legal private contracts between private corporations and private citizens.

The Federal Govt is proposing compulsatroy compliance by private financial intitutions to transfer wealth to private citizens for no other reason than fear of prosecution.

The Federal Govt is proposing subsidizing the financial malfeasence of the mortgage brokers (don't ask/don't tell suicide mortgages) and the financial incompetance of the borrowers who believe in free lunches.

The Ferderal Govt is proposing to monumentally alter the free capital markets in order to allow people who should never have qualified for a home the couldn't afford, to remain in the house for some indefinate period of time. But it won't too long, because the reason they had to qualify for a subprime loan is a lack of financial planning ability and resources. The first economic downturn and there will be a watershed of foreclosures (why not? they have nothing invested anyway - a house valued at $400,000 with a $500,000 mortgage and no downpayment. See ya.)

When some number of mortgage 'victims' make the case that they can't afford even the new payment, Schumer et.al. will have the Federal Govt devise a program where the taxpayer will subsidize those who can not afford to continue to live in thier $500,000 homes any longer.

If we go down this road, I expect that the average taxpayer will blow a cork. Yeah, the one struggling to live within thier means, in thier $150,000 home, paying off the credit cards and saving for college and retirement. The party that pushes this fiasco through will have utter hell to pay.

I have little confidence the R's will see this.

Whether it's the market for education, prescription drugs, the steel industry, W et al. repeatedly insert the government into areas in which it has no business. I can hardly wait until January 2009.

Amen FreeSooner,

W ain't a conservative. From his exercise in nation building in Iraq, his warrantless spying on Americans, No child, Gay Marriage Amendment...it's all well meaning, but it's also all about a MORE intrusive federal government. Don't even get me started on the spending that he and the "Republican" Congress of 2000-2006 got into...

The free market has been dead since at least FDR, and the financial industry is the most governmentally co-entangled of them all. I guess you and many of the other posters here so far haven't been following blackhedd's columns. This is a multi-faceted problem caused by the failure (absence?) of the market pricing mechanism. In a very real sense the risk of the loans was severed from the profit for the loans by selling the loans to clearinghouses that bundled the loans and sold them as low-risk securities. The assessment of the risk was assumed to be the same as for the broad mortgage market itself despite the fact that the bundles weren't necessarily broad market slices. It was exacerbated by lenders who were making money cutting corners on their risk assessments for loans, because after they made the loan it was going to be resold. It worked so long as rates were low or trending lower because you could borrow short for cheap to cover the long. And the government writes the regulations on all of this. And as soon as rates went up instead of down, everything went BOOM!

All of which wouldn't matter if only the bad loans were going to get flushed and the only people who were going to be affected were the fools who made the bad decisions in the first place. But along the way, the foolish got co-mingled with the prudent, and now we are all substantially at risk. The collapse of the subprime market could trigger a collapse of the larger mortgage market (it already has slowed it), which in turn will cause problems for the larger credit markets. And since all business today is in some way based on credit, it is the whole economy that is at risk because of a few well placed idiots.

The way out is to provide the lenders with a mechanism by which they can extend the low rates to customers who are paying on time but won't be able to if the rates go up. Those who can't pay anyway need to be flushed through the system. The catch is that in order for the people who are getting paid to stay solvent, they need to be able to boost the payments of those who can pay the higher rates. But that does introduce the economic incentive to make the bad moral choice. If we could count on it being only temporary, I think the best answer would be tax credits for organizations that extend the lower rates for no more than 5 years so the people who could afford the higher rate don't have a dilemma. The non-payers still need to be flushed. Five years should be sufficient time for lenders to plan for a transition, and it might be enough so that everyone can afford the higher rates when they do reset. The problem of course is that none of these programs ever seem to be temporary.

 
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