Wrong and Wronger: Compounding the Mortgage Mess with Bigger Mortgages.

It doesn’t seem like the mortgage cowboys are learning any lessons. On Tuesday Freddie Mac, a government sponsored entity, reported a staggering net loss of $2 billion. If this wasn’t enough to make your day, they also announced a decrease in fair value of net assets dropped by approximately $8.1 billion. In what seems to be a stating the obvious statement, Freddie Mac chief executive officer and chairman said:

“Without doubt, 2007 has been an extremely difficult year for the country’s housing and credit markets and, as our third quarter financial results reflect, we have been impacted by the deterioration in these markets,”

The chief financial officer offers us another salient point of view:

“Weakening house prices and deteriorating credit have hurt Freddie Mac’s results, as well as those of other participants in the mortgage market,”

Weakening house prices are causing all this mess? Here I was thinking that rampant greed, financial alchemy, turbo charged mortgages, and credit standards [oxymoron alert]; in fact standards are so low, your cat can get a credit card. No seriously, a cat named Messiah got a $4,200 credit card in Melbourne Australia. The owner of the cat tells us:

“It’s a bit scary and it’s a big problem,” she said. “It was very easy to do and I’m not even a professional crook.”

When a person steals your identity and credit and charges $300 at a Target, they go to jail. When a shady mortgage outfit steals your life and leaves you with a $500,000 mortgage, you get an eviction notice. See how things work? If you think things couldn’t get any weirder, Fed Chairman Ben Bernanke announced two weeks ago a brilliant idea out of the Einstein playbook of physics:

“As Congress and the financial services industry struggle to cope with rising mortgage defaults and a deepening housing slump, Federal Reserve Chairman Ben Bernanke Wednesday proposed that the federal government guarantee so-called “jumbo” home loans worth up to $1 million.”

Let me get this straight. You want to give these two…:

ImageShack


…More access to funds? In his defense, how could he possibly see this coming? After all, Ben Bernanke did say this in May of this year:

“As the problems in the subprime mortgage market have become manifest, we have seen some signs of self-correction in the market. Investors are scrutinizing subprime loans more carefully and, in turn, lenders have tightened underwriting standards. Credit spreads on new subprime securitizations have risen, and the volume of mortgage-backed securities issued indicates that subprime originations have slowed. But although the supply of credit to this market has been reduced–and probably appropriately so–credit has by no means evaporated. For example, even as purchases of securitized subprime mortgages for collateralized debt obligations–an important source of demand–have declined, increased purchases by investment banks, hedge funds, and other private pools of capital are beginning to fill the void. Some subprime originators have gone out of business as their lenders have cancelled credit lines, but others have been purchased by large financial institutions and remain in operation. Importantly, we see no serious broader spillover to banks or thrift institutions from the problems in the subprime market; the troubled lenders, for the most part, have not been institutions with federally insured deposits.”

The bold is added to emphasize each wrong point. I would put more here but will spare you an entire page in bold. You can read the rest of the Nostradamus speech here. So I pose this question to you. Why would you trust a person that got it so wrong only three months before the August credit explosion to lead us out of this mortgage debacle? In addition, why would you give this person more power by increasing caps on government sponsored entities that are clearly facing trouble? His proposal was issued only two weeks ago and he didn’t see what occurred to Fannie Mae and Freddie Mac on Tuesday of this week. I’m not sure I would write a blank check to a company that just reported a $2 billion loss and is openly stating that the problem was home prices. Home prices were never the disease! Prices merely reflected the underlying cause which was that of mortgage and credit inflation. The issue about “jumbo” mortgages shouldn’t even be on the radar since the median home price across the United States is approximately $225,000 and GSEs guarantee loans up to $417,000 which are considered conforming loans. But Bernanke isn’t alone. We have a wise senator also backing this proposal:

In response to a question from Committee Chairman Sen. Charles Schumer, D-N.Y., Bernanke suggested that mortgages eligible for government guarantees be capped at $1 million.

“I think that’s a very good idea,” Schumer said of the guarantees. “In fact, legislatively, it’s something that I would try to introduce and get passed.”

Schumer introduced a bill last month that would allow Fannie Mae and Freddie Mac to raise their total loan portfolios by 10 percent for six months. Bernanke suggested the new guarantees on jumbo loans should also be temporary.”

I wonder why Schumer has a sense of urgency to support this proposal? Let us take a look at his top contributors:

1. Goldman Sachs – $350,850

2. Citigroup Inc – $227,550

3. JP Morgan Chase & Co – $195,900

4. Credit Suisse First Boston – $191,294

5. Morgan Stanley – $186,500

6. Bear Stearns – $154,250

7. Merrill Lynch – $125,100

You can continue reading the list here. These names sound familiar, don’t they? The last thing that the current economy needs is a compounding of mistakes. Raising jumbo mortgages will essentially give Wall Street an exit from their massive credit gamble and a place to off load toxic mortgages that you and your family will have the pleasure of paying off. Doesn’t this make you feel all warm and fuzzy? If you think about it, raising the cap does nothing for the person facing foreclosure because what they are dealing with is payment shock. Many are on 2/28 mortgages or some other mortgage concoction that has no way of being paid off. Let us assume the cap is raised to $1 million for the sake of argument. A person in Los Angeles, let us call him John Subprime is facing a major reset in the next few months. His teaser rate is going to explode on his $500,000 mortgage. Thankfully, the government sponsored entities are their to help him. They’ll take the note off the lenders hands and securitize it over a 30 year conventional term. But guess what? Good old John Subprime is unable to make the payment because he now has to pay the entire amortize value of the note when before, he was paying an artificially low teaser rate on either an interest only or negative amortization loan. In fact, the reason he got subprime to begin with was because he didn’t qualify for the 30 year conventional mortgage! Why would you get anything but a conventional mortgage with multi-decade low interest rates? Most folks facing foreclosure in the majority of the country will fall under conforming loan limits; those that don’t are simply living in bubble states and raising the caps will institutionalize inflated prices at the expense of tax payers. Let us not even talk about a moral hazard here. As Will Ferrell so eloquently put it, “I feel like I’m taking crazy pills!” Or to paraphrase another movie this move of raising caps is simply wrong and wronger.

We do have a better option that has a better name to it. It is called a cram down and Tanta over at Calculated Risk does a great job explaining it. This was a viable option for Chapter 13 bankruptcies for over a decade. What occurred is lenders were instructed to restructure the debt to reflect the current market value of the home and any mortgage debt above the market value was treated as unsecured debt. Owner stays in home and lender is forced to write off charges on their books, not on the government’s books. However, this practice has taken a hit since 1993 and is facing stiff opposition by the Mortgage Bankers Association. Their argument is a fear of giving judges “free rein to rewrite” mortgages and this will create more mortgage instability in the markets. I thought the instability came from allowing these gurus to price the mortgages with complicit rating agencies? As you can see from our above example there is extreme lobbying going on right now and sadly, neither major political party is immune from these groups. Make no doubt about it, raising caps is not the solution. There are other more realistic options that should be put on the table. Just keep your ears peeled for a politician who has a backbone enough to stand up for the right solution. The housing debacle is gaining traction and if this credit crises sends us into recession, you can rest assured that politicians will be talking about it next year as a major issue.

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10 Responses to “Wrong and Wronger: Compounding the Mortgage Mess with Bigger Mortgages.”

  • The subject of increasing Freddie and Fannie loan limits is very important, and I agree with everything written here. It would institutionalize higher home prices. Prices have reached a level here in California that is destructive to the economy, the ability of companies to attract employees, and the ability of young families to live normal lives. I see it every day at my bank when we try to approve people for loans, using sensible underwriting standards. Very few qualify using real standards for sustainable ability to carry mortgage debt.

    Think about the median home price in the USA of $225,000 and a loan limit of $417,000. I do not know what the percentage of loans (or total loan dollars) that Freddie buys from high priced areas like California, but it is very high. I remember in the late 70s, early 80s, (when I worked at Freddie) 40% of their volume was California. Raise the limits to $1,000,000 and it will be what? 60%?

    The prime beneficiary of higher loan limits will be lenders such as Countrywide. They desperately need this to survive, and have been lobbying hard. The primary losers of higher limits are the taxpayers who will pay for a bigger bailout, and future home buyers facing permanent unaffordability due to sustained high prices. Do not be fooled. Prices reached these levels because of financing that provided loans with unsustainable and artificially low payments, with no verification of income, and 100% financing. These high prices are not based on real sustainable ability to carry the debt. The result has been the pain of people losing their houses, and the pain of high and increasing payments.

    We are starting to see the beginning of an unwinding and correction that will take years. We do not need to increase loan limits and impede this. Think about Freddie taking this huge loss only 1.5 years from the peak in home prices, when they were supposed to be buying prime loans with sophisticated underwriting models. Its losses can only increase at this point.

  • That is right. The Governator is trying to work with these lenders and I guess many of them are wising up that a smaller monthly payment is better than no payment and foreclosure. There is legislation encouraging lenders to not adjust rates on those that will face issues should this occur. Sounds great but who will determine whether you can afford your rate resets? If this is the case, everyone should opt to state that they can’t afford their rate resets. This in conjunction with cram downs is finally starting to offer some solutions to this problem that make financial sense.

  • I concur with Sensible Lender. The adage ‘follow the money’ (as outlined by Shumer’s contributors) and who else benefits from the proposed increase leads directly to the doorstep of CFC and other wobbly mortgage giants.

    The rolling credit bowling ball is headed straight at the ten pins of those financial contributors to most of Congress, and their solution is to send another bowling ball after the first one in the hopes it’ll knock the first one off path. But then – what about the 2nd ball? How to deal with that? More of the same.

    Sooner or later, one of those balls is going to hit the pins. CFC wanted to be the lead dog, the kingpin – and guess what – it is. And so now is first in line wanting that protection proposed by the Fed and Congress.

  • DrHousingBubble…I’d be very interested in your feedback on Indymac Banks recent speech to the UCLA Anderson School…some very interesting and honest perspectives on what’s going on in the mortgage market…

    http://alumni.anderson.ucla.edu/content/aw/2007/video/AW_Keynote.htm

  • As usual, prescient. This maybe the last year we hear that old classic, “Have yourself a merry HELOC Christmas . . . “

  • So I think many folks share my goal to accelerate the unwind so the economy can reset and we can begin to inflate again from a reasonable level of debt. I think the only way for this to happen is for everyone in the financial industry to hit rock bottom.

    They all need to show up to work, day after day, and play “How do we lose less money today than we did yesterday?” After doing that for a few months, losing their Mercedes and “million dollar” homes, they will just walk away.

    It may actually help if the government gets involved now and raises limits to $1 million. This would cause Freddie and Fannie to implode faster and bring more financial wizards down to rock bottom. So far we have 2 CEOs, a bunch of realtors, and a few thousands of mortgage brokers that are done for.

    The California plan to freeze mortgage rates for people that can’t pay should make it interesting for any Calif. lenders resell any mortgages.

    What about all the trophy wives? Will someone please help the trophy wives? How many of you guys only have one wife? Could you find a place in your heart for one or two more?

  • The Indymac speech by Mike at UCLA was (IMHO) pretty pathetic. It was just another guy (in a long line of other guys just like him) trying to use smoke and mirrors to disguise what’s really going on and try to convince you that this is a temporary problem that will turnaround very quickly. It is to his significant personal and business benefit for you to believe all that stuff.

  • Jim, that was good.
    Dr. should listen to that, I agree.

  • California Governor Convinces Major Lenders To “Freeze” Rates On Subprimes!

    Wow! This is really interesting! I just wonder how long the “freeze” will last?

    http://gov.ca.gov/index.php?/press-release/7481/

  • Where do we begin with this. Well first it was a great sales piece for IndyMac. When he started the talk he mentioned IndyMac was trading at $20, which now it is trading at $9.
    This talk also occurred before Freddie and Fannie problems and their massive losses. He is wrong on more points than he is right. I’ll present my counter-argument here and leave it up to you to draw your conclusions.

    He argues the 1st bust in 1998 was rough and they grew out of it. Well, they grew out of it because the housing boom was just around the corner to help them grow. He views this 2nd bust in a similar light and I’m assuming his implication is that they will grow out of this in a similar fashion. Unfortunately there is no housing boom to save them. One of his true statements is the US has $10 trillion mortgage debt. Not once in the talk did he mention the word “bubble” which should receive an honorary award for spin.

    He saw the cuts as positive and not cause of the current problems. In fact, he insinuates that the Fed raising rates may have led to the current crunch. Greenspan pushing ARM loans was good in their view. Fannie Mae/Freddie “didn’t keep up with home prices” is another of his arguments and not housing inflation/bubble. These words are never uttered.

    He views what occurred in the housing industry as innovation for the lack of growth in Fannie and Freddie. I’ll let you decide if innovation is the right word.
    Another change since the talk is LA is now down even in the median price reports.
    ML-Implode was at 161 and it now stands at 189.

    Oh, and how he said no REOs over $500,000 in California in prime areas:

    http://apps.indymacbank.com/individuals/realestate/listings.asp?PType=S&City=&State=CA&Zip=&BedroomMin=0&BedroomMax=NOMAX&BathroomMin=0&BathroomMax=NOMAX&PriceMin=0&PriceMax=NOMAX&submit1=SEARCH+CRITERIA+%3A%3A

    Carmel Valley, Irvine, and Brentwood seem prime to you don’t they?

    ARM chart is out dated. That chart was issued in January, the newer one (which you’ve seen here) shows 2008 hitting a peak in March of 2008.

    His premise of adding more homeownership sounds warm and fuzzy but is financially irresponsible. He may have tempered his words if he knew how brutal his earnings were going to be and also the major hits in the GSEs.

    He talks about no articles about him growing his business or positive media press. Are you kidding? What about all the flipping shows, books, etc that pumped the market. These were their 3rd party sellers and pushers. No need for media to help you out. He blames the rating agencies but his business directly benefits from the agencies. There is much hypocrisy in what he says and there is a lot of spin.

    His income argument is completely wrong. We’ve talked about the actual raw number of incomes over $100,000 and you can also see that these products came into existence because people couldn’t qualify with old traditional standards. He views the standards as impediments while I view them as necessary brakes. I also respectfully disagree with his assessment. The boom in jobs was in many positions that are going away (read foreclosure story #1 and #2).

    $56 trillion net worth. $21 trillion is in housing for all Americans. So nearly half is in housing. So if housing goes down, what happens to the housing net worth? Can’t have the argument both ways.

    “US debt is not out of control.” – Wow. Maybe the declining dollar will have something to say about this.

    He also argues that if your net worth is growing, you can spend more than your annual income. Bwahaha! This guy believes the bubble will keep on going! Oh that’s right, he didn’t use the word bubble once in the entire talk. If you don’t have a financial background I can understand how someone would be snowed by this type of presentation. In fact, people like this fueled the market. He jokes that the mortgage mess is because of him; I would argue that he is one of the agents that fueled this bubble. And listening to his logic, he would have you believe that there is no housing bubble. I’ll leave it up to you to draw your conclusions. IMB is now trading at $9 a share, down nearly $1 billion in market cap since he spoke; I wonder if his shareholders find this funny? IMB also announced massive losses and possibly talking about cutting its dividend after his talk. What happened to his talk of his companies massive liquidity? By the way, their market cap is currently at $709 million and they have “$30 billion in assets?” Well by looking at their growing REO list which also includes prime areas which he said weren’t on there, their assets look bubbly. But heck, we can see that his company follows his mantra of spend more than you earn.

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