I’m full of warm feelings today so let’s say nice things about the government and government-ish people who are trying to help the housing market. First, the national mortgage settlement people, who are a diffuse group of 49 state attorneys-general1 plus some federal regulatory people. A while back they got mad at some banks that serviced mortgages, because the “service” those banks provided included a whole lot of foreclosing on houses with shoddy paperwork and a certain amount of foreclosing on the wrong houses, etc. So they ended up signing a settlement with some of those banks in which the banks promised to (1) do somewhat less of that and (2) fling billions of dollars at homeowners in various forms of mortgage relief more or less unrelated to the shoddy foreclosure practices.
This was a good idea! The shoddy foreclosure practices were bad, but they were not like a massive macroeconomic problem. They were mostly a paperwork problem. If you fixed the paperwork problem then you’d still have the other problem, the one where millions of people are unable to pay their high-interest-rate underwater mortgages. Flinging billions of dollars at those people addresses that problem, which strikes many people as more important than the paperwork.
So the other day Bank of America, one of the banks that signed the settlement, announced that it is making good progress at flinging out that money, which is nice! Except there is an amusing / amusingly evil footnote to that, which is: they are mostly flinging out other people’s money. This is less nice! Here is the FT:
Investors in US mortgage securities have been forced to absorb large writedowns in response to a deal between leading financial groups and government agencies over the “robosigning” scandal. ...
On Wednesday, BofA said that 60 per cent of the $4.75bn in first-lien mortgage principal it has thus far agreed to forgive would come from non-government guaranteed loans that were packaged into bonds and sold to investors.
Of JPMorgan’s $3bn in forgiven mortgage debt, slightly less than half has come from investors’ holdings, a person familiar with the matter said. ...
“Many of us expected a settlement to hold servicers responsible for their misconduct; not a bank bailout settling with other people’s money,” the Association of Mortgage Investors said.
Of course, I didn’t expect banks to pay with their own money either, because the settlement explicitly said that they could pay with other people’s money, and I have met people and I know that they prefer to give up other people’s money rather than their own. I feel like economists probably have a name for this preference.2
The settlement people were not total dummies, though, and they addressed this issue. Each bank is obligated to come up with a certain amount of mortgage relief, and you get different amounts of credit for different kinds of relief. Simplifying slightly, each dollar of principal that you reduce on your own loans gets $1 of credit. Each dollar of other people’s loans that you reduce gets $0.45 of credit.3 Of course each dollar of principal that you reduce on your own loans costs you more than a dollar of principal that you reduce on someone else’s loans, but the difference is not $1 versus $0. Reducing your own loans may make it more likely that you can avoid foreclosure and get paid back the (reduced) amount; reducing clients’ loans may make them mad at you and more inclined to, like, stop doing business with you or sue you over your bad underwriting or a variety of other things.4 Strangely the $1.00:$0.45 ratio seems to have made the banks indifferent between their money and investor money, given that the forgiveness has been roughly 50/50 bank money and investor money.
That indifference is kind of random - why should investors pay as much as banks? they didn’t do anything wrong - but you could have some warm feelings about it. The whole trick of the mortgage settlement is that it takes this weird irrelevant distracting issue - bad paperwork! - and turns it into actual coordinated macroeconomic relief . If you just breathe deeply and repeat to yourself “I don’t really care that banks used paperwork worst practices”5 then you can reach that zen place where you realize that there’s a compelling case for mortgage write-downs, and that there’s also a good case for servicers writing down mortgages based on questions like “will this write-down avoid foreclosure?” rather than questions like “who owns what beneficial interest in this mortgage?” You might even reach the place where you notice that, since banks need to reach a certain amount of credit and they get 55% less credit for writing down others’ loans, letting them do that will lead to more mortgage write-downs and more foreclosure avoidance.6 And that’s good!
Or not. Punishing the banks is good too, whatever.
Anyway a tangentially related coda. I enjoyed and was puzzled by this item in the Journal’s Real Time Economics blog where they discussed the “DeMarco trade.” This is a cute name given to the fact that high-coupon agency MBS have traded down a bit (from, like, 110) since the election, since:
- high-interest mortgages really should be refinanced since interest rates are lower now;
- many of them haven’t been, because it’s really hard to refinance what with credit standards being higher, collateral having lost value, people having lost jobs, etc.;
- there’s a political push to make it easier to refinance high-interest mortgages;
- FHFA boss Ed DeMarco has stood in the way of that for agency mortgages, but now maybe he’ll be fired and refinancing will actually get easier;
- which would increase prepayment risk and reduce the value of these high-coupon MBS.
You don’t have to agree with Felix Salmon that above-par MBS are “an undeserved windfall”7 to think that this seems like a macroeconomically good thing: more refinancing means less foreclosure etc. etc. But it’s also bad for mortgage bond investors! Such is life! The Journal has this quote:
“If prepayment speeds rise that translates into higher supply” in lower-coupon bonds, Mr. Scott said. “It’s very unfortunate but the rumor of something that could benefit the economy via structural changes to our market is actually negating what the Fed has done in terms of inducing a lower mortgage rate.”
It should not surprise you that Mr. Scott is “Brad Scott, co-head of agency MBS trading at Bank of America Merrill Lynch,” because if he were not an agency MBS trader that quote would make no sense at all. The Fed is inducing a lower mortgage rate in order to encourage refinancing. When that happens, you can’t say it “negates” the Fed’s efforts, unless you believe that the Fed’s efforts are not intended to stimulate the economy but rather to give money to mortgage bond investors.
They’re not. Neither is the mortgage settlement. Good things are good things, even if they come at the expense of mortgage investors.
US mortgage bond investors take large hit [FT]
Quelle Surprise! HUD and Obama Whoppers About Mortgage Settlement, FHA Finances, Housing Market Remedies Coming Home to Roost [NC]
Yes Banks Are Paying “Penalties” in Foreclosure Fraud Settlement With Other Peoples’ Money [FDL]
Refinancing Worries Overshadow Fed Influence in Mortgage-Bond Markets [Real-Time Economics]
2.Is it “rationality”?
3.That comes from Table D-1 of the Bank of America settlement document. Under “Portfolio Loans,” “First lien principal forgiveness modification” is listed as “$1.00 Write-down = $1.00 Credit” for LTV < = 175%; the same item under “Service for others” is listed as “$1.00 Write-down = $0.45 Credit.”
4.Also each modification has some cost in terms of time and effort and paperwork, and your goal is actually to fulfill your settlement obligation, so you get more obligation bang-for-the-buck for the same amount of time, etc., by writing down your own loans.
5.If you’re a detail-oriented type you can add to this mantra “... in foreclosing on homes where for the most part they actually owned the mortgage and the borrower was actually delinquent, though there were some exceptions which I’m not going to worry about right this second.”
6.For instance: Bank of America forgave $4.75 billion of principal, 60% from investors and 40% from itself. By my math that gets it $3.2 billion of mortgage-settlement credit. Which it could also get by just forgiving $3.2 billion of its own mortgages instead of $4.75bn of a blend of its own and others’. So homeowners got an extra $1.5bn+ of mortgage forgiveness because BofA was able to give them investors’ money rather than just its own.
7.What does “deserved” mean? What does “windfall” mean? Presumably you’d never buy a new-issue agency MBS at par if it could only lose value (as rates go up), never gain value (as rates go down). There had to be some prospect of rates going down and homeowners not refinancing. Whether that prospect comes from homeowners being lazy or dumb, or it not being quite worth it, or their credit deteriorating so they couldn’t refinance, or banks being jerks and raising credit standards, or whatever, that prospect was part of the initial investment decision. So it’s not an “undeserved windfall,” exactly. Nor is it a human rights violation if conditions change so that homeowners do refinance! It’s just expectations, and sometimes some of your expectations come true, and other times they don’t. I'm not a big believer in "windfalls."