akasidney

No Relationship Between Shorting and Stock Prices

With the same study parameters, do you think you'd find any relationship between buying and stock prices? You're a joke.

Hottest Potato in Washington: The Homeowner Bailout Plan

Rick:
While the country certainly has no interest in propping up inflated housing prices, it does have an interest in slowing to the degree possible the default rate through treatment of the disease, not the symptoms. There are different ideas out there as to how to do that, and the followng is a very simple way to do this that does not distort or 'prop up' the market, reward the financial imprudence of homeowners, cost U.S. taxpayers 100's of billions of dollars, or require all of the mortgage based financial instruments to be untangled in some fashion. Also, it allows mark to market accounting to coninue to be used, and possibly most importantly allows all mortgage based assets to be valued once again, thereby recapitalizing those who hold them, restarting the markets of them... and guaranteeing their repayment.

Sounds too good to be true, of course... but it's not. All that is required is that government enter as a 'partner' with the current mortgage holder in order to make the monthly payments. It turns out that nearly all the mortgage defaults are on adjustable rate mortgages (ARMS') after they 'adjust'. In exchange for giving up any claim to any increase in the house value over time and continuing with their original low payments, the government renogiates with the mortgage holder a new lower ARM rate in exchange for guaranteeing them the payment. If you do the math, that would amount, even in it's greatest possible value (on ALL the outstanding ARM mortgages, some 4 million homes) to approximately $1.5 billion a year... hardly even a bridge to nowhere in the national budget. When the house is ultimately sold, the proceeds would be split between the parties to the degree of their investment, with the only caveat being that the original owner doesn't share in any value above the value of the original mortgage. As houses traditionally are held for longer periods of time than that which we could expect it to take for the national economy to be rebuilt, the government should do fine... and the original owner will keep their house. If any owner chose not to avail themselves of the offer, of course they have no partner to split any increase in asset value with.

Because, as I stated above, the payments on the mortgages would be guaranteed, the value returns to all of them, and the huge Credit Default insurance market that is killing companies like AIG would disappear in a second (no defaults), restoring the asset values of companies, 're-capitalizing them' in the same way they were 'de-capitalized'... through asset revaluation.

It is absolutely in the interest of the Nation to do something like this that can quickly and completely clean up the problem caused by the bursting of the bubble. It will take possibly 10 to 20 years for many of the more hard hit markets to recover their value... but they will, and in an orderly, market driven fashion.

The Debate: McCain's Insane Mortgage Proposal

Treating the disease, not the symptoms.
While I’m personally a staunch Obama supporter, the proposal made by John McCain last night during the debate regarding the purchase of underwater mortgages has some merit. There have been a variety of proposals for this line of attack, including recently by Martin Feldstein in the WSJ. I have also proposed a plan, outlined below. Following my plan is a précis of Feldsteins plan, followed by a comparison of both. There is great merit in a strategy of treating the disease and not the symptoms:
Some pertinent data points;
• Number of families who now hold a subprime mortgage: 7.2 million1
• Proportion of subprime mortgages in default: 14.44 percent2
• Proportion of subprime mortgages made from 2004 to 2006 that come with “exploding” adjustable interest rates: 89-93%
• Proportion of completed foreclosures attributable to adjustable rate loans out of all loans made in 2006 and bundled in subprime mortgage backed securities: 93%
• Number of subprime mortgages set for an interest-rate reset in 2007 and 2008: 1.8 million Valued at: $450 billion

There are 7.2 million subprime mortgages out there worth 1.3 trillion, of which possibly 70% of them have exploding rate mortgages, which means about 5 million have exploding rates. Exploding rate mortgages account for 93% of the bad mortgages, which means that possibly 4.5 million of these will go bad, or 63% of the total, at a value of $820 billion and an average value of $180,000. If the ARMs reset from 7% to 12%, the increase in monthly payments is about $590 per month. $590 per month times the total of 5 million is about 3 billion dollars per month. Therefore, $700 billion would pay for 233 months, or nearly 20 years of payments… and this without renegotiating the loans so that maybe they just go to… say… 9% with the government picking up the difference. The holders of all the CDO’s would then be able to value them, mark them back to market, solve their balance sheet problems… financial problems solved. From the housing markets point of view, it would relieve the pressure of the foreclosure spiral forcing down prices more than ‘normal’, and provide years for the economy to recover and housing to rebound. Furthermore, any homeowner who availed himself of the help would give up all or a part of the appreciation of the property over time, penalizing them for getting jammed up, but not penalizing the guy who is paying his mortgage and playing by the rules.

If the sub-prime ARMS were renegotiated down to 9%, the monthly payments the government would be liable for would be an average of $225 per house per month, or $1.1 billion annually. The $700 billion under those circumstances would be good for 636 months, or 53 years…

This would be a much cheaper and more effective way to solve the problem… renegotiate the exploding rate, paying the difference and profiting from the increase in asset value over time.

The following is the proposal advanced by Feldstein in the WSJ:

The Problem Is Still Falling House Prices
The bailout bill doesn't get at the root of the credit crunch.
By MARTIN FELDSTEIN

A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.
...
We need a firewall to break the downward spiral of house prices. Here's how it might work. The federal government would offer any homeowner with a mortgage an opportunity to replace 20% of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. This would be available to new buyers as well as those with mortgages. The interest on that loan would reflect the government's cost of funds and could be as low as 2%.
...
Consider a homeowner who has a mortgage equal to 90% of the value of his home. The 15% decline in the value of his house that may be needed to bring it back to its prebubble level would shift that homeowner into negative equity. Further price declines would make default attractive. But the 20% mortgage replacement loan would take the loan-to-value ratio to 72% from 90%, making it unlikely that prices would fall far enough to push him into negative equity. An interest saving that could be as large as $3,000 a year would provide a strong incentive to accept the mortgage-replacement loan, even if the individual thinks that he might temporarily have a moderate level of negative equity.

Below is a comparison of the advantages of the two plans point by point:

• No budget busting huge amounts of capital required in any one year, but rather nominal amounts in any particular year.
o Feldstein’s plan would require huge outlays of capital, a trillion dollars by his own estimate, in order to protect the 5,000,000 threatened mortgages, which is a totally unnecessary budget buster
• No need to try and ‘untangle’ all of the bundled, sold, sliced and diced mortgages… they will be paid.
o A benefit of both plans.
• Slows the fall in house values, shoring up all real estate assets both residential and commercial
o A benefit of both plans
• Doesn’t penalize those who ‘play by the rules’
o The Feldstein plan rewards those who for what ever reason can’t make their payments by making them eligible for a very cheap very long term loan. This penalizes those who are paying and is unfair on it’s face.
• Allows Mark to Market rule to continue to be used
o A benefit of both plans
• By establishing a value for all the mortgage-related assets, the markets in them will restart, liquidity problem solved.
o This is less clear under Feldstein’s plan, as there still could be defaults. Payment is left to the original mortgagee, and what if they decided to take that $80,000 and pay off some other more pressing bill. Because of that threat, the trillions of dollars in derivatives would not be as secure and thus would not be as valuable. They may be as liquid, but at a risk induced lower price… not a good thing.
• Moral hazard: companies that participated in selling the bubble take a hit for their reckless behavior through the discount in the ARM through the revaluing downwards of their assets.
o Feldstein’s plan does not recognize the need to lower the ARM (more appropriately an ERM – exploding rate mortgage) increases through a blanket one time renegotiation with all holders. This is equivalent to what happens when someone secures a better deal rescuing a company than the deal originally offered to the original stock holders… such is life.
• The program could be expanded to include anyone who was threatened with foreclosure due to ARMs… not just sub-prime, but Alt-A, etc.
o A benefit of both plans.
• No bankruptcy interventions necessary.
o A benefit of both plans.

In sum, there is merit in the strategy advanced by McCain… however, his methodology is poor and can be greatly improved upon.

Plan B for Reviving the Economy: The Mortgage Investment Bill

With all due respect, I think that this is a better plan, and below it's compared to Marty Feldsteins plan:

Treating the disease, not the symptoms.
www.responsiblelending...
Some interesting numbers from this data;
• Number of families who now hold a subprime mortgage: 7.2 million1
• Proportion of subprime mortgages in default: 14.44 percent2
• Proportion of subprime mortgages made from 2004 to 2006 that come with “exploding” adjustable interest rates: 89-93%
• Proportion of completed foreclosures attributable to adjustable rate loans out of all loans made in 2006 and bundled in subprime mortgage backed securities: 93%
• Number of subprime mortgages set for an interest-rate reset in 2007 and 2008: 1.8 million Valued at: $450 billion

There are 7.2 million subprime mortgages out there worth 1.3 trillion, of which possibly 70% of them have exploding rate mortgages, which means about 5 million have exploding rates. Exploding rate mortgages account for 93% of the bad mortgages, which means that possibly 4.5 million of these will go bad, or 63% of the total, at a value of $820 billion and an average value of $180,000. If the ARMs reset from 7% to 12%, the increase in monthly payments is about $590 per month. $590 per month times the total of 5 million is about 3 billion dollars per month. Therefore, $700 billion would pay for 233 months, or nearly 20 years of payments… and this without renegotiating the loans so that maybe they just go to… say… 9% with the government picking up the difference. The holders of all the CDO’s would then be able to value them, mark them back to market, solve their balance sheet problems… financial problems solved. From the housing markets point of view, it would relieve the pressure of the foreclosure spiral forcing down prices more than ‘normal’, and provide years for the economy to recover and housing to rebound. Furthermore, any homeowner who availed himself of the help would give up all or a part of the appreciation of the property over time, penalizing them for getting jammed up, but not penalizing the guy who is paying his mortgage and playing by the rules.

If the sub-prime ARMS were renegotiated down to 9%, the monthly payments the government would be liable for would be an average of $225 per house per month, or $1.1 billion annually. The $700 billion under those circumstances would be good for 636 months, or 53 years…

The following is a comparison of the advantages to the above plan to Martin Feldsteins plan, as published in the NYT.

• No budget busting huge amounts of capital required in any one year, but rather nominal amounts in any particular year.
o Feldstein’s plan would require huge outlays of capital, a trillion dollars by his own estimate, in order to protect the 5,000,000 threatened mortgages, which is a totally unnecessary budget buster
• No need to try and ‘untangle’ all of the bundled, sold, sliced and diced mortgages… they will be paid.
o A benefit of both plans.
• Slows the fall in house values, shoring up all real estate assets both residential and commercial
o A benefit of both plans
• Doesn’t penalize those who ‘play by the rules’
o The Feldstein plan rewards those who for what ever reason can’t make their payments by making them eligible for a very cheap very long term loan. This penalizes those who are paying and is unfair on it’s face.
• Allows Mark to Market rule to continue to be used
o A benefit of both plans
• By establishing a value for all the mortgage-related assets, the markets in them will restart, liquidity problem solved.
o This is less clear under Feldstein’s plan, as there still could be defaults. Payment is left to the original mortgagee, and what if they decided to take that $80,000 and pay off some other more pressing bill. Because of that threat, the trillions of dollars in derivatives would not be as secure and thus would not be as valuable. They may be as liquid, but at a risk induced lower price… not a good thing.
• Moral hazard: companies that participated in selling the bubble take a hit for their reckless behavior through the discount in the ARM through the revaluing downwards of their assets.
o Feldstein’s plan does not recognize the need to lower the ARM (more appropriately an ERM – exploding rate mortgage) increases through a blanket one time renegotiation with all holders. This is equivalent to what happens when someone secures a better deal rescuing a company than the deal originally offered to the original stock holders… such is life.
• The program could be expanded to include anyone who was threatened with foreclosure due to ARMs… not just sub-prime, but Alt-A, etc.
o A benefit of both plans.
• No bankruptcy interventions necessary.
o A benefit of both plans.