56 Car Economic Pile-Up

I'm not that smart a guy. I got a lot of Cs in school. And I am having a hard time digesting how it came to be that my qualifications for drafting a recovery plan seem superior to the pundits actually doing so.

In my Seeking Alpha article posted on 12/8/08, I cast a negative outlook on Consumer Discretionary Spending XLY (down 16% since), and the broader markets, namely IYY (down 22%), and SPY (down 23.5%). And I talked serious smack about the banking sector and its shady Level III asset problem, suggesting SKF as a bearish hedge (up 99% since).

Maybe my economics professors should have given me more credit for tending to oversimplify all those confusing variables.

More of a real estate professional than a stock market enthusiast, I wish there was a pure residential real estate play to short. But until banks go government and the market capitulates in earnest, SRS will do, since I suspect commercial real estate will follow suit with Housing Doom Part Deux.

Of the myriad facets within our insipid bailout program, the least effective subset is that of the loan modification. I say “is” and not “has to be” because its failure is already evident… we just have too much political inertia to change course. Be advised, however, there is a huge distinction between “loan refinances” and “loan modifications”.

Refinances are for folks who can:

• truly afford the new terms, AND…

• pony up good credit worth defending.

This is where we should be subsidizing rates down to 2% and terms out to 40 years. This is where our government can make a difference.

While this move temporarily eliminates any revenue I could personally derive from executing refinances as a real estate broker, I’m all about separating commission from advice. And while banks are giving free money away, the best advice I can give anyone who will listen is to help bring this proactive servicer-to-consumer model mainstream.

Modifications on the other hand, are for people who have already missed their payments, and this reactive model is doomed before it starts. While it may be warranted to extend true victims a revised 40-year-fixed-principal-and-interest payment… unless the propensity to repay can be demonstrated with a clean credit history, then like the Seinfeld sandwich guy would say…”no principal or rate reduction for you!”

Then there is the group of people who everyone loves to blame… the “entitlement crowd”. Now personally, I don’t blame people too much for feeling entitled, because if you extend an undeserved benefit to an otherwise hardworking person and then take that benefit away, of course they are going to get salty.

Nor, by the way, do I blame investors for getting fat while underwriting these loans in the first place. Who really is so naïve as to think that incentives for the common good will match up to incentives for individual gain anyway?

But I do blame in advance, the pundits being pressured to “do something” who will pave a new lane on this freeway and then act surprised when it gets jammed with more traffic.

Here is the point: the entitlement crowd could not afford the old payment… and they cannot afford the new payment… and even if they could afford the new payment, they will not be able to afford it the first chance they get.

Am I being ruthless? You bet I am. Because while my income last year sank to 20% of the previous year (that’s 20% of… not 20% off)… I still pay my bills. And now I get to pay more tax on the meager income I do make to repay the mess the entitlement crowd made. You know why? Because I still have a credit profile to defend.

If we offer loan modifications to people who have already destroyed their credit, thereby killing the integrity of the fundamental method by which we measure credit worthiness, then we not only reward the people who are undeserving… but we also provide an unprecedented incentive for well intentioned consumers to just stop carrying their burdens.

Well I guess not unprecedented, if we count healthcare… but I digress.

If I tell you that 50% of all loan modifications previously executed... are already in default... would you believe me? What if I tell you this statistic is four months old!!

Once the credit is damaged there is NO INCENTIVE to make payments on a depreciating asset while the opportunity cost of renting is cheaper. If values continue to decrease (and they will) then the modificationee will do the wrong thing... again. Because that is what they do.

If it were so simple to fix things this way, then how about the next time there is a traffic jam on the freeway, we all just hit the gas at the same time? Are you going to trust the car in front of you?

Disclosure: Author holds a long position in SRS

Comments

[Lok Sang Ho:]

Your point about moral hazard is well taken. That is why I would proposed a price support program, which will give incentives to people to honor their obligations. I prefer to let those who have missed their payments go the default route, implying foreclosures, or the reselling to the government route(at the appraised market price as of today; see my earlier articles in Seeking Alpha), with any negative balance either as a write off should they declare bankruptcy or as a payable to be taken care over the longer term. I would let the government rent out units to former homeowners at market prices.

Mar 11 09:14 AM

[po folks:]

The entitlement crowd stands accused, but also remember there were plenty of liar's loans, where the borrower got away with inserting an extra zero to the left of the decimal point in his/her income. Just take it easy on bashing the less fortunate (until after the facts are all revealed, at least). Good article, though.

Mar 11 10:31 AM

[pitchingpen...:]

So Seth,
You're close to ground zero of the confligration being in North County. And, I'm sure you have come in contact with people through your business who might fall into the category you mention in your following point; you or your kindred may have even put them into a mortgage on the property they are now wrestling with.
"Here is the point: the entitlement crowd could not afford the old payment… and they cannot afford the new payment… and even if they could afford the new payment, they will not be able to afford it the first chance they get".

"Am I being ruthless? You bet I am. Because while my income last year sank to 20% of the previous year (that’s 20% of… not 20% off)… I still pay my bills. And now I get to pay more tax on the meager income I do make to repay the mess the entitlement crowd made. You know why? Because I still have a credit profile to defend".
Yes, I'm thinking a little too ruthless. I really think the majority of borrowers that were scamming, flipping, and unsustainably speculating for profit, etc., are already out of the system - their properties have already been foreclosed upon.

I believe those still struggling with their situation are folks who are experiencing the economic fallout of the normal reasons for falling into foreclosure (death, illness, divorce, job loss, income loss. Add to that the ongoing economic deterioation and that effect on small business income (That was a 20% of prior years income for you, right?)and not everyone perhaps planned as well as you for the economy to "Fall of a cliff" as that guy in Omaha described our situation.

"If we offer loan modifications to people who have already destroyed their credit, thereby killing the integrity of the fundamental method by which we measure credit worthiness, then we not only reward the people who are undeserving…"

Those you describe above do seem like the target population that the Financial Stability program is meant to serve with the refinance/modification opportunity, but you stiil need to ease up on the value judgment. It seems we always go back to "blaming the animal for getting caught in the trap". I know there are folks who lenders call the "Chronics", some will make it with some help, not redefault, others will not.

"but we also provide an unprecedented incentive for well intentioned consumers to just stop carrying their burdens".

I think the point you make above is where the real "next big surprise" is waiting. As unemployment and the destruction of small business continues to mount, the economic hardship is moving up the socio-economic ladder. I believe there are a vast number of "successful" folks, who are current on their mortgages and other bills, who are thinking thoughts that many have not thought for 20 or 25 years. Such as: My house is 25%-50% under water. My income is way down, or maybe I've lost my job. I can keep paying if I raid my 401K. Or maybe, they still have their income and can afford the payments, it doesn't matter.

They are thinking thoughts about rational default, and their numbers are legion. Your philosophic arguments matter not. The majority of these folks are NOT "irresposible borrowers". In fact, when it comes right down to nut cutting time, when its time to choose who they are really responsible to, if they weigh keeping what's left of their stack vs. the credit hit, they will choose to be responsible to their families, and not to the lenders.

It's just business decision.

Who’s left out of the new Financial Stability and Relief plan?

In a nutshell,investors and speculators (mostly gone now). Those with jumbo mortgages. Those who can’t document their incomes. Those who owe so much more than their houses are worth (over 105%, good luck with that in North County) that a lender would do better by foreclosing. NO SOUP FOR YOU!!!

Mar 11 12:51 PM

[Seth Chalnick:]

Thanks a lot for reading my article and also for your greatly valued feedback. Lock Sang Ho, you make some good points and I look forward to reviewing your articles.

75792 and Pitching Pennies, in my ambition to make the article readable, I perhaps overlooked making the salient points sufficiently clear. Namely, I am going out of my way to not blame the entitlement crowd, or anyone else for that matter… but not placing blame about their decisions, and being ruthless about not catering to their bad decision making are two different things.

Yes, I am ruthless about not throwing good money after bad. Doing so would be fruitless, irresponsible, and stupid. But let's not overlook how greatly in favor I call for lenders to cut their losses and share in the responsibility for allowing the individual incentives of their operators to override the incentives of their industry. I just want it to be done in a way that will stop the hemorrhaging rather than add more bullet holes.

Another review of my article will show that I am not bashing the less fortunate, but rather pointing out the obvious. I do not blame anyone for doing what they thought was right at the time. But I do not feel sorry for folks who didn’t “buy” anything, but instead, merely speculated. And while Pitching Pennies makes some excellent points about innocent hard-working families getting swept up in this firestorm… I respectfully submit how the idea that most speculators are out of the market, is patently false.

On the contrary the majority of the speculators are about to be shown for what they were. The “successful” people referenced, only further highlights the myth that socio-demographic reasons were at play. The folks with sup-prime loans got hit first because they had shorter term rate re-set periods associated with their loans. If we lived in a gentler, kinder universe that offered 7yr fixed to people who could use a break then the “successful” people with their 5yr loans would have been the first to crack.

We have an over-leveraging fallout problem based on math and bad fundamentals… we do nott have a problem with a class of lazy people bringing down our financial universe.

Only the smallest percentage of these “successful” folks’ loans have even begun to re-set yet. When they do, we will begin to see the financial storm come in earnest.

This is why I draw a huge distinction between modifications and refinances as they relate to TARP. I am all for the refinancing or modifying or transferring-of-wealth or extortion or socialism or whatever you want to call it… as long as we’re focusing on helping folks who still have their credit to protect. If something is wrong with the system, then let’s fix the system, but not by rewarding folks who don’t operate within the rules of the system.

Mar 11 01:41 PM

[Jade Queen:]

I agree with Wakeup. If paper had not been sold away from collateral, it would be quicker and more efficient to figure out what is going on. Fannie and Freddie were bad ideas whose time never should have come.

Mar 11 05:21 PM

[User 375281:]

Good article. Interesting how whenever someone is "brutally objective", there are always those who will by knee jerk response, need to instinctively defend the "less fortunate". The fact of the matter is that the less fortunate among us (here in the good ole USA , anyway) have benefited tremendously from the success of the hard working individuals and INSTITUTIONS in our economy. You must first and foremost protect and enable those very people and institutions that have allowed so much wealth and increased living standards to be provided to those less fortunate. My fear is that we are at a tipping point where the "less fortunate" are job #1, and that will not work for anyone for very long!
I will make the point that a great deal of the current pain and destruction of wealth is the direct result of trying to extend "benefits" (in the way of money... loans...to people who just flat out didn't deserve those loans)............Soci... engineering VS. sound business practices that have stood the test of time and done this country and its people great service for generations.
You might liken the situation to a lifeboat trying to take too many people aboard to "save" them from drowning. At some point, if the Captain of that lifeboat tries to save one more drowning person, the entire lifeboat and all of it's occupants will be lost to that fate of drowning............So... has to be the "bad guy" in this scenario, but in fact he is the true hero that knows that if he overextends the capacity of that boat he puts all at risk.

Mar 12 02:48 PM

[po folks:]

Agree with user 375281 that NOBODY but qualified borrowers should get mortgages in future. This means everybody! It's already happening. A buddy of mine that works at a bank tells me a 750 credit rating now is only considered an average risk.

This helps restore things in the long term, but unfortunately, makes it hard for the US consumer to spend, and we do have this little recession continuing to deepen. (Strong medicine, but really the only legitimate way out. So, no tears from me over that, either.)

My earlier comment about the less fortunate concerns only the past. The actual amounts involved in each type of default are still very opaque, and we all very badly need to know. I have not seen any facts that substantiate this crisis was ALL the fault of the subprime mortgage defaults, so I suggest we don't point the finger until it is time. The bad practice of lending to unqualified borrowers should never be restarted going forward.

Finally, all will be revealed someday, if crooked originators, securities bundlers, "loan liars", and the plain gullible people are given an opportunity to explain themselves... in front of a judge. Many types of fraud played a role in causing this damage, and it must not happen again.

Mar 12 06:44 PM