Is it the Taxpayer's Job to Bail Out the Banks?

Bernanke is asking taxpayers to bail out banks. In a rehash of already failed ideas, plus one new one, let's tune into Bernanake's speech on Reducing Preventable Mortgage Foreclosures.

Over the past year and a half, mortgage delinquencies have increased sharply, especially among riskier loans. This development has triggered a substantial and broad-based reassessment of risk in financial markets, and it has exacerbated the contraction in the housing sector. In my remarks today, I will discuss the causes of the distress in the mortgage sector and then turn to the key question of what can be done in this environment to reduce preventable foreclosures.

The recent surge in delinquencies in subprime ARMs is closely linked to the fact that
many of these borrowers have little or no equity in their homes. For example, data collected under the Home Mortgage Disclosure Act suggest that nearly 40 percent of higher-priced home-purchase loans in 2006 involved a second mortgage (or "piggyback") loan. Other data show that more than 40 percent of the subprime loans in the 2006 vintage had combined loan-to-value ratios in excess of 90 percent, a considerably higher share than earlier in the decade.3 Often, in recent mortgage vintages, small down payments were combined with other risk factors, such as a lack of documentation of sufficient income to make the required loan payments.

This weak underwriting might not have produced widespread payment problems had house prices continued to rise at the rapid pace seen earlier in the decade.

My Comment: Bernanke is essentially saying there would be no problems if we did not have any problems. The trend of ever rising home prices was standard deviations above both wages and rent. Had the prices of houses continued to rise, there simply would have been a bigger problem down the road. The only real solution is to allow home prices drop to levels that are affordable.

Delinquencies and foreclosures likely will continue to rise for a while longer, for several reasons. First, supply-demand imbalances in many housing markets suggest that some further declines in house prices are likely, implying additional reductions in borrowers' equity. Second, many subprime borrowers are facing imminent resets of the interest rates on their mortgages. In 2008, about 1-1/2 million loans, representing more than 40 percent of the outstanding stock of subprime ARMs, are scheduled to reset. We estimate that the interest rate on a typical subprime ARM scheduled to reset in the current quarter will increase from just above 8 percent to about 9-1/4 percent, raising the monthly payment by more than 10 percent, to $1,500 on average. Declines in short-term interest rates and initiatives involving rate freezes will reduce the impact somewhat, but interest rate resets will nevertheless impose stress on many households.

My Comment: This is an honest assessment for a change. You know things are bad when political hacks are forced to admit the truth.

In the past, subprime borrowers were often able to avoid resets by refinancing, but currently that avenue is largely closed. Borrowers are hampered not only by their lack of equity but also by the tighter credit conditions in mortgage markets. New securitizations of nonprime mortgages have virtually halted, and commercial banks have tightened their standards, especially for riskier mortgages. Indeed, the available evidence suggests that private lenders are originating few nonprime loans at any terms.

My Comment: This too is an honest assessment for a change.

This situation calls for a vigorous response. Measures to reduce preventable foreclosures could help not only stressed borrowers but also their communities and, indeed, the broader economy. At the level of the individual community, increases in foreclosed-upon and vacant properties tend to reduce house prices in the local area, affecting other homeowners and municipal tax bases. At the national level, the rise in expected foreclosures could add significantly to the inventory of vacant unsold homes--already at more than 2 million units at the end of 2007--putting further pressure on house prices and housing construction.

My Comment: Nonsense. Falling prices are exactly what is needed and more home construction when inventories are already sky high is exactly what is not needed. The situation calls for no response. The free market, if left alone, would take care of the situation nicely. And if that causes some bankruptcies at banks then so be it. Lenders who make bad decisions should not be bailed out by taxpayers. Fed manipulation got us into this mess. Fed manipulation will not get out out of this mess.

Of course, care must be taken in designing solutions. Measures that lead to a sustainable outcome are to be preferred to temporary palliatives, which may only put off foreclosure and perhaps increase its ultimate costs. Solutions should also be prudent and consistent with the safety and soundness of the lender. Concerns about fairness and the need to minimize moral hazard add to the complexity of the issue; we want to help borrowers in trouble, but we do not want borrowers who have avoided problems through responsible financial management to feel that they are being unfairly penalized.

My Comment: The only way to eliminate moral hazards is to do nothing.

Let me turn now to some recent efforts to help distressed borrowers refinance. The FHASecure plan, which the Federal Housing Administration [FHA] announced late last summer, offers qualified borrowers who are delinquent because of an interest rate reset the opportunity to refinance into an FHA-insured mortgage. Recently, the Congress and Administration temporarily increased the maximum loan value eligible for FHA insurance, which should allow more borrowers, particularly those in communities with higher-priced homes, to qualify for this program and to be eligible for refinancing into FHA-insured loans more generally. These efforts represent a step in the right direction

My Comment: This represents a step towards nationalization of mortgages. Clearly Bernanke does not even know what the primary goal of the FHA is. More on this in a bit.

Not all borrowers are eligible for this program, of course; in particular, some equity is needed to qualify. In addition, second-lien holders must settle or be willing to re-subordinate their claims for an FHA loan, which has sometimes proved difficult to negotiate. Separately, some states have created funds to offer refinancing options, but eligibility criteria tend to be tight and the take-up rates appear to be low thus far.

My Comment: More nonsense. Eligibility requirements are too low. There should not be an FHA at all. Nor should government be promoting housing. Government promotion of housing is one of the reasons why housing is not affordable. The other is the Fed micro-managing interest rates.

In cases where refinancing is not possible, the next-best solution may often be some type of loss-mitigation arrangement between the lender and the distressed borrower. Indeed, the Federal Reserve and other regulators have issued guidance urging lenders and servicers to pursue such arrangements as an alternative to foreclosure when feasible and prudent.

My Comment: On a one on one basis I do not object to these workouts as long as the workouts are voluntary between lenders and borrowers.

Unfortunately, even though workouts may often be the best economic alternative, mortgage securitization and the constraints faced by servicers may make such workouts less likely. For example, trusts vary in the type and scope of modifications that are explicitly permitted, and these differences raise operational compliance costs and litigation risks. Thus, servicers may not pursue workout options that are in the collective interests of investors and borrowers. Some progress has been made (for example, through clarification of accounting rules) in reducing the disincentive for servicers to undertake economically sensible workouts. However, the barriers to, and disincentives for, workouts by servicers remain serious problems that need to be part of current discussions about how to reduce preventable foreclosures.

My Comment: It is not for servicers to decide (at least it shouldn't be) what is in the best interests of everyone. By the time rules and other barriers are worked out, it will be too late anyway.

Loan modifications, which involve any permanent change to the terms of the mortgage contract, may be preferred when the borrower cannot cope with the higher payments associated with a repayment plan. In such cases, the monthly payment is reduced through a lower interest rate, an extension of the maturity of the loan, or a write-down of the principal balance. The proposal by the Hope Now Alliance to freeze interest rates at the introductory rate for five years is an example of a modification, in this case applied to a class of eligible borrowers.

My Comment: Freezing interest rates at introductory rates as an across the board measure is likely a violation of contract except when there is explicit agreement between all parties involved. Even then, it will not prevent walking away when it is in the best interest of homeowners to do so. I encourage people to walk away when it is in their best interest. Please see Disingenuous Begging By Paulson for more on this topic.

Lenders tell us that they are reluctant to write down principal. They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again. Moreover, were house prices instead to rise subsequently, the lender would not share in the gains. In an environment of falling house prices, however, whether a reduction in the interest rate is preferable to a principal writedown is not immediately clear. Both types of modification involve a concession of payments, are susceptible to additional pressures to write down again, and result in the same payments to the lender if the mortgage pays to maturity. The fact that most mortgages terminate before maturity either by prepayment or default may favor an interest rate reduction. However, as I have noted, when the mortgage is "under water," a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure.

My Comment: If lenders write down principal it will invite everyone to ask for the same, over and over. It also punishes those who put up a substantial down payment for whom no writeoff would occur. Finally it would encourage those able to make payments to purposely get behind to ask for writeoffs. Loan writeoffs simply will not work on a broad brush basis.

In my view, we could also reduce preventable foreclosures if investors acting in their own self interests were to permit servicers to write down the mortgage liabilities of borrowers by accepting a short payoff in appropriate circumstances. For example, servicers could accept a principal writedown by an amount at least sufficient to allow the borrower to refinance into a new loan from another source. A writedown that is sufficient to make borrowers eligible for a new loan would remove the downside risk to investors of additional writedowns or a re-default. This arrangement might include a feature that allows the original investors to share in any future appreciation, as recently suggested, for example, by the Office of Thrift Supervision.

My Comment: This idea is beyond stupid. Please see Postpone But Don't Forget for more details.

A potentially important step to facilitate greater use of short payoffs is the modernization of the FHA, which I have supported. Going beyond the current proposals for modernization, permitting the FHA greater latitude to set underwriting standards and risk-based premiums for mortgage refinancing--in a way that does not increase the expected cost to the taxpayer--would allow the FHA to help more troubled borrowers. A concern about such an approach is that servicers might refinance only their riskiest borrowers into the FHA program. A combination of careful underwriting, the use of risk premiums, and other measures (for example, a provision that would allow the FHA to return a mortgage that quickly re-defaults to the servicer) could help mitigate that risk.

There are, no doubt, tax-related, accounting, and legal obstacles to expanding the use of principal writedowns. For example, investors in different tranches of mortgage-backed securities may not benefit equally, securitized trusts may not be permitted to acquire new equity warrants, and principal writedowns may require a different accounting treatment than interest rate reductions. But just as market participants, with the help of regulators, obtained greater clarity on the use of interest rate freezes through guidelines issued by the American Securitization Forum, industry and regulator efforts could also help clarify how this alternative type of workout might be effectively applied.

My Comment: See how complex all of this is? I had someone write me today telling me how "simple" this all is. It is only simple if you forget to look at the details. But the real scary thing here is the clear proposal by Bernanke to nationalize this mess through the FHA. In other words, Bernanke is asking for a taxpayer bailout of banks.

Reducing the rate of preventable foreclosures would promote economic stability for households, neighborhoods, and the nation as a whole. Although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done. The fact that many troubled borrowers have little or no equity suggests that greater use of principal writedowns or short payoffs, perhaps with shared appreciation features, would be in the best interest of both borrowers and lenders. This approach would be facilitated by allowing the FHA the flexibility to offer refinancing products to more borrowers.

Ultimately, though, real relief for the mortgage market requires stabilization, and then recovery, in the nation's housing sector. Modernization of the FHA would be of help on this front as well. I am sure that the FHA and the Department of Housing and Urban Development, given the appropriate powers by the Congress, will make every effort to expand their operations and to help improve the functioning of the market for home-purchase mortgages. For community bankers, FHA modernization and expansion would provide an important opportunity--of which I urge you to take advantage--to better serve your customers and community.

The government-sponsored enterprises [GSEs], Fannie Mae and Freddie Mac, likewise could do a great deal to address the current problems in housing and the mortgage market. New capital-raising by the GSEs, together with congressional action to strengthen the supervision of these companies, would allow Fannie and Freddie to expand significantly the number of new mortgages that they securitize. With few alternative mortgage channels available today, such action would be highly beneficial to the economy. I urge the Congress and the GSEs to take the steps necessary to allow more potential homebuyers access to mortgage credit at reasonable terms.

Laying the Groundwork for Nationalization of Housing

Bernanke's speech was mostly a rehash of old ideas that have failed spectacularly. However, Bernanke proposed one new, and scary idea: nationalization of mortgages by the FHA on a grand scale. Bernanke is clearly asking taxpayers to foot the bill for irresponsible bank lending. I urge Congress to do nothing.

Professor Depew on Minyanville seems to agree. He wrote an excellent post today on Bernanke's speech .

Please read Five Things You Need to Know: Laying the Groundwork for Nationalization of GSE's

FHA Mission

With that let's review the FHA Mission

The original goal of the FHA was to provide a stable mortgage market for American families who dreamed of home ownership. The FHA would also provide the funds needed to construct low-income housing, something that was desperately needed.

Because the plan was working so well, the FHA soon became part of the Department of Housing and Urban Development. This allowed even more Americans to have access to affordable housing. In fact, since its inception, the FHA has grown to become the world’s single largest insurer of home mortgages.

The FHA's Failed Mission

The Mission of the FHA was to provide affordable housing. How could it possibly have failed more than it did? In fact, it has failed so badly, that the proposed new mission is to bail out banks that made poor lending decisions to people who could not afford to buy houses.

Those poor lending decisions drove up the price of homes. Taxpayers paid thru the nose to support the original mission, now taxpayers are asked to pay through the nose to support the new mission.

Comments

[darkmink:]

When The FED was set up in 1913, the bill was signed by President Wilson who later said it was his biggest mistake.
The Fed was given a funding method that made it independent of Congress; they still are because they can create deposits.
In the old days The FED printed a Federal Reserve Bond and a messenger delivered it to a Ferderal reserve bank. BUT now deposits of electronis funds are made by computer. NOW get this: if some or all the funds are used to buy Treasuries the FED gets to keep the interest earned!!!! Hold on there is more, when the FED was set up it was funded by twelve banks. Those banks or surviving banks still own the FED.
Inflation, almost no interest bank accounts, regulations that favors the banks, and now since the law was changed, so
that banks and brokers can be one. HELL the FED has been puting it's owners first since 1913. It is a private company
always has been.

2008 Mar 06 10:53 PM

[muley101:]

Plan B: The Mortgage Investment Bill
for Reviving the Economy

by Stan Muse

The Federal Reserve is out of Federal Funds rate options and now the Congress is about to pass legislation which will be the largest bailout bill in the history of the world. Fannie Mae and Freddie Mac are now penny stocks with perhaps over 1000 bank failures yet to come. The American taxpayer will be told that they and their children will be writing big checks to rescue the Wall Street crooks and congressmen that caused all the problems, while receiving nothing in return.

Anyone who has been following recent congressional hearings knows by now that this is unacceptable to Main Street, the voters who will be firing their congressmen for turning the USA into a socialist country. It is also widely believed that this bailout bill may not be embraced by Wall Street because of its onerous terms even if passed. Finally, it will not provide sufficient liquidity for improving the rest of the economy.

A much more effective and fairer way to end our economic crisis is easily attainable. To state it simply, all Congress has to do is to pass a Mortgage Investment bill which allows individuals a one-time option to use some of the funds in their IRAs to pay off their mortgage balance in full, without any penalty, interest, or taxes for doing so. In return, individuals choosing to exercise this option give up their mortgage interest tax deduction for life. This bill could be passed quickly and independently of any other economy-related legislation currently being debated, or included in the current bill. Individuals choosing this option would need sufficient IRA funds to pay mortgage balance in full. The actual payment to the individual’s mortgage company would be done by the IRA managing institution to avoid fraud.

As one senator recently stated, ‘for most people their home is their IRA’. For many others, their 401-K plans hold many trillions of dollars, much of which by now is parked in money market funds or T-bills as mine is. If these IRA funds could be released to pay off mortgages, we could possibly avert, or at least significantly shorten, the economic recession we now find ourselves in. In fact, no other bailout legislation may even be necessary, although more regulatory legislation is certainly needed.

I asked Allan Meltzer, Arthur Segel, and Ellen Zentner to review this proposal and received some positive responses. Ellen said it seemed to be fool-proof and better than a reverse mortgage. In fact, it is a no-brainer for the homeowner with a large 401-K balance, and for the government. The only people who might object, as Ellen stated, are the bankers who want to keep homeowners dependant on them, especially those in the upper-income group. But even the bankers can not want the government to own a large stake in their business for a multitude of reasons.

It makes sense to allow people to use their IRA money, which they earned, to invest in the best and safest investment they could ever make, their home. Presumably they will need a place to live in retirement on a fixed income. It makes no sense for someone with more than enough IRA funds to cover their mortgage balance to loose their home because they lost their job and can not pay their mortgage. It also makes sense because it is not some form of government bailout which rewards the bad behavior of mortgage companies and unqualified borrowers. Instead, it rewards the good behavior of those who have saved and invested in the economy

If only 5 million people chose this option, for an average of only $200,000 each, the result would be $1 Trillion in paid-off mortgages, providing liquidity to the mortgage industry. By executing the option, an individual’s annual mortgage payment would become disposable income to put back into the economy or back into IRA accounts. To the individual, the effect is the same as lowering taxes. If only 5 Million people were able to put back $20,000 per year into the economy, the result would be a $100 Billion per year stimulus package for many years to come.

In my case, with $800K in IRAs and a secure pension, I would increase disposable income by $1600 per month while reducing the IRA balance by only $160K, but saving over $120K in future interest payments. I could retire, which I can not afford to now, and leave my six figure job to someone else. I could also quickly replenish the IRA money used to pay off my mortgage with the extra income.

Adding a further provision to delay receiving Social Security payments for a year in order to exercise the option would be a baby step towards privatization of Social Security. Anyone financially able to exercise the option should be able to delay the payments. For every 5 million people choosing the option, approximately $100 Billion would remain in the Social Security fund. This could fix our problems with Social Security for good.

Some of the benefits of this plan would be to:

• Immediately increase an individual’s or married couple’s disposable income by tens of thousands of dollars each year while enabling them to become debt free, helping families to stay together
• Save homeowners hundreds of thousands of dollars in mortgage interest payments
• Encourage individual IRA savings by many who have never saved
• Allow many people to retire earlier than they otherwise could
• Create demand for housing, reducing inventory, and stopping the decline in home prices
• Stimulate the overall economy, creating and saving jobs
• Not cost the government anything, and actually Increase federal, state, and local tax revenues by eliminating individual mortgage interest tax deductions, without raising tax rates
• Force the banks to sell their good loan assets to cover their bad loan losses, instead of forcing the taxpayer to buy their worst loans, and increase liquidity for new loans to those who need them
• Allow the free market economy to work through the crisis rather than resorting to socialism
• Not increase the national debt nor the money supply as a bailout would do and contribute to inflation
• Allow the individual home owner to the freedom to become their own banker with the money they earn, reducing America’s dependence on bankers, and changing America from renters and borrowers to homeowners and savers


The merits of this simple plan, the Mortgage Investment bill, for saving the economy, instead of trillions of dollars for a Wall Street bailout which will socialize the finance industry, are obvious and would benefit everyone involved. The individual gets more disposable income and a chance to live debt free, the capital markets get needed liquidity, the government collects more taxes and collects them sooner at the expense of the bankers, the housing market gets more demand, and the general economy gets a much needed boost for the next few years.

Democrats should like this plan because they can claim that it lets the wealthy pay for this mess. Republicans should like it because it increases disposable income, which has the same effect the same lowering taxes. The average voter should like it because it addresses all segments of the economy with a huge economic stimulus package, not just Wall Street, and costs nothing while helping to pay off the national debt and potentially fixing Social Security.

2008 Oct 01 10:46 PM