Paulson: Massive mortgage workouts needed

Happy Thanksgiving.

Based on the response to the previous item, it's a safe bet this piece of news will not be popular on this blog: "U.S. Treasury Secretary Henry Paulson, convinced individual workouts will not solve a worsening mortgage crisis, is pressing the industry to help large groups of borrowers qualify for more affordable loans."

More, from Reuters tonight: "In an interview with the Wall Street Journal, Paulson said he he was 'aggressively encouraging' the mortgage servicers who collect payments from borrowers to develop new criteria that would allow large numbers of borrowers to qualify for mortgages with better terms.  This is a shift from Paulson's previous strategy of encouraging the industry to work individually with borrowers."

The other headline from the WSJ interview is that Paulson predicted the default/foreclosure problem "will be significantly bigger next year because 2006 (mortgages) had lower underwriting standards, no amortization, and no down payments."

In other words, if you thought the 2005 vintage of mortgages was crappy, you ain't seen nothing yet.

Paulson's comments raise a lot of questions, not the least of which is whether this is good policy.  I know in advance many of you think it's terrible policy, and that it encourages and rewards borrowers who made poor financial decisions. Beyond that: Will Paulson's jawboning work? Will lenders rewrite mortgages by the hundreds of thousands without any regulatory or legislative relief in return? Will the investors who own the mortgages agree, again without anything in return?  Or will there be some horse-trading behind the scenes?

Update: Tanta, in a "Dear Mr. Paulson" post at Calculated Risk, opines on likely horse-trading and regulatory relief: "Concrete bennies have to be put on the table. Regulatory relief. Fun with reserve and capital calculations. Approval of mergers and acquisitions. You know the drill. This is about maximizing profit. You are going to have to do something that makes this profitable, if you're going to expect lenders to do it on a large scale. Your job, of course, will be to write the PR that says that all this "regulatory relief" to for-profit banks and mortgage companies is all about Helping the Poor and being Heroes to Homeowners."

Your thoughts? Comments? Insights? Email story tips to lalandblog@yahoo.com.
Photo Credit: Treasury.gov
Hat tip: Sunsetbeachguy

Comments

[Cal]

Think about why they are starting to push on this. It isn't just housing for them, large scale housing defaults deflates the credit bubble very quickly, they now recognize the issue and need time to manage it.

Will propping up housing prices slow down transaction for a long time? Yes. Will this transactional lull hurt the economy? Yes. But I am guessing the calculus of the situation is that housing pain like that is manageable, they are worried about systemic credit market failure and are trying to go to incredible lengths to make sure that doesnt happen.

It is similiar to what is happening in Europe with the covered bond market (they stopped trading). They would rather have no trades and true market prices not be revealed than low distressed prices which affect everyone. Homeowners essentially "mark to market" their homes, just as banks have to "mark to market" assets on their balance sheets. Both are extremely leveraged right now and will have tremendous issues if they are forced to face their reality.

Their are of course a tremendous amount of unintended consequences about this approach. But ignoring any of them at the basic level I think there is little chance for success. But apparently making illiquid markets more illiquid is going to somehow reduce volatility (not something that ever worked historically). This is purely a desperate move to buy time and work on a hail mary.

[Ann]

(1) Will lenders rewrite mortgages by the hundreds of thousands without any regulatory or legislative relief in return?

Highly doubtful. The loans are too bizzare and substantial rewriting would (a) delay repayment of the principal beyond the point of acceptability and/or (b) put the lender in a negative position with the interest IE: lender borrowed the money at X% in order to lend and agreeing to accept an interest rate that is lower than that leaves them with a negative cash flow and a break-even interest rate leaves them in the soup with their shareholders

(2) Will the investors who own the mortgages agree, again without anything in return?

The short response is they would agree to that when pigs will fly.

An investor will absolutely not agree to modification without getting something in return. It could be adding accruing but unpaid interest to the backend, it could be a balloon payment of the loan in 2-5 years, it could be a lump sum payment of all or part of any interest which they would forego.....

The idea than an investor would agree to lowering the principal owed would be a complete non-starter.

(3) Or will there be some horse-trading behind the scenes?

With whom? The company that originated the loan? The company servicing the loan? The multiple investors who own the loan?

The servicing companies can not even identify who OWNS a lot of these loans.

That was the issue in the 3 groups of foreclosure cases dismissed in the US District Courts in Northern Ohio. The servicer filed the foreclosure but could not prove who owned the loan and was the successor in interest to the mortgage. (The loan note which is the debt for the money is one thing and the mortgage is a seperate thing which grants a security interest in the property.) If the servicing companies in those cases could have identified the owners of the loans, they would have done it in heartbeat and produced the documentation to establish the chain of ownership. Instead they spun their wheels as they couldn't figure out who owned it. In the one case, the Judge was highly suspicious of what documentation they belatedly produced which was dated after the foreclosure was filed and which had been solely prepared by the servicing comany's lawyers on that case. The Judge all but accused them of falsifying documents and creating fraudulent documents. (I practiced in Federal Court for years and, after reading the Court's opinion, would recommend that those lawyers avoid theFederal Court for a few decades - Judges have very long memories.)

A lot of these loans are 80/20 piggybacks. There are two different sets of loans secured by a mortgage. That means 2 different lservicing companies and 2 different lenders (if they held their own paper) or 2 different groups of investors (scattered all of the US and the world) if the loan was sold. That would be an utter nightmare to co-ordinate and to reach an agreement among al the parties.

Bottom line is that no matter how much a property may appreciate in value, sooner or later the borrower has to pay back the amount they borrowed. If the house was $400,000 with 0 down and an 80/20, it won't matter if it shot up to $1,000,000 in value. The debt is still going to be $400,000. The best the borrower could do would be to refinance it into one loan with maybe a better interest rate but that rate will still be at least market rate. Add to that the return to tighter lending standards such as documented income and the 28/36 debt/income ratio, and on that $400,000 loan, the borrower is going to have to PROVE at least a $105,000 income or better.

It is the tighter lending standards that are creating the diminishing ool of buyers. It is chicken 'n egg question. The number of potential borrowers (buyers) is substantially reduced it they have to prove income and not exceed that 28/36 debt/income ratio. Fewer buyers reduced demand. Less demand means prices have to drop. Basic Econ 101.

Frankly, Paulson's comments smack of desperation (as does the Gubenator's very undefined deal with 4 lenders.) The olicymakers are panicked, see no solution that preserves the status quo of the past 4-5 years, and are grasping at straws to get breathing room in the short term. (And there is an election next year.)

[arroyogrande]

How about this angle...

"Paulson said he he was 'aggressively encouraging' the mortgage servicers who collect payments from borrowers to develop new criteria that would allow large numbers of borrowers to qualify for mortgages with better terms...Paulson predicted the default/foreclosure problem "will be significantly bigger next year because 2006 (mortgages) had lower underwriting standards, no amortization, and no down payments."

So he wants the loan industry to "develop new criteria", to help solve the problem *caused* by the lending industry developing "new criteria" (low underwriting standards, no amortization, no down payments).

Absolutely brilliant.

Hey, if he can convince mortgage servicers (and the investors that back the mortgage pools) to eat the loss in assumed future revenue that these loans were supposed to bring, then more power to him. However, I see one of two things happening (or maybe both), assuming that "better terms" includes "lower rates/continued teaser rates":

1. Credit tightens even more as lenders/investors realize that renting out money at "better terms" for 2 to 5 *more* years isn't a healthy business proposal. I wonder what those mortgage backed bonds will be worth when the future income stream is discounted?

2. The rates aren't REALLY lowered, and the additional interest needed for the loan adjustment is just tacked onto the principal, basically converting a resetting ARM into a ticking time bomb negative amortization-ARM...to keep the homeowner in the house just long enough for the loan to get sold to someone else, hot-potato like.

These are the same concerns that I have with Schwarzenegger's proposal.

- arroyogrande

[mike]

Since so many mortgages were written that banks etc had no business writing, make them restructure them. I'd much rather they suffer from their predatory practices than the people they preyed on.

[sunsetbeachguy]

For the best insider analysis on this issue read Tanta's letter to Paulson.

The money quote is "I'm from The Blogs and I'm here to help you."

http://calculatedrisk.blogspot.com/2007/11/
dear-mr-paulson.html

[Steve]

This is a good idea, expecially for CA. I know how the majority feel on this blog, yet the reality is no one, even those waiting to buy, win with the potential number of foreclosures on the market. The deals will stil be out there even with this group policy.

[amir]

Give me a break. The politicians just want some good press to make it look like they care. Also, they worry that this housing debacle will topple the economy (it will).

The horrible truth is that there is nothing they can do. People will lose their homes. RE prices will drop. Recession will happen. There is no magic bullet. You can not fix an economy that is basically built on capitalism by suddenly saying: oops, sorry, we meant markets work only when it brings prosperity not recession.

The sad truth is that we have overspent and lived above our means. We need to pay the price. That is true both on the citizen level and the government level.

[dog-walker]

I see three options. Which is best?

1. Find some way to provide loan reworking to potential defaulters so they can stay in there houses. (Somehow by a previously unknown form of magic maintaining current housing prices and therefor destroying the buying power of EVERYONE, wage slave to idle rich.)

2. Find some way to provide loan reworking to potential defaulters so they can stay in their houses (despite prices that are correcting to historical norms. BUT, who WANTS some form of loan reworking-- i.e. lengthened and heightened indentured servitude -- on a rapidly depreciating asset?)

3. Take the hit from defaults and move on.

My slant is as Peter predicted in response to Paulson's comments, but take my slant away (if you can, I obviously can't.) Is there any other option?

[Aaron Kramer]

Those of you who think this is a good idea just don't understand the true implications. Real Estate prices are headed south because they were over inflated and unaffordable. Many people were able to purchase homes because of the availability of cheap credit. Now that prices are dropping isn't in the home owners best interest to walk away from homes they can't afford rather than service the debt on a upside down loan? This plan benefits the lenders and government not the home owners. The home owners will be slaves to their unaffordable debt for a generation or more. Lenders don't want large inventories of homes that are falling in value. If they felt that the market was stable or heading up wouldn't they salivate at the opportunity to obtain homes for future resale on the cheap? I know it is counter intuitive but the best thing for the vast majority of home owners who are upside down on their loan is to walk away now while they can. Just consider making payments on a $400,000 loan when the house is only worth $250,000. The companies offering help are the same ones who sold the bad loans and now they are offering a backup plan that helps them and screws the borrower a second time. Does anyone really think that the lenders are suddenly altruistic? This program is criminal and immoral and I hope home owners walk away while they can. The nice thing about mortgages is that they are nonrecourse loans. The lenders can't go after your other assets to be made whole. This crisis will not pass in a few years it will take at least a decade,. If you don't believe me look at Japan. Good luck and Happy Thanksgiving to all.

[tew]

Folks, Paulson is a banking establishment insider to the core. He will figure out a way to use tax dollars to subsidize this program. For the handful of citizens paying attention it will clearly be a government subsidy. But for most, the spin will make it look like the banks and other private institutions are taking the hit. For instance, they'll do something like providing low rate borrowing facilities to the banks. This will amount to a direct subsidy, but can easily be spun to confuse a large majority of people.

[Mary C.]

Isn't it true that most of these mortgages can't be redone even if the lenders wanted them to? The mortgages are based on paper sold on worldwide markets, sometimes changing hands more than once. Now, those markets have pretty much dried up. The capital is no longer available to do what Paulson wants to see done. I wonder if the people in these positions even understand why this happened in the first place, or why it's so difficult to fix. They still think/live in the world where the local bank made all home loans.

[LA-renter]

To all the little people who are stuck in this mess: Beware of the "relief"!

"Look, the lenders are gone... and they've left us this beautiful giant horse on wheels..."

Some months ago, my first thought was: "Man, this bursting housing bubble is going to hurt the big cats." This bubble is different. It's big money that's stuck holding the bag.

Life is unfair, and the goverment has priorities. You are a lower priority. So, everything that's politically feasible will be done to save the big cats.

Relief should be examined in this context. The "relief" is not for saving your house or your credit. The relief is meant to queeze out the last penny you have.

[Ann]

I was reading the main post to my husband and got to the sentence

"Paulson said he he was 'aggressively encouraging' the mortgage servicers who collect payments from borrowers to develop new criteria that would allow large numbers of borrowers to qualify for mortgages with better terms. "

He shot back - Been there, done that and look what happened when the lenders "develop new criteria that would allow large numbers of borrowers to qualify for mortgages...."

Have to agree with him - I hadn't focused on the absurdity of that sentence,

The lenders claimed that the 2/28s, 80/20 piggybacks and option ARMS were "better terms" for those who couldn't qualify for a 20 or 30 year fixed.

Can't say the lending industry has demonstrated such good judgement as to lead anyone to believe that they can come up with new loan products to get out of the mess.

[Brother Joe]

Most people who write on this blog don't make any sense...

The facts are in...Lenders screwed up....by making faulty loans...

In my opinion, the stupidest "Loan Product" that ever came up is the "80/20"...

You can not even finance a "Yugo" without a downpayment...

How can you give home loans with no "Money Down"?

The number of bad loans is very "Minuscule"....

Keep wishing for "Home Prices" to crash!

[Nancy Fleming]

I have purchased two homes in the last eight or so years. Each home I purchased was based on what I could afford now and in the long term. I conservatively opted for a 30 year fixed rate mortgage. I knew I would have to pay for the mortgage on what I earn now and in the future. In the future I hoped that my earnings would increase and that I would have extra money based on my mortgage staying the same and not increasing. The opposite formula seems to have been used in many mortgage home loans.

I am not a savvy person when in comes to finances and the intricacies of home mortgage loans, but I am pragmatic. My goal was to purchase a home that I could afford to pay for and to, again, hopefully, be able to keep my home and even use it for my retirement via a reverse mortgage program.

I sort of understand people being blinded by their dreams and wishes and being drawn into loans that look so good now, but I do not understand how lenders with all of their knowledge could not see a melt down in the future of foreclosures and unpaid loans.

How could the lenders not know that when the adjustable rate adjusted the people they loaned money to would not be able to pay? I am certain money was made by the top echelon, but overall it is so bad for the economy How could they have in good conscience granted these loans? And how could the government not have the oversight to see it coming and put and halt to it?

Now the government is looking to step in and help the folks that got in over the heads. I have two conflicting emotions on this. My first is – why should those that did not use their heads and review all of the documentation and make a good financial decision be bailed out? My second, more selfish emotion is – BAIL THEM OUT. The more homes that are on the market will decrease the value of my home – supply and demand.

It is a very complicated thing. But I do know they lenders are not stupid and should have seen they would be taking a loss on all of the loans upon which they now cannot collect.

I wonder if there is a cottage industry here lurking in the background – all set up in advance by the financial institutions that should have known better in the first place. Follow the money and if it stinks, prosecute those who have profited by the loss of all of these homes.

[are they crazy]

Which loans for whom? What about those that had a decent loan and chose to extract their equity and now don't want to pay? What about those that were flippers and speculators? What about those that lied about it being their primary residence or lied about their income in order to get a loan? Once you remove all the garbage, how many loans are there actually left to "save?" Blaming the banks - I don't think so. I haven't seen a story yet where a loan officer or mortgage broker put a gun to anyone's head and forced them to take any loan, nor have I seen stories of realtors forcing people to buy homes. They made easy money available, but so what, drugs are easily available too. Does that mean you should buy them? Many people knew you don't buy a house that is more than 3 times your income, period. In order to afford a $500K house, you would have to make over $166K/year. If you fix all these mortgages it will just keep the overinflated house prices overinflated and reward irresponsible people. A good plan - not so much.

[Jonah1979]

What rich people like Henry Paulson don't realize is that it doesn't matter if you restructure these loans. People could only afford them because they were on 2/28, ARMS etc loans. I'm sorry but a family with a household income of 75 - 100k and needed a special loan, can't afford a 600k house whether it's on a fixed 30 year or not.

[Keith]

The thing is that someone's gotta take a hit somewhere and if the gov't is going to do anything real to help this out then the person left holding the bag is the taxpayer in general. How can these teaser rate loans that would be re-structured make any money or break even for the investors/servicers holding them now if they are only allowed to adjust upward a small amount or none at all? Even if the gov't split the diff on the loss wit the loan holder, the taxpayer would still shoulder the burden at some point. Well, Hillary's going to raise taxes & Obama thinks anyone who makes over $97,000 a year is upper middle class so maybe it's unavoidable anyway.

[Don Condliffe]

Interesting comment by Aaron Kramer that people should "walk away" from homes that have" upside down" loans where the amount owed is now much more than the current home value. Of course "current value" in the current situation is a lower value set by lower current demand which resulted from an over correction in underwriting practices.

What is missed in all the comments I see here is that large numbers of people being forced and or chosing to walk away from their homes is just what would trigger a liquidity crisis, deflationary spiral and a great depression. That is the looming catastrophe that Paulson is scrambling to prevent. Hopefully enough people will get the logic of avoiding a general collapse of world trade and economic activity, so that a soft landing can be arranged. That is a valid reason for a tax payor assisted bailout, even if some bad decisions don't get punished.

[Rich]

It was reported elsewhere that a move is afoot to change the bankruptcy laws to allow judges to restate the value of homes in foreclosure in order to facilitate keeping people in them. So the matter may be achieved through bankruptcy law if it doesn't happen in the lending market. As for incentives to investors, investors face material losses if large percentages of the packaged mortgage shares they own are foreclosed and sold at discount, so staving loss of value of their investment is their "incentive".

The anecdote coming from the field is that troubled borrowers are facing lenders who won't negotiate with them in a timely fashion, so by trying to preserve their particular positions lenders are just making some or all of the various bailout methods inevitable. In fact, such behavior may be indicating they already consider imposed solutions to be inevitable...

[A Proposal]

I'm wondering if something like FDR"s "bank holiday" would be appropriate--that is, have a single day where the mortgage of everyone who has purchased a house since, say 2004, had their mortgage examined by a Federal inspector. Fannie Mae loans would be issued for owners who were able to stay in their house at the _current_ valuation, and holders of the mortgages would be offered the choice of being paid off at the _current_ value or going through foreclosure.

The cost to the taxpayers would be the risk on the Fannie Mae loans (the limits could be raised from the 430K or whatever it is now in high cost states), but in general, it wouldn't be that much. The cost to the mortgage holders would be non-existent, as they can always force the property owner into foreclosure as before, or they can get back a large chunk of their money immediately (and probably more than if they forced into foreclosure).

Only the federal government has the money to capitalize a trillion or so dollars worth of loans, so it couldn't be private (though it seems to me private companies could offer a program like this). But if the Feds did it for a limited time period (it doesn't have to be a single day) we would at least get it behind us, which was the intent of FDR's bank holiday (which also got the bank crisis behind us).

[Dave]

>> You can not even finance a "Yugo" without a downpayment... How can you give home loans with no "Money Down"? <<

A Yugo depreciates a LOT the moment you take it off the lot. A down payment is required so that the value of the car is always greater than the amount of the loan outstanding. A house doesn't usually depreciate the moment it's taken off the market; for the last 20 years housing had been going up at varying speeds. The difference is real and important.

[Ann]

"Obama thinks anyone who makes over $97,000 a year is upper middle class so maybe it's unavoidable anyway.
Posted by: Keith"

Obaa is correct. An income of $97,500 puts your household in the TOP 16.47% of all households in the US.

That means you have an income that is more than every 83.53 households out of every 100 households.

Definitely NOT "middle" income. It is not even upper middle income.

Oh, and save the 'but it is middle class in LA stuff. In LA county, that income of $97,500 puts you in the top 21-22% in income.

Still NOT 'middle income' as you have more than 80 out of every 100 households.

Poor is the very bottom (0) to the 20th percentile of income.
Lower middle class is from the 20th percentile to the 40th percentile.
Middle class is those at the 40th percentile mark to the 60th percentile mark.
Upper middle class is from the 60th percentile to the 80th percentile.
Rich is from the 80th on up.

Nationally, $97500 is NOT upper middle income.
In LA county, $97,500 is just barely within the upper most reaches of upper middle class.

[Aaron Kramer]

FDR's "bank Holiday" also bankrupted half the private banks in the country and handed the Fed a monopoly over the financial system. The Federal Reserve took over 10000 banks during the bank holiday. Additionally FDR confiscated all gold coins in the country at $20 an ounce and 3 months later took the fixed price up to $35 dollars.(Nice Trade huh!)

With regards to avoiding a Depression and reworking everyones mortgage after a certain date both are impossible to achieve. We are headed to a Depression because the Federal government, virtually all state govs and most cities are flat broke. ADDITIONALLY MANY MAJOR FINANCIAL INSTITUTIONS ARE ALSO INSOLVENT and most consumers are also finished. The rest of the world is building up its infrastructure with their own savings and we need 3 BILLION a day to keep the party going. After we renegotiate /renege on the debt that we owe foreigners,they hold a unequal proportion of the underlying securities, do you really think they will continue to finance our lifestyle. Are you nuts!

Those of you who think this is a small problem don't understand that there are derivatives on derivatives and this has magnified the problem 300 fold. It is not just 1.5% of the mortgage market the problem is multiple trillions and possibly 10s of trillions.(This is JP Morgan's derivative problem) The only hope is to take our medicine and save the limited capital we have and rebuild anew. If we allow bailouts for those who put us in the situation then we will all suffer enormously.

"The inherent vice of capitalism is the unequal sharing of blessings; the inherent virtue of socialism is the equal sharing of miseries. "
Winston Churchill

[Keith]

Ann,

Thanks for your comment! Your right about the statistics, so what would a true "middle class" income be here in So Cal? Is it in the 40 - 60k range? I'm being serious, just curious. If it is, then there isn't much room for the middle class in So Cal, no doubt. If you compare the average cost of living across the US with the average wages, filter out all the regional static, then where does that So Cal wage stand? I've always thought the tax break to buy a house is a crock, why should one taxpayer get favored treatment over another because they sign a mortgage. Do away with that first, or give back favored tax treatment for interest on any kind of debt to everyone.

So how are we going to sell all these $800k homes? Or even $600k homes? Say massive debt relief does come down for real with the gov't shouldering some of the burden, does that leave a wide swath of So Cal living in a a nice home eating crackers and driving an old jalopy? It's not like the homeowners are going to walk away free and easy, they'll have to take some of the burden as well. What happens to the consumer fueled economy of So Cal? I don't want to see anyone kicked out of their house, but what is the alternative? Is the "cure" worse than the sickness? Rip the bandage off fast or slow, it's still the same result.