Bailout talk: Krugman and Barnes

We know most of you are strongly opposed to any direct government aid to borrowers or lenders. Lou Barnes has a name for people like you: "market solution hard-heads." Still, this is a discussion that is just beginning, so we want your thoughts on two columns. Sorry, both are behind pay walls.

Paul Krugman, the left-leaning New York Times columnist, writes today we need "Workouts, Not Bailouts."  Krugman says bailing out hedge funds and other investors in mortgage-backed securities would be like saving Enron -- it would be "saving bad actors." However, Krugman argues the government should intervene to help borrowers re-structure their mortgage loans: "My guess is that it would involve federal agencies buying mortgages — not the securities conjured up from these mortgages, but the original loans — at a steep discount, then renegotiating the terms."

Krugman is considered a real hotshot in liberal circles, but he does not know this story as well as Lou Barnes at Inman News. Barnes' column this week is informative and scary. Highlights:

--He writes the Fed's move this morning "firewalled the mortgage panic from the rest of the banking system," but does nothing to solve the mortgage crisis.
--He defines the mortgage crisis: roughly $4 trillion in mortgages outstanding are frozen -- nobody wants to buy them, nobody can sell them. (These are the sub-primes, the Alt-A's, the second mortgages, the 100% no doc "liar loans", etc.)
--Real estate markets and entire economies in "bubble zones" (that's us, folks) are freezing up: "They will not survive this degree of credit starvation. They have a month, maybe two; and this time the economy will not be spared the consequences."
--Now comes the Barnes bailout: "The solution is going to require federal intervention, and that's going to require a victory of prudence over market-solution hard-heads."
--He floats two ideas: Re-underwite the $4 trilllion, or create a new version of the Resolution Trust Corp. to buy and re-market the illiquid loans.

We know most of you won't like the Barnes idea; that's OK. But at least play along with his logic -- If California's mortgage market freezes -- it doesn't matter what a house costs because nobody can get a loan.  Then what?

Comments

[yours truly, johnny dollar]

What do you mean "direct" government aid? You can take out the word "direct." This is what you get for playing it fast and loose. How many ways can you spell Enron?

[T]

I don't get why a re-underwriting of the loans is necessary. It sounds like they just need to get a new valuation that the market accepts is low enough to cover the "newly recognized" risks. Once that happens its ok to trade them again. Those holding the securities now will take a well deserved hit and then business can continue.

It sounds just like the falling housing market. Right now sales are down because the buyers and sellers aren't meeting in the middle. Once prices come down they will and sales will pick up again.

[Jonah]

If tax money is going to be used to bail out people who lied about their income and greedy lenders then the government better write me a check for 100k towards my house. I've been responsible and shouldn't be forced to pay an outrageous amount just so we don't ruin the current market values.

[Kathryn]

I'm confused about how a bailout would help. Many of the people who are in foreclosure got these creative loans that are interest only with negative amortization, they can't afford the payment of a 30 year fixed loan regardless of the interest rate.

A house is a house. If you put nothing down what's the big deal w/ a foreclosure, you move, that's it. I'm tired of people acting as if a house is something more than a place to live. And I don't get why the leftwing types aren't happy with the price of housing going down. If the correction continues, homes will be affordable for more people. A bailout only benefits the liars and financially illiterate.

[LA renter]

Context is everything. Any proposal can seem prudent/necessary if you frame the context right.

With that said, will real estate markets and entire economies, not survive? He says they have a month, maybe two; and this time the economy will not be spared the consequences." Is this a bogeyman? Do what I say or else?

I have a question about a Resolution Trust Corporation. Is it a self-sustaining entity? That's is, give back to lenders the true value of their asset minus a processing fee. How exactly do you re-market a loan that cannot be paid?

Whatever is done, it is demoralizing to think that bad behavior is going to be rewarded on a grand scale, either for the borrower or lender. Being cynical, I suspect the lender will get the best deal.

[Nathan]

Well, Barnes' term "market-solution hard-heads" is, while probably offensive to the individuals he is describing, quite apropos. I think he is trying to make the point that the ostensible unfairness of a "bailout" (whatever form it may take) is the lesser of the two evils when compared to the consequences of a frozen market and the resulting havoc on the economy.

The innuendo is that the hard-headedness comes from a general ignorance of economic and market principles. In essence, "this is going to be worse than you think and realize, and believe me - you don't want this." But, I think he might be discounting the sentiment that is out there a little to sharply. Honest, hardworking people that have stayed in their seats despite the hype and chosen prudence over greed and overleveraging, are genuinely upset because while Wall Street and Main Street have gotten together for one big credit orgy, these individuals have been ruthlessly priced out of the market.

Asking this group of Americans to support a "bailout" is like asking the sleep-deprived neighbors of some all night, hard-partyers to hand out coffee, aspirin and massages to help soften the impending hangover.

Yes, Barnes is right that many are likely underestimating the consequences should the government stay on the sidelines in a substantial way, but he is also underestimating the throngs of the angry who are collectively chanting "Let it Burn".

[amir]

The real victims of the real estate bubble are not the ones who are living in big new houses that they have no business owning, but the frugal fiscally conservative middle class that did not buy houses they could not afford. Which of these groups should own real estate in this country? I think the latter. By the way, there is no way to help the home owners without helping Wall Street sharks and the amount of money is this requires is more than the strapped federal government can afford.

[sheila]

who says "left-wing types" aren't happy with the price of housing going down? that is absurd. the lefties are the ones, for better or worse, who believe that home ownership should be available to almost everyone who works hard and behaves responsibly, not just to rich "flippers" who had the enormous capital to screw up prices for normal working people.

and i don't see what's wrong with the Feds buying the loans, restructuring them (maybe into 40-year loans at fixed interest?) and having whomever is stuck with the hot potato simply shut up and service the loan.

call me old-fashioned, but why do they have to keep selling and re-selling the damn loans? once the lenders dump these stinkers off onto the Feds (with the obvious caveat that the Fed will NOT buy any crap loans going forward), they will start lending again, cautiously, perhaps, but that doesn't have to be a bad thing. it hasn't always been that hedge funds were the real estate speculators - it used to be banks, and not that long ago. why not a return to that direct relationship?

[CD]

Email your state Representative let him or her know how you feel about this.
It's an outrage. No bail out. Lets be really loud and clear on this one.

[Pioneer10]

I'm a "leftie" and want no part of this dumb Barnes idea. People who bought houses they can't afford and the speculators armed with toxic loans by Wall Street deserved to be burned not only becuase of moral hazard but they have and currently have raised house prices to the point where normal people can't buy a house w/o tremendous financial strain

[Cal]

I dont see how workouts will work or bailouts or re-underwriting loans, etc. It would leave the market out of balance (price higher than fundamentals dictate), it would still be a bailout for SOMEONE (homeower (not a spelling mistake) or loan investor). There is a huge difference between someone who can afford their loan and has a temporary issue (lost job, medical bills) than someone who fundamentally cannot afford their home.

The proper response is to provide a way for people who lose their homes a rapid way of getting back on their feet. Rental assistance, less of a ding on freddie/fannie guidelines for someone who went to foreclosure to more easily qualify for a new home, etc. You would then get a balanced market faster (which helps the economy instead of hurting it) , minimize the dislocation and let the people live with their decisions. I predict that in no way will this solution be considered.

Also, I think Lou Barnes $4 Trillion number is a much more realistic number than the $1.2 or so trillion being bandied about by various people like Ben Stein. So many people defined subprime by FICO less than X score, I think you have to look at loan characteristics. The traditional "4 C's of lending" are Capacity, Credit, Capital and Collateral... FICO is only one of those (Credit) . Ignoring Capacity (no doc, low doc or stated income, no amortization or neg am) , Collateral (pushed appraisals, basing apparaisals on other pushed appraisals, etc), and Capital (no down payments, closing costs rolled into the loan) just because 1 C (Credit) is above a certain threshold is quite simply stupid and was only possible through selling loans to people who throught they were properly underwritten. It plain to anyone who bothers learning anything about loans that the number of BAD loans is much greater than the number number of loans below some arbitrary subprime FICO.

[pugtv]

Here is my Bailout proposal -

It should be financed by all of Krugman's assets 1st. If that's not enough, anyone else who believes in a bailout should contribute all their assets next. Those who don't believe in a bailout should not contribute.

How about it Krugman? Put your money where your mouth is ...

[anon]

When housing prices fall to levels reasonable relative to wages, loans will be written without benefit of government intervention. Stop the condo conversions immediately--affordable rentals are needed for those who will lose their homes. You can't ask we who have rented and saved to bail out this madness.

[LA Expat in Arkansas]

What's the difference between a bail-out and the War in Iraq? Very Little: innocent people will get hurt at the expense of fat cats who will be the only ones to profit off this mess.

We will add more (Trillions and Trillions) debt to be shouldered by our children, and it will be another big quagmire.

P.S. My apologies if my comparison seems extreme and pease don't lambaste me about our soldiers who've sacrificed their lives fighting for our "freedom". I know. I'm truly sorry, and I have a son of draft age.

[Peter]

I am a renter who has been saving diligently for over a year, trying to accumulate enough for a twenty percent down payment. The sooner the real estate market corrects itself from the obscene overvaluations of recent years, the sooner I will be able to buy a house.

I don't see why I, as a taxpayer, should support the obscene prices that the market has produced in recent years. It is immoral and irrational.

There's nothing wrong with renting. Barnes and Krugman act as if renting is a shameful, stigmatized lifestyle. If you can't afford the mortgage payment, just rent a place. Sheesh.

[albert]

I got screwed royally by waiting for a housing market to go down and saving my money to get a conventional downpayment and loan. All of my friends were laughing at me , telling me to get into a house by any means , no money , no problem. I hoped market will bring the market down after it went up artificially , thanks for our goverment. Now our goverment is stepping up again screwing us one more time , keeping the inflated and absolutely unreasonable prises up.
Thank you very much , I was taught a lesson about our great country today.

[albert]

Peter: I absolutely agree with you.
What is more laughable:renting and having 100k in the bank or posing like you have it made ( big house) , while being desperate, broke , live under constant pressure and on top of everything having neg. ammortization/interest only , 2/28 loan ??????
I prefer renting.

[beacher]

I'm hardly a market-forces purist. And in any case, the market is never really operating on its own. There's always government money to help some and undermine others (usually help a corporation to undermine local biz, that kind of thing). I woulld prefer the government help out more, not less.

But I'm inclined to say no bailout. These funky loans are what made it possible for regular people to buy a slightly too expensive house, thereby raising the other home prices. Like other posters, I was hoping a market correction would bring home prices back to a range where I could afford to buy, with a normal 30-year, 20 percent down loan. A bailout would seem to keep those prices artifically in the stratosphere.

We've seen the charts and read the stats about how statistically unaffordable homes in CA are. If this won't change it and bring prices down, what WILL make SoCal more afforable?

[Cal]

"But at least play along with his logic -- If California's mortgage market freezes -- it doesn't matter what a house costs because nobody can get a loan. "

I didnt read this until after I posted the last. It should be clear that conforming loans are available, Jumbo Loans are available just with a higher cost (higher risk premium) and tighter underwriting standards. The secondary market for jumbo loans is hurting, but it is a consequence of the the originators, securtizers and ratings agencies misleading the end investors as to what they were buying, Trust has been broken. The only way to regain trust would be a market mechanism where the underwriting for every loan was painfully transparent to anyone who wanted to know. There would have to be even more standardization for things like appraisals (and how appraisers are chosen) and processes like VOE, VOD, and the like.

If the market completely rejected all jumbos no matter how conservatively underwritten then a very strict underwriting and higher than market rate government program could be temporarily adopted as a bridge. But you would want conservative underwriting so that the loans could easily be offloaded on the secondary market later (people are confident in the loans and collateral) so the government is just filling a temporary credit gap and that private industry could see that they foolishly were letting money get away from them. It is the same theory that Bernanke uses to inject liquidity into the market, give money out but at a penalty rate to encourage both sides (lenders are borrowers) to come up with a more efficient solution.

I guess people only think interest rates can only stay low, housing can only go up and Ben Bernanke really will fly over their house dropping dollars.

I was thinking about what Lou was saying regarding the re-underwriting those loans that are considered dangerous. I thought he meant re-underwrite them and then have Fannie and Freddie take them over. But what he meant is to use the Fannie and Freddie standarization to give transparency to the loans such that the risk can be priced by the market. That is why the markets are seized up, they dont know the risk so they cant come up with a price. I like that idea, it could get money flowing again and liquidity helps the market from overcorrecting.

[Kathy]

Any artificial fixes to this mess whether it's creating a Resolution Trust for the ripoff artists who lied on their loan applications, or dropping wads of cash into the system, or lowering the interest rates, none of these will prevent the day of reckoning, they'll just postpone it. I wonder if the Bush administration is trying to prop up the economy untill they get out of Dodge.

[JK]

Let me get this straight... I have been renting for years trying to save enough money to afford a home. I've waited the market out because it was obvious even to a novice like myself that the prices were ridiculously out of line with what the average person can afford based on today's wages. I wait and wait for what I know is a pending crash. The crash is on the horizon and the government steps in to the rescue leaving me on the sidelines again?

I'm so tired of the government using my tax dollars to provide others with things I can't even afford my self...

[buz algood]

I cannot see any majority support for a government bailout of richy rich hedge fund "geniuses" and their million dollar bonuses or idiot, greedy homeowners who refinanced themselves into oblivion or bought way above their means. Time for them to pay up or get out.

[NotBuyersMarketYet]

Where is Alan Greenf@rt in all this?

[AnnS]

“And I don't get why the leftwing types aren't happy with the price of housing going down. If the correction continues, homes will be affordable for more people. A bailout only benefits the liars and financially illiterate. Posted by: Kathryn”

LEFTWING?? You are blaming those who are liberal in the sense that they believe that the individual has obligations to the society at large and that rampant greed should not be sole goal of and guide to human behavior?
I suggest you go think again. It is the die-hard rabid “free market” right that created this mess with their no-holds barred, forget-common-sense lending and pricing practices. It is that same crowd that is pushing for a bailout to save the collective hedge fund behinds – and don’t forget the every happy living-on-anti-depressant relators who sold this snake oil myth that a 1950s 800 sq ft ranch house with no yard was worth far over $500,000. The buyers were typically the greedy voracious consumers who just ‘had to have’ that house so they could jump on the gravy train and get rich; or had to get the refi to buy the SUV and go to Australia on vacation. Very few buyers (I would guess less than 10%) were doing a refi to lower their payments or get the money for something essential like medical bills. “Left-wing liberals” worry about affordable housing for all the population and not about keeping some jumped up, greedy, gotta-make-a-fast-buck-flipping-property wanna-be in their McMansion.

Now what Krugman wrote is that something should be orchestrated that would allow buyers the time to renegotiate with the loan holder. His reasoning is that with the loans being sold so many times over, a buyer can’t find the person to talk to about restructuring the loan who has the authority to do such an alteration of the loan terms. (and pugtv posting above OBVIOUSLY didn’t read his column and latched onto a simplistic – and dead wrong – interpretation of the Krugman’s suggestion. Take some advice, pugtv, don’t comment on what you know nothing about – it’s a waste of page space.)

How much good would that do? Doubtful it would do a lot. The buyer would have to be in a position where they could repay the loan if the interest rate were lowered and/or payments extended. Negotiating a continuation of an interest-only ARM wouldn’t solve the underlying problem that the buyer can not afford the house. From the lender’s viewpoint either they get stuck with the over-valued house in a falling market or they renegotiate the terms and have an under-secured loan (and the buyer has a house that is in negative equity with respect to the loan, and worth far less than they paid for it.)

Very few buyers/borrowers would be in a position to repay the money if the interest was less or the loan lengthened. Most of the problems are coming from:

(1) ARMs done as refis to ‘get the equity out’ (an extremely stupid concept since you can never really realize the equity until you sell the house and in the meantime you owe a lot of money and haven’t ‘gotten’ anything except the right to repay the money plus a lot of interest.) This may or may not be renegotiable to avoid default. It depends upon the borrower’s income.

(2) ARMs with a teaser rate (2/28) for purchase. These buyers are seriously in deep trouble. They stretched to get into a house they couldn’t afford if it were a conventional 30 year at the then 4-5% interest. Doubtful they could repay the loan even if extended to 40-50 years at 2-3 points below current prime.

(3) Option-ARMS. Another ‘can’t fix’ disaster. These people borrowed far more than they could hope to repay under nearly any circumstance. They went right to the edge on debt and gambled on future appreciation.

(4) Interest-only. These folks are toast. They didn’t have a hope of affording the property nor ever being able to repay the principal absent a miracle. They were greedy and they gambled. Negotiating with the lender couldn’t possibly save them.

Maybe a few (I would guess a lot less than 10-15%) could renegotiate their ARM that has a short term into a long term fixed with a lower interest rate and payment that they could manage. It is probably even less than that.
This is assuming that the holders of the mortgage securities would even negotiate. Most of those packaged securities were sold in bits and pieces to groups of investors – and the terms of the security forbid changing any terms of the underlying loans if such a change would adversely affect the interests of the investors. All it would take is one investor out of several to say ‘no deal’ on a renegotiation.

Ergo, Krugman’s suggestion is pretty much an exercise in futility.

Lou Barnes must have money in a hedge fund that owns a lot of these turkey mortage securities.

(1) Real estate markets and entire economies in "Bubble zones" (that's us, folks) are freezing up: "They will not survive this degree of credit starvation. They have a month, maybe two; and this time the economy will not be spared the consequences."

That is not a bad thing. It will immediately force prices down so more than 17.6% of those in LA county might be able to buy a house. It is a question of affordable housing for all of the population. Prices were driven to truly insane heights by speculation and loans which the borrowers could not, and can not, afford to repay. It is in the best interest of the community that prices come down –and if a minority of the population get hurt (think realtors, mortgage brokers, appraisers, speculative developers of McMansions), it is the sacrificing of a few for the good of the many.

An economy which relies upon insane upward rising pricing of housing in order to function is not an economy which is viable in the long term. Speculation in the essentials of survival (food, housing, etc) which drives the prices of these necessities out of the reach of all but a few (like 17.6% of LA county) is dangerously destabilizing for a society.

A ‘consumer driven’ economy which relies upon consumers borrowing more and more money to keep buying and buying is not sustainable – particularly when their incomes are not rising at the same rate as their debt repayment, let alone their consumption. Sooner or later the consumers run out of money and can not borrow anymore and then the economy crashes into a wall. Beginning in 2005, we started seeing consumers who are not in the upper 10% of income reducing their spending. Now consumer spending is hitting the wall. National savings are now negative – the first time since the Depression. Overall, the population is living on credit and borrowed money. They can not keep buying at the same rate, let alone buying more and more – they are drowning in debt and don’t have the income to sustain the spending.

(2) “If you were a short-term but highly leveraged holder of non-agency loans -- a big mortgage bank -- your capital was gone, and so were you. The mortgages had only to fall in market value a few percentage points. If you were a long-term holder, leveraged, you are in terrible trouble. There are lots of you. New buyers do not wish to join you.”

Pretty clear that what he is really worried about is the impact on the poor little hedge fund investors (and all the other suckers who bought into the snake oil of mortgage securities and tossed in a few hundred million dollars.)

[anon]

Wow.
The self-righteous idiocy on display here is unbelievable.

First of all, if you voted for Bush, shut your mouth. You have nothing to say about this because you helped install the architect of this mess.

Second, no neg-am borrower, no matter how egregious, should be "punished" until the entire Bush/Cheney mob is doing life in a SuperMax. It has been their policies that created this credit mess to hide the looting of the US Treasury to fill the pockets of their cronies and propagate a holy war in Iraq.

Third, to all you holy, pure, fiscally responsible saints, you are just as complicit in this mess as anyone else. You voted in the people who did nothing to stop this. You sucked at the teat of this economy as it was overheated by cheap money. You prospered off the myriad economic side-effects of the swindle...just like everyone else.

Finally, to demand that nothing be done to help stave off total collapse of the economy because it offends your precious sensibilities and (this is lowest of the low-brain rants) because you're "a taxpayer" is complete idiotic, self-righteous, self-serving vanity.