By Ramsey Su
Did you hear that B&G Mortgage (Bernanke and Geithner Mortgage) is offering a new option ARM loan program? The interest rate is zero and repayment is optional. Other terms will be decided later.
Government intervention has been off the charts since the bursting of the real estate bubble and they are still not done. This week, Obama is expected to announce his new and improved grand plans. Pertaining to real estate, the trial balloons of the past few weeks have been confirmed in detail in a speech by Federal Reserve governor Elizabeth Duke – Rebalancing the Housing Market.
If you are unfamiliar with these proposals, you may need to glance through the speech to know what I am talking about below.
This is the key sentence of her speech, in the second paragraph:
So, in crafting appropriate policy responses, an important starting point is to carefully analyze what we're solving for.
Policy makers should indeed give that problem some thought. What are they trying to accomplish? Each new round of policies has proven to be more destructive than the one before it, and this upcoming round won't be an exception.
There are two parts to the new plan:
Refinancing of underwater mortgages at lower rates and converting REO's (1) into rentals. I can summarize the plan in one sentence: Let's throw money at it.
That is the plan.
The money is going to come from B&G Mortgage (see the previous post about Bernanke and Geithner Mortgage). Mr. G. is going to create all the junk mortgages, while Mr. B. will be buying them all up.
This will not work. I can explain in detail why it will not work. I can also propose ideas on what will work. In the end, it probably doesn't matter. I have no ability to alter or influence decisions that have already been made. So it is far more pragmatic to analyze the potential outcome of these policies.
The deterioration of a piece of property starts on the day when a borrower decides to stop making payments. At that moment, all incentive to improve and maintain the property is gone. This cycle ends when the property is sold and the delinquent borrower is removed.
REO's as such are not sold at distressed prices. They are sold at prices that reflect the distressed conditions, which may be physical, legal, or reflect obsolescence. It is unreasonable to expect a property in neglected condition to sell for the same price as one that shows pride of ownership.
The longer a piece of property stays in this cycle of deterioration, the more severe the damage it will inflict on the market. That is the primary mistake of all government interventions to date. The focus needs to be on how to shorten this deterioration period instead of prolonging it.
The new plan is going to do more prolonging. Just like with HAMP (2), there are going to be long delays just because of the logistics. Giveaway criteria have to be formulated, followed by months, maybe even years of screening for eligibility. There will be mass confusion and fraud. Every borrower is going to want a lower mortgage rate, including me. Every borrower who's under water is going to re-evaluate his position given the new choices. Would it be better to continue paying if mortgage rates are lowered? Maybe defaulting is the correct move, and then renting back the house at an even lower cost?
Servicers will once again have to process millions of applications with minimal financial incentives. They won't be told what is right, but they will bear the blame for anything that goes wrong.
Lenders who were reluctant to lend before will be even more reluctant now. They will be originating agency (3) conforming loans with even more scrutiny, just to be certain that they cannot be put back to them due to some technicalities.
How is any of this good for the real estate market? Properties that should be sold will remain in the possession of those who are already receiving, or are expecting to receive a government subsidy.
This is also the first time that government intervention is moving into the rental market. Who is going to be buying the agency REOs and what conditions are going to be imposed on the buyers? I can easily see these properties being sold at unreasonably favorable terms to quasi non-profit entities, which will rent them out without any economic considerations. Could we see 'eviction intervention' similar to 'foreclosure intervention'? Why would borrowers that have not made a mortgage payment in years be interested in paying rent? Isn't free housing a right?
The free market has offered the perfect solution. There are plenty of buyers in every metro area to gobble up REOs, especially the type of properties the agencies have in their portfolios. There are owner-users, flippers and investors who will fix up the properties and put them on the rental market. These are the perfect buyers who will pay top retail price and return the properties to their highest valued and best use. But that would of course be too simple for the government.
I can also see a repeat of the RTC (4) era, when properties were pooled and sold in bulk to those with the best political connections and influence, at unbelievable bargain basement prices. In the current era, I would e.g. closely watch the Wilbur Ross Company, which has James Lockhart as its vice chairman, who once was director of the FHFA (5) (by the way, this is not meant to insinuate that they have done anything improper. Just saying, people with the necessary influence have already found their way into the private sector and this is a pertinent example).
Unrelated to the upcoming grand plans of Obama, the agencies filed suit against 17 major banks over the losses incurred in the MBS (6) sold to them. The timing is unfortunate, but the statute of limitations is supposedly about to expire. These same banks are already facing civil suits from investors and possibly criminal charges by the Attorney Generals for their role in the robo-signing scandal. These are ironically the very same banks that the government is accusing of not making enough loans. These are also the same banks that the government forced free TARP (7) loans upon, because they were/are considered 'too big to fail.'
Policy makers are playing with fire. Yes, the banks deserve to be punished, and so do the rating agencies and above all, so does Alan Greenspan, for their respective roles in the fiasco. However, for the sake of the country, we need to stabilize the real estate market first and apportion blame later.
If there was ever a time for a uniform approach to mortgage lending, the secondary market and recourse, that time is now. The market needs clarity and stability. Lenders need some safe harbor guidelines. Investors need to know their rights. Buy/sell decisions need to be based on free market principles instead of anticipation of the next government intervention.
What lies ahead? We know there can be no demand improvement without a rise in employment. At the moment, employment is heading down. Do not look to home construction to stimulate employment. There is vast excess supply. Any stimulus in that arena would only serve to exacerbate the supply problem. There are nothing but dark clouds ahead. All my previous real estate opinions have in fact proven to be overly optimistic. Investing is a war between greed and fear. In the real estate market, from my personal viewpoint, fear is today winning the battle.
(1) REO = real estate owned – involuntarily, by banks after foreclosure, ed.
(2)HAMP = 'Home Affordable Modification Program' [sic, ed.]
(3) agencies = the GSE's (government sponsored enterprises), Fannie Mae, Freddie Mac and Ginnie Mae
(4) RTC = Resolution Trust Corporation – the entity that administered properties after the savings and loans bust-up in the early 1990's, ed.
(5) FHFA = Federal Housing Finance Agency; Lockhart was appointed its director after the GSE's went into 'curatorship', ed.
(6) MBS = mortgage backed securities, ed.
(7) TARP = 'Troubled Asset Relief Program'