"Why is it good for a lender to be forced to make concessions to borrowers?" Floyd Norris asked last night.
It's a good question. On the face of it, the Bush administration's plan to freeze mortgage rates would seem to place a burden on lenders by restricting them from exercising their contractual rights. What's more, if a freeze doesn't burden lenders--if it benefits them--why would we need a government organized plan to bring it about? Shouldn't the self-interest of mortgage lenders have arrived at this through the action of the free market?
But few, if any, lenders or investors are complaining. Indeed, most seem enthusiastic about the plan. Stocks of lenders such as Countrywide rallied on the news. This implies that the Bush freeze is good for at least some lenders. We've got our own ideas about this that we'll revisit later today (hint: it's a collective action problem.) But for now we want your opinion. In comments, leave your answers to Norris' question. And, after the jump, feel free to vote in our poll asking whether Floyd Norris and investors buying up shares in lenders are right: is the freeze good for lenders.
Would You Like a $1 House? [New York Times]
Posted by Lil Jon , Dec 07, 2007 10:27AM
Segment 2 borrowers "may be offered a loan modification under which the interest rate will be kept at the existing rate, generally for 5 years following the upcoming reset."
The operative word is MAY.
The govt brokered this deal to redefine, in essence, 'customary practices' to make it easier for servicers to alter the terms of loans which have been securitized, and for some technical tax and financial reporting reasons.
No one must do anything. You should write a post to clear all this up, rather than fanning the flames.
http://www.americansecuritization.com/uploadedFiles/FinalASFStatementonStreamlinedServicingProcedures.pdf
Posted by just me , Dec 07, 2007 10:37AM
Its too bad the banks weren't forced to take it up their exhaust pipes and pay penalties for allowing shitty credit risks to over-borrow in the hopes they could find a bigger idiot to buy their house with the help of a bigger idiot bank to finance it.
Dude, Ponzi schemes rule !!!
Posted by laura goldman , Dec 07, 2007 10:41AM
Last night, President Bush last week announced a voluntary agreement with mortgage lenders to freeze introductory interest rates for up to five years on certain sub prime mortgages. I can only react with horror.
Satyajit Das, the former architect of derivatives himself and now the author of several books on the subject, derides this type of program as “the socialization of losses.” Maybe I could swallow the socialization of losses better if the socialization of profits was to follow. The program as it stands now is the equivalent of playing “head or tails” with a two headed coin or the schoolyard game of “one, two, three, shoot” with a fingerless man.
The “girly men” have taken over the White House. Those presently in power do not have enough guts to stand up and take the bitter medicine now. Delaying the inevitable is not a solution. It is not even a band aid. Those in power in the nation’s capitol do not want to use up their own political capital to save the nation’s capital.
Mark Twain said, “History does not repeat itself but it does rhyme.”
In 1990, Japan also suffered a credit bubble. Instead of swallowing the bitter medicine immediately, the Japanese government lowered interest rates to zero (sound familiar). They handed out endless subsidies to dying banks and real estate companies instead of deploying the money into more productive uses. The Christmas in July approach failed miserably and Japan plunged into recession that they still have not recovered from. The Japanese stock market experienced a decline of 90% from 1990 to 2003.
Although President Bush stopped drinking more than a decade ago, I thought he would remember that the best cure for a hangover is not a Bloody Mary brunch but a cup of strong coffee. The White House has become an irresponsible bartender. They have opened the tap on the beer keg and are continuing to serve those already too drunk on credit. We pundits like to call this the moral hazard.
There are so many problems with this program that I do not know where to begin. In their zeal to avoid a bail out, the program is voluntary. It would seem that the White House and the Secretary of Treasury Hank Paulson are overly optimistic about the charity of Wall Street, a place known for more sinners than saints. In my informal survey of affected institutions, I could not find anyone that had committed to the agreement.
Even worse, I talked to many foreign institutions that are holders of the affected bonds. They were promised a rise in the interest rate on their investment which they will no longer receive. They are spitting mad and have vowed, “I will never invest in the States again.”
Our government can not go around randomly breaking contracts. Soon foreigners will balk at investing here and demand a “risk” premium. The line to file a lawsuit against this program must already be wrapped around the court house by now. The legal costs need to be factored into the cost of this non bailout.
Martin Feldstein, chief economic advisor to President Reagan, told Bloomberg, “What are they going to think about investing in American securities in the future if the government can say, 'Well, you thought these were the interest rates and the contract, but we're going to roll that back now, and you'll just have to settle for less'?"
In our zeal to help the affected home owners, we have forgotten that the mortgages were sold to buyers counting on a steady income stream. Now that income stream is frozen at a lower interest rate.
It is hard to feel bad for the faceless institution that bought these bonds. These days, money travels quicker than the speed of light. The faceless institution could have repackaged those bonds for sale to a retail investor. How will we all feel if this ill conceived program forces a little old lady investor to move from her house because she can no longer pay her rent due to the reduced income from this investment?
The costs will keep mounting. It is too early to estimate how many homeowners will actually be able to participate in this program. We would be naïve to think that the homeowners who can not participate and the homeowners that are paying mortgage will not want additional benefits.
In light of the revelations this week that Goldman Sachs was shorting the sub prime mortgages for their own account at the same time that they were selling them to unsuspecting investors, Hank Paulson, the former chairman Goldman Sachs might not be the right person to be handling the credit crisis for the nation.
In 2003, Warren Buffett called credit derivatives, the real weapons of mass destruction in Fortune Magazine. How prescient especially since we did not find any in Iraq.
Posted by freeze , Dec 07, 2007 10:42AM
Bush is not freezing anything. There's no new law, no new mandate that the "lenders" (really investors in the securitized mortgages), are not willing to do. All those big boys wanted was a clear from the gov that they will be acting on legal grounds and preserve the tax free status of the REMIC trustees when they act to postpone the rate reset on some subprime borrowers who they would offer the postponement in any event. They want some relief from the massive number of foreclosures that are in the pipeline, and will be in the pipeline in the coming years. They are happy. Bush is finding out that scoring political points on this one is tricky, no matter whether Carney wants to start blaming the democrats now.
Posted by serious question , Dec 07, 2007 10:54AM
Laura Goldman,
Do you have Down Syndrome?
Posted by , Dec 07, 2007 10:55AM
Thats quite a ramble laura. I dont know where to begin either. Lets focus on the idea that investors are being denied the rate step up. True, but they would also be denied the rate increase and loose principal as well if there was a default. This is a classic loan workout. Lenders give a bit in order to come out as whole as possible under now diminished circumstances.
Posted by Bernard Guerrero , Dec 07, 2007 10:57AM
Even worse, I talked to many foreign institutions that are holders of the affected bonds. They were promised a rise in the interest rate on their investment which they will no longer receive. They are spitting mad and have vowed, “I will never invest in the States again.”
Eh, well. I imagine they were probably not too happy with the prospect of the underlying mortgages going belly-up and the REO getting dumped on the market, depressing recovery rates further. Anyway, people are lending to Argentina again, I imagine the U.S. mortgage market will manage, somehow.
I'm not thrilled with this, either, mind you, but it isn't the end of the world.
Posted by , Dec 07, 2007 11:36AM
Mike's Hard...helping Ron Paul nail Laura Goldman since 1837.
Posted by , Dec 07, 2007 11:40AM
i think the real question is what would be our reaction if korea, thailand, or japan, or china, brazil, argentina had proposed this as a solution to their problems.
Posted by , Dec 07, 2007 11:52AM
wow, you wealthy nerds wont let that mediocre mikes hard joke die will you. haaacks!
Posted by dp , Dec 07, 2007 11:57AM
It's a slippery slope when the government is allowed to get it's greedy, "all-knowing hands" into the market. If this freeze happens, what prevents the government from requiring mortgage servicers to have fixed/bracketed rates for certain credit levels of borrowers in the future? More gov = less efficiency...period.
If people/institutions want to make bad bets, god bless 'em. I'm not expecting Uncle Sam to help me out with a bad weekend in Vegas....
Posted by double play , Dec 07, 2007 12:16PM
for 11:57 AM
The federales are not freezing anything. They are just letting the mortgage servicers know that what they were thinking of doing with a segment of the subprime borrowers (postpone rate resets) is kosher. The IRS has just affirmed it. Paulson also wants to make sure that other real solutions (change in the bankruptcy laws for example) are preempted by this. So they make a lot of noise but then you get suckered into believing the government has frozen rates, what a crime! No such thing has happened. Bush is getting a bad rap for playing politics. Though Carney will blame the democrats anyway. Give Bush a break, willya?
Posted by , Dec 07, 2007 12:20PM
11:57 Very simplistic view that "more govt = less efficiency". What would be so efficient about massive foreclosures, real estate sold at fire sale prices, big losses at the lenders, lots of legal fees.
As pointed out, this is no bailout. Merely a mechanism that affirms that lenders, if they so choose, can workout loans in whatever way they see fit, without worrying about an aggressive IRS breathing down their neck.
Posted by Ramblin' Wreck , Dec 07, 2007 12:30PM
Not that I agree with any of the "actions" being taken, -- I'll hesitate to call them rate freezes or bailouts for double play's sake -- but when you think about it, isn't it kind of like a writedown in a sense? Sure, they won't get the higher rates, but that also may prevent some defaults. Really, if the subprime borrowers are as worthless as everyone thinks, wouldn't the "actions" at least keep an income stream open, rather than all of the obligations defaulting?
Posted by market efficiency... , Dec 07, 2007 12:41PM
Anyone stupid enough to procure financing through an ARM when rates were at historic lows (and couldn't go much lower) for properties that were at historic highs should lose their house. Any firm ignorant enough to loan money to someone this stupid should be sold for $0.27 on the dollar. The smart (efficient) one's should be able to go in and rape those "fire sales" for all they're worth. I'm an American and in my America "only the strong survive".
Posted by anon , Dec 07, 2007 12:41PM
I think there will be many class actions lawsuits filed against any issuer of mortgaged backed securities who changes their provisions. I've been told that it's a common provision that no more than 5% of the loans may be modified. This sounds like a slam dunk breach of contract case. Can anyone confirm the 5% provision? While the modification of the terms may result in a net benefit to investors by avoiding default, it's still material change to the agreement.
Posted by , Dec 07, 2007 12:45PM
until you approve violation of the PSA, this is just a publicity effort to get troubled borrowers to deal with the problem now, instead of slipping to delinquency/foreclosure when they could have had a loan mod
ask any of the tens of thousands who got loan mods in the past few months.
Posted by WDE , Dec 07, 2007 12:52PM
There's got to be a better way to solve this, besides giving all of these cashiers a free pas on repaying their higher interest rates. Can't they lump the lost interest payments onto the principal and just lengthen the AM on the mortgage? I would imagine this would either stagger foreclosures, or thwart some of them. I abso-f'in-lutely hate the idea of giving the guy who makes $60k a year, but took a mortgage with annual payments of $55k a year a "get out of jail free" card.
Posted by the five percent solution , Dec 07, 2007 12:58PM
heey anon 12:41 PM! Read this -
From the horse's mouth:
Other agreement provisions may limit the total number of loans that may be modified to a specified percentage (typically, 5% where this provision is used) of the initial pool aggregate balance. For agreements that have this provision: i) in most cases the 5% cap can be waived if consent of the NIM insurer (or other credit enhancer) is obtained, ii) in a few cases the 5% cap can be waived with the consent of the rating agencies, and iii) in all other cases, in order to waive the 5% cap, consent of the rating agencies and/or investors would be required. It appears that these types of restrictions appear only in a minority of transactions. It does not appear that any securitization requires investor consent to a loan modification that is otherwise authorized under the operative documents.
The horse is the American Securitization Forum. The agreements/documents they refer to are existing agreements, nothing to do with Paulson and Bush, who are just blessing them Forum members and their saintly souls.
Posted by dp , Dec 07, 2007 1:00PM
To 12:20
I'm not saying that massive foreclosures would be a good thing. It wouldn't, and I think everyone agrees on that. Certain measures need to be taken by lenders with pressure (not legislative action) from the gov't to prevent mass foreclosures. But when you let start letting the gov't modify agreements that orginated legally in the private sector, where does it stop?
Posted by daveNYC , Dec 07, 2007 1:02PM
It's good for lenders. Part of the freeze plan involves looking to re-fi people (good luck with that). Even though only a very small percentage of borrowers will probably qualify, it still means the opportunity for a few more quarters worth of closing costs and prepayment penalties going right to the bottom line.
Posted by double play , Dec 07, 2007 1:05PM
dp @ 1:00 PM
Which private agreements is the gov modifying right now? None. Or do you work for a member of the American Securitization Forum and do know about certain PSA or REMIC that is getting forced to change contracts? None of this is happening.
Posted by re-fi me , Dec 07, 2007 1:16PM
The refinancing part of this announcement (where government apparently is stepping up to help) can definitely be a boost to the "lenders" very much, perhaps at tax payers expense.
Therefore my vote is "yes" the announcement does help the "lengers" on the balance.
Posted by yea right , Dec 07, 2007 1:39PM
I skimmed over the responses so far and it looks like, in my humble opinion, that everyone may be over-thinking this one. If the banks enforce the terms as they are now on these weak credits, they would be forced to take a lot of property back in foreclosures. The big problem is that the foreclosure process is backlogged, leaving banks with homes providing no cash flows and unable to liquidate for an extended period of time. The problem only gets worse when the foreclosure process is allowed to move forward. Based on what I have seen in the press, the current recovery rate on these foreclosures is down from the traditional 80% to around 50%. Do not think that the banks are behind this deal because they have suddenly developed a conscience, they are in survival mode and have no desire to take on the collateral on the problem loans at 50 cents on the dollar. Most balance sheets would not survive (just look at the meager loan loss provisions for proof).
Posted by Keith , Dec 07, 2007 1:52PM
They're all talking nice because they know Pelosi & Reid and all the other communists running Congress these days would attempt to hammer them if they didn't agree to this.
Bush may have vetoed whatever it would have been, but what if they linked it to something important? Yikes.
Voluntarily playing by Congress's rules is winning them goodwill points and a simple way of hedging their bets.
Posted by , Dec 07, 2007 1:55PM
Keith Hahn!!! Welcome back
Posted by Ben_H , Dec 07, 2007 1:55PM
To Anon 11:40s comment: Argentina, for one thing, did much worse. When the country suffered a self-inflicted economic crisis culminating in default and devaluation in 2001, mortgage borrowers, who had mainly borrowed in USD, found themselves deeply underwater. The friendly, new Peronist government did the following:
- Suspeneded all foreclosures for 60 days. (This has been rolled over every 60 days for the last 6 years).
- Turned all USD mortgages into peso mortgages at 1:1. The ARS was worth $1 before the deval, and around $0.40 shortly thereafter.
Argentina had actually developed a small MBS market. Most of the issued paper had been sold to US institutional investors. With the stroke of a pen, the value of these securities was vaporized. Managed to pick some of these radioactive crap for my book in '03 for around 20 cents on the dollar. The bank that had originated the mortgages and which stonewalled on offering original investors any sort of compensation (in fact, it sued and managed to claim that mezz paper it owned should still get some payment -- and won in Arg courts) wound up buying it back from us at 40 cents.
Fast forward a mere 2 1/2 years. The same bank has started up an MBS program again, and US institutional investors are buying.
It's sad, but investors' short memories buy us all a lot of bad policy...
Posted by , Dec 07, 2007 1:55PM
look, i'm all for being paranoid of government interference but this IS NOT IT. double play is right. loan workouts have been going on already and will continue to maximize present value on loans to the benefit of whoever holds the ultimate credit risk, maybe the bottom of the coupon stack on securitizations gets the short end of the stick with less excess spread but otherwise, it would be fantastic if this prevents unnecessary foreclosures
Posted by , Dec 07, 2007 3:22PM
Anon responding to Ben H
(hopefully not heller) i dont disagree on argy or even the short memories of investors when it comes to the sight of easy money (we probably wouldnt be in the situation if it wasnt for that one constant). But i do think we need to either recognize our hypocrisy or swallow our own medicine. Im in favor of the latter.
Posted by harlynman , Dec 07, 2007 5:40PM
The American Securitization Forum wrote the rate freeze presented to the public by the President and the Treasury Secretary.
I found it on americansecuritization.com.
The framework allows servicers to modify loans without borrower signatures
Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 13, third paragraph from bottom of page
According to the American Securitization Forum's Framework for the rate freeze, borrowers will not have to document current income to be eligible for refinancing, even if they received initial loans with embellished incomes
Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 3, FICO test
Counseling and modification expenses are to be charged to securitized trust cash flows, so service providers, like Countrywide, which has a representative on the board of the American Securitization Forum, will profit from the process.
Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 7, first full paragraph
Appraised value for modifications are based on the date of origination, even if the current value is much less.
Source: American Securitization Forum, Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans, Executive Summary, December 6, 2007, page 2, second bullet
Some of the firms that may profit from the rate freeze are members of the industry group that authored the plan