Will The Bush Bailout Exacerbate Problems In The Housing Market?

Posted by just me, Dec 10, 2007 10:55AM

its more the realization that the republicans will lose in 08 and this is the massive timebomb that the reps leave behind to sink the dems in 12.

Posted by The Dude, Dec 10, 2007 10:59AM

I don't know about "exacerbate" but certainly could make it greater than expected.

Posted by , Dec 10, 2007 10:59AM

Not if Ron Paul gets the nomination

Posted by Bulging Bracket, Dec 10, 2007 11:01AM

Of course the intervention is a bad idea: all interventions are a bad idea. It does appear that this one of the better interventions that could have been chosen, since it is only a stay of execution rather than a pardon. Higher eligibility requirements aren't "severe", they're a return to sanity. The exotics should die, outside of the high end home market.

DB's readership (in a few years at least) are one of the few groups where exotic mortgages make sense - you can have substantial assets that are locked up, high financial sophistication, variable income, etc. Your average 150k or less household income family shouldn't be getting into anything remotely "interesting". So if we are to have an intervention - pretty much a requirement in an election year - let it be this one, especially if it ends up being halfhearted and mostly symbolic.

Posted by John Carney, Dec 10, 2007 11:03AM

BB:

"Half-hearted and mostly symbolic" is, as far as we can tell, the best case scenario. In short, the more i read about the plan, the more I've convinced that the more effective it is the worse it is. If it's just symbolic we should all be relieved.

Posted by supa freak, Dec 10, 2007 11:12AM

Quoting this guy will cause serious cred issues.

From his wiki bio:
"He is also credited as a contributor to his father's 1985 book, "The Great Income Tax Hoax: Why You Can Immediately Stop Paying This Illegally Enforced Tax".

Also:
Peter Schiff has heavily endorsed Republican presidential candidate Ron Paul[3] and started an e-mail campaign[4] asking his clients and colleagues to donate the legal maximum of $2,300 to the Ron Paul presidential campaign.

Posted by Evaluator Speculator, Dec 10, 2007 11:13AM

Well, it is only at first glance that it seems like a bad idea. The devil, as always is in the details.
What the plan seems to be considering is a. identifying salvageable situations, b. forgetting those who are beyond help and c. trying to make the best of a bad situation

For the holders of these MBS: they are probably going to have a significant capital loss if all these homes come on to the market, so for them it becomes a least of evil situation to let the mortgage stay 'alive' and keep getting the minimum interest payments

Householder's perspective - gives those who may have a chance to pay their mortage a fighting chance to try and keep their houses, while giving them 5 years of breathing space

Economic perspective - less foreclosures, the better.

I think the key thing is that they are only hoping to identify around 600k or so of 'salvageable households', so they are helping out only those who need a life preserver, not those who have drowned or are going to drown anyway.

Additionally, a lot of the people in trouble probably didn't completely understand the exotic mortgages they were taking - this will give them breathing space to shift to (relatively) more manageable mortgages.

I shared your skepticism initially, but it really becomes a choice of least of evils. If this had not been done, we would have a whole lot of people on the roads, a significantly deeper economic crisis, bondholders taking even more losses and overall, an even more grim situation.

It's not a question of just moral hazard anymore, but a situation where the creditor can figuratively 'choke' the houseowner, which will give him nothing more than an academic satisfaction, if that, or allowing some homeowners to 'live' in the hope that they make good on their entire payments eventually.

Posted by Matt, Dec 10, 2007 11:33AM

.... we would have a whole lot of people on the roads...

Diagree disagree disagree.

I call BS on this whole myth being propagated that somehow if people's mortgage payments are not reduced they will end up on the streets.

Anyone ever heard of renting? The whole problem is twofold - 1) people who should have been renting in the first place ended up buying homes 2) people bought homes they could not afford.

The solution is as simple as walking out of the house and renting. How complicated is that? Millions of people do it. All this 'home-ownership' hype has almost put owning a home up there with food, water and air. Why is 'owning a home' so important - so much so that it needs to be non-homeowner subsizided (through tax deductions)?

If people can no longer put up with the payments - fine - go out and rent! Why do you need handouts to be able to stay in the house?

And as far as the investors go, if someone buys a CDO of CDO without knowing head or tail of what even a mortgage is - they are supposed to suffer the pain of speculation gone wrong. That is how future speculation is controlled.

So idiot homeowners who bought houses they could not afford speculating that home prices would go up sufficiently - or ones who tried to cash-out on all built-up equity need to feel the pain.

Investors who speculated on the same issue - home prices continuing to go up need to feel the pain.

Smart homeowners (and investors) who sold out at the peak and made a killing will go out and enjoy. And the current crop of speculators will think twice the next time around ONLY of they get burnt.

It's not a question of just moral hazard anymore

WRONG! It is the ultimate moral hazard - should speculators (investors as well as homeonwers) be bailed out from the shit they landed themselves in just because the shit is too deep?

The hazard is 2 way - first, speculators are sent the message that if they eff up sufficiently, the system will bail them out. Second, non-speculators (people who took out fixed rate loans, people who bought smaller houses with lower leverage) are sent the message that they are fools. Speculating would have turned out just as well (maybe even better!!)

And that leads to an even bigger speculative bubble next time round. And when that bubble will start to burts, there will be apologist like you again peddling the same tune.

Posted by , Dec 10, 2007 11:40AM

I read the proposal over the weekend. It doesn't propose doing anything material that most servicers aren't already doing. It is basicly taking industry best practices and publicizing them as a rescue plan.

Posted by Evaluator Speculator, Dec 10, 2007 11:40AM

Matt, in principle, I don't disagree with what you are saying. However, the practical considerations (disadvantages) of not bailing these people out outweigh the advantages for the US.

Btw, let us not get personal - I'm not an apologist for easy money policies, not an american, and don't live in america. You are of course free to think what you like, but the world is not 'my way or the highway'.

Posted by Mort Glickman, Dec 10, 2007 12:59PM

Matt,

You are unique here at DB in your ability to see through all of the bullcrap to get to the crux of the issue. Kudos.

Ron Paul 2008.

Posted by Matt, Dec 10, 2007 1:03PM

It doesn't propose doing anything material that most servicers aren't already doing. It is basicly taking industry best practices and publicizing them as a rescue plan.

There is a fundamental different. Such provisions are in place for a small fraction of borrowers who may find themselves in genuine hardship. That would include unexpected medcial expenses, illness/accidents leading to temporary loss of income and other such unforseen circumstances.

But over here, speculation gone wrong (or downfall due to overt greed) is being equated with genuines and unforseen financial harship.

Being unable to pay your mortgage because you had to pay a large medical bill is not the same as being unable to pay because you took out an ARM hoping that prices would keep going up and you would refi but you couldn't!

And had upfront to investors as well as borrowers that inability to pay post-arm rates (along with some easily achievable financial harship metric like FICO

There is a fundamental different. Such provisions are in place for a small fraction of borrowers who may find themselves in genuine hardship. That would include unexpected medcial expenses, illness/accidents leading to temporary loss of income and other such unforseen circumstances.

But over here, speculation gone wrong (or downfall due to overt greed) is being equated with genuines and unforseen financial harship.

Being unable to pay your mortgage because you had to pay a large medical bill is not the same as being unable to pay because you took out an ARM hoping that prices would keep going up and you would refi but you couldn't!

And had upfront to investors as well as borrowers that inability to pay post-arm rates (along with some easily achievable financial harship metric like FICO<660) would result in a 5-yr freeze - the ARM loans wouldn't have happened in the first place (come to think of it, that would have been a good thing!)

@Evaluator Scepulator,

At the very outset, classifying an immense moral hazard as 'not a moral hazard' belies any honest analysis of the situation. The speculators first bid up the assets hurting prudent borrowers (while being subsizided by the prudent renter).

Now that the bubble has burst - the combined lot of speculators is screaming - help us or you're screwed. That is what true 'my way or the highway' is. Speculate with me or get left behind. Bail me out of my speculation gone bad or get hurt in the process.

Of course when speculators land hard they will hurt. But that is the lesson of speculation - you win big and you lose big. Any attempt to protect the downside (without capping the upside) is fundamentally incorrect.

Go back and read your last post. You are essentially advocating letting people live in houses they bought knowing well they could not afford it - just because it will be they have now created so much shit that somehow others will have to cave in.

Think about it. If that is how all decisions ended, would anyone ever make a prudent investment decision again instead of going all out into speculation?

And you actually thing that would be good for the economy overall? Downside protectiong is only sensible when there is upside capping - essentially a managed communist economy. But then again, is that what we are aiming for?

Posted by Anal_yst, Dec 10, 2007 1:04PM

Matt also don't disagree with you generally but a few caveats, first, that these people on the whole simply cannot "walk out and rent". When the value of the home has dropped to the point where they have negative equity, this is not a viable solution in an of itself.

Second, what I've yet to hear alot of talk about is making sure we don't get into this situation again in the future. If there is any good that can come from regulation, it will be in the form of mandatory and relatively simple up-front disclosure of mortgage terms, not necessarily the outlawing of 'exotic' forms of mortgages for lower-income or lower-credit quality borrowers. If people are explained that their 2-year IO option will reset to prime+30 and they might not be able to refinance at a lower rate, and they still choose to take the mortgage knowing they're likely cutting off their nose to spite their face, then fine so be it. The beauty of a (lightly) regulated free market is that people by definition must have enough rope to hang themselves should they so choose, no matter how ill-advised.

Posted by Evaluator Speculator, Dec 10, 2007 2:36PM

Matt - I do not disagree with you - I actually agree with most things you are saying.

I am saying it is moral hazard - but if these people are not assisted, it would result in an economic crisis of epic proportions, not just a correction - even a large one, which would be healthy.

I think speculators have learnt that house prices don't always go up, the CDO holders have learnt that merely AAA does not mean it's absolutely secure.

The point I am trying to make is that even though there is moral hazard, even though speculators need to learn their lesson, the downside risks are so great as to justify some intervention.

It is not a situation where the US can have massive home loan defaults and not expect significantly adverse consequences. Due to the size of it's economy, the consequences for the whole world would be fairly dramatic. A correction and a weaker dollar for a period of time due to the measures taken to stabilise things would be acceptable.

However, it's the 2nd and 3rd order effects that worry me, not a correction in US house prices. Workers from Brazil to China would be unemployed, and one must ask the question if they deserve to be punished for a US housing bubble. Markets did go wild, investors did go wild. But in a completely intervention free correction, the people who bear the brunt of it would be different.

This may be acceptable from a pure economic point of view, but just imagine the human consequences in countries where there is no social security or government support for these people - it will lead to mass unemployment, riots etc

Extreme position, I know, but not out of the realm of possibility, and this is the situation which I am interested in avoiding.

Posted by Matt, Dec 10, 2007 2:43PM

Anal_yst

Negative equity in a mortgage is a lender's headache. You can actually walk out of a mortgage and the only impact is to your credit score. All that the lender has recourse to is the asset on which he holds the lien (unlike lets say a credit card where the lender could come after your other assets). So yes, walking out and renting is a VERY feasible solution.

But that doesn't make you a 'homeowner' and people dont like that - neither do people like missing out on those sweet sweet itemized deductions that idiotic renters like us dont get (come to think of it, post rate-freeze the mortgage is essentially an IO -> 100% mortgage payment deduction). And the powers that be want grant even MORE tax breaks to homeowners. Why would you want to miss out on that!!

Also, broker fraud has become a convenient target even though it probably contributed to no more than a fifth of the entire mess.

People made fundamentally risky financial bets speculating on home price appreciation. Lets not forget that a huge number of loans are delinquent even pre-reset. So these buyers bought houses they could in NO WAY afford - not even with introductory rates. Let us not forget the 'Flip it now' home videos. For that matter money managers who all of a sudden felt they could pick up funky financial instruments. The only way speculators will learn that 'risky investment' means that there can be significant loss is if they lose. No way else.

Posted by , Dec 10, 2007 3:12PM

Anal_yst @1:04

RE: negative equity, thats not quite true, its called a short sale and there are a lot of them happening right now.

Bailing all these people out is the absolute worst thing we could do. The fact is the bubble has to burst and asset prices need major correcting, it will happen one way or another.

Posted by Matt, Dec 10, 2007 8:30PM

Evaluator Spectator, you comment has unfortunately morphed into a global socialist scheme where responsibility for all people (poor in other countries, speculators in the US) is shoved onto the prudent tax payers of the US.

You build up nice scenarios but absolutely what responsibility does the aforementioned tax payer have to any of these groups?

Workers from Brazil to China would be unemployed, and one must ask the question if they deserve to be punished for a US housing bubble.

Is that even a serious question? Those workers did no favors, they worked and got compensated accordingly. And if they live in a country and support a political system which has set them up to be completely at the mercy of the spending of profligate US residents, yes they will be punished (if that is the term you prefer to use)!

More appropriately, they reside in countries where - inspite of massive potential and resources - the local government has driven them to a desperate state. The only out for them, in the recent years, has been consumption by the US. If the US stops consuming, there folks will go back to their original state. The blame for not being able to leverage the additional inflows into building sustainable institutions and free markets in their own countries is their own failure.

Where in all this does it figure that the US taxpayer has some sort of responsibility towards them?

And that was just from the economic and moral viewpoint. From the more political viewpoint - all the above mentioned nations maintain reasonably antagonistic stands towards the US (inspite of, and mostly denying the US contribution towards their economies). Be it opposing US policies in every international forum, or even stupid things like fingerprinting only US tourists (Brazil does this, and I have heard more than one smug comment from Brazillians about this - some sort of payback).

We trade - nice and good. They sell, we buy. But beyond that, somehow thnking of their poor for some vague cause when all of them are opposed to this very country doesn't really fly.

It is also funny how people constantly denounce the US as a wannabe global cop and as chide it for not acting equal to other countries but when it comes to handouts, the same people expect some big brotherly role of this country.

Posted by Evaluator Speculator, Dec 11, 2007 9:44AM

Have you ever heard of financial restructuring? This is exactly what it is. Companies get in trouble, and in agreement with their lenders restructure their payments in a mutually agreeable and realistic fashion. This happens in completely free markets, without any demands from the government. Well, that is exactly what this is.

A lender and a borrower are both aware they have made a mistake, and are now restructuring the cash flows to a realistic level - with NO public / taxpayer bailout or subsidy. So how does this become a taxpayer bailout as you are saying???

Let me get this straight - you are willing to risk significant global risks, a crash in the dollar, years of problems in the US housing market, foreigners selling off their holdings of US treasuries, a permanent loss of superpower position for the US etc. etc. so speculators can learn a lesson? And this when most US mortgage bond holders are willing to restructure their payments? When MBS holders are speaking with their wallet and are ready to compromise?

Some lessons are not worth the price.

Also, most people like the US - I don't know where you are getting your information - where I am, and in most of the countries around me, people are adopting american culture and like america. They may not agree with every policy, but that does NOT translate into hating america.

Posted by Matt, Dec 11, 2007 11:33AM

Please stop referring to this plan as a natural restructuring. None of those people were given loans with the explicit guarantee that if they couldn't refi/afford the post-ARM payment then their interest would be frozen.

If is a moral hazard because had that been made public, noone would have NOT taken out an ARM (or not bought a house for that matter!)

Some lessons are not worth the price.

The same argument is peddled at EVERY single bailout - be it a domestic one (s&l, Chrysler, various munis) or an international one (think Argentina or the annual 'forgive African debt' charade).

It is always 'just to prevent the most disastrous things from happening to poor unconnected people' where 'everyone has learnt their lessons' and it 'wont happen again.'

That is until the next bailout where same logic is regurgitated.

Posted by Evaluator Speculator, Dec 11, 2007 12:53PM

Matt, I am not finding fault with your logic - it is correct.

Like you, in most cases, I would not support a bailout - Chrysler, Argentina etc.

Where I would support - the current situation, or if one of the big banks (illustratively Merrill, Morgan, Wachovia, BofA or a similar one) went bust and the government supported it - i.e. where the potential for the system getting dramatically undermined / destroyed exists. In that scenario, I do have sympathy (although very unenthusiastically) for government interference due to the potential magnitude of the consequences for the world at large.

I think our disagreement is not on principle, but rather on the degree. I do wish more people would think like you.

Was interesting to exchange views with you.