Government Sponsored Mortgage Placebos

by: Markham Lee

Many politicians, government officials, fair lending advocates, et al, have jumped on the mortgage problem, proposing a host of remedies, bailouts, new regulations, etc. Despite their good intentions, these proposed “solutions” are merely “Government Sponsored Mortgage Placebos” that may quiet down a scared populace, but won’t really solve anything. The most recent example of a “Mortgage Placebo” is President George Bush’s announcement that FHA was going to effectively rescue the American home owner by guaranteeing certain mortgages and helping people refinance to lower rates.

From the Wall St. Journal:

President Bush, looking for ways to respond to the subprime-mortgage crisis, will outline a series of policy changes and recommendations today to help borrowers avoid default, senior administration officials said.

Among the moves will be an administrative change to allow the Federal Housing Administration, which insures mortgages for low- and middle-income borrowers, to guarantee loans for delinquent borrowers. The change is intended to help borrowers who are at least 90 days behind in payments but still living in their homes avoid foreclosure

[…]

By allowing the agency to back loans for delinquent borrowers, the FHA estimates it can help an additional 80,000 homeowners qualify for refinancing in 2008, bringing its total of refinancing guarantees to about 240,000, senior administration officials said.

Whilst it sounds great on the surface, let’s consider the following:

1) FHA is only going to guarantee an additional 80,000 mortgages (on top of the 160,000 they anticipate guaranteeing in 2008).

2) 179,599.00 homeowners went into foreclosure during the month of July and roughly 165,000 home owners went into foreclosure during the month of June. If foreclosure rates remain steady from July’s levels, we could estimate that an additional 900,000 households will face foreclosure by the end of 2007.

3) The FDIC reported that there was roughly $27.5 billion worth of residential mortgage loans that were 90 days or more past due at the close of Q2. If we estimate an average mortgage size of $300k (due in part to the areas in which most of the foreclosures are concentrated), that’s approximately 91,667.00 total households.

4) Home owners with ARMs are much more likely to wind up in default, with estimates ranging that 25-33% of ARMs will wind up in foreclosure. Now consider that there are roughly 2 million ARM mortgages scheduled to reset over the next eighteen months and we have 500k-700k worth of potential loan defaults and foreclosures.

5) It doesn’t appear this program will really get moving until 2008, and it appears limited to those in “pre-foreclosure” meaning that if you’re in trouble right now, this program probably can’t help you.

6) Many people are in foreclosure because they bought more home they can afford and can ONLY afford the teaser rate, a refinance to a prime rate mortgage won’t change the fact that they’re in a home they can’t afford.

Even with the understanding that there is some overlap with the foreclosure numbers, it doesn’t change the fact that the Bush program won’t come close to addressing the sheer magnitude of the foreclosure problem facing the United States. Furthermore, doesn’t address the fact that many people simply bought more house than they can afford. In short, the Bush program is a mere drop in the bucket that won’t even address a key aspect of the overall mortgage problem.

So no one thinks I’m only picking on the GOP, the same goes for Senator Hillary Clinton’s proposed $2 billion fund to help out home owners in trouble.

From the NY Times:

“In a speech scheduled for this morning in New Hampshire, Mrs. Clinton is to propose providing $2 billion in federal money to help “at risk” homeowners avoid foreclosures and to assist state and local governments build rental properties and other housing for families in need.

[…]

According to a preview of her remarks provided by her campaign, Mrs. Clinton, of New York, will lay out a plan to deal with mortgage lending abuses and to “preserve the dream of homeownership” at a time of crisis in the mortgage markets as homeowners default or face foreclosure when their adjustable rates climb upwards.

The reality is the same for Mrs. Clinton’s program, the size of the rescue simply pales in comparison to the size of the emergency. I also think that whilst some of her attempts to curb lending abuses will have a positive effect, it won’t prevent lenders and/or borrowers from making bad decisions. If the borrower is convinced that overspending on a home is the ticket to wealth, understanding all of the costs isn’t going to prevent many of them from taking on the loan, nor will it prevent lenders from originating bad loans if they think they can pass the risk on to someone else via securitization.

Whilst I think that on some levels, the politicians and activists are making “good faith” efforts to help home owners in trouble, the fact remains that the problem is simply far too big to be adequately addressed by the proposed programs/solutions.

Furthermore, none of these “rescue programs” or any of the solutions being suggested by politicians, community activists, fair lending advocates, etc, addresses arguably one of the most fundamental root causes of the foreclosure problem: many home owners bought more home then they could afford. In other words, the best solution would be one that helps many of these home owners sell their current homes and trade down to a more affordable one.

A true solution to the mortgage crisis would have to address the following:

  • The way mortgage originators assess risk and originate mortgages
  • Loan underwriting standards with respect to the mortgage loan itself, but also within the context of the borrower’s overall debt picture. The Wall St. Journal reported that banks were limiting revolving credit lines in areas that have seen significant housing appreciation; in other words the banks were admitting that they were aware that borrowers would using HELOCs to pay off credit card debt and in some cases, the HELOC and the credit cards were with the same bank!
  • An overhaul to the mortgage debt markets, (starting with) involving the credit rating agencies, the use of mark to model valuation methods, how lenders treat the use of debt securities as collateral, etc.
  • Educating the borrowers with respect to the true cost impact of the mortgage obligations they’re agreeing to and the true performance of their homes as investments. I would even go so far as to educating borrowers to understand that something that something you live in can’t be an investment, because you have to sell your home to realize your profits and the bulk of said profits will go towards your new home.
  • Continuing along with the concept of education, we need to abandon the idea that everyone needs to own a home, even if it requires subsidies, special programs or high interest loans. The current mortgage crisis has made the truth quite clear: some people would’ve been better off staying renters until their finances were strong enough to sustain home ownership.
  • One final note: why in the world did the stock market react positively to what is effectively an attempt to put out a forest fire with a shot glass? Isn’t that a clue that the market is still out of touch with reality and/or is basically looking for anything that hints at a return to the “good times” of the real estate boom, as opposed to attempting to build a sustainable financial model for the future?

    Sources:

  • RealtyTrac: July 2007 U.S. Foreclosure Market Report – August, 21, 2007
  • FIDC: Quarterly Banking Profile – August 22, 2007
  • Credit Suisse Research Report: “Mortgage Liquidity du Jour: Underestimated No More” – March 12, 2007
  • Wall St. Journal: “Bush Moves to Aid Home Owners” – August 31, 2007
  • NY Times: “Democrats Campaign on Mortgage and Trade Issues” – August 7, 2007
  • Wall St. Journal: “Credit Crunch Moves Beyond Mortgages” – August 23, 2007
  • Disclosure: As of the writing of this article the Author doesn’t own a position in any of the companies mentioned in this article.