Subprime Solutions: Private or Public?
Even the current administration seems to be giving up on the idea that we should just wait out the subprime crisis and let the perfect market correct itself. Now the battle is shaping up over whether to act through a private, negotiated deal or to change the laws and bind the lenders.
David Sirota weighed in with support for one piece of proposed relief: amending the bankruptcy laws to permit renegotiation of home mortgages. In the special way that only Sirota can do, he lays into the Democrats who are siding with the mortgage companies to fight helping families with high-priced loans that exceed the value of their property.
Secretary of Treasury Paulson announced work on a private-deal approach that would stop the subprime mortgage meltdown by leaving borrowers in their current teaser rates longer. Homeowners in trouble will be divided into three categories: those who can continue payments after an increase, those who can continue payments only on the teaser rate, and those who can't even pay the current teaser rate. The plan is that first group pays, the middle group gets help, and the last group gets moved out.
The economic idea behind both the bankruptcy amendment and the private deal is that dumping all the troubled properties on the market at the same time will chase home prices down further. The private deal would hold some people in their teaser-rate mortgages longer, and the bankruptcy plan will move some people into long-term fixed rate mortgage that would pay 100% of the value of the property. The two approaches use different measures, but both say that people who really can't afford the homes need to get out.
There are a zillion issues in both plans, but four questions about the not-yet-released deal have me worried:
1. Will the plan stop the slide in the real estate market? The implication of the early reports is that the freezes are temporary. If that means the mortgages will be frozen until these people can be shifted into fixed, 30-year mortgages they can afford then it should have a stabilizing effect on the market (like the bankruptcy proposal). But if the plan is to jump up rates in six months or a year, then the real estate market is unlikely to stabilize. Buyers will wait, knowing that more distressed buyers will be selling soon.
2. What is the infrastructure? The bankruptcy courts regularly value real estate and test borrowers ability to pay. Will there be a new infrastructure to make the sorting decisions that the voluntary plan proposes? Or will the lenders make the decisions?
3. What is "voluntary"? If the Treasury plan is designed around voluntary give ups, then it may be an illusion that delivers little. If it is mandatory, then Congress will need to get involved. Unlike the bankruptcy proposal, which must pass Congress but that meets clear Constitutional guidelines, the private deal has no clear legal basis. Forcing wholesale revision of mortgage terms will result in a flurry of lawsuits, enriching the lawyers and tangling up the homeowners.
4. Bankruptcy screens debtors differently (see, for example, the means test) and would likely provide relief to a smaller group of people. Of course, once debtors had the power to rewrite their mortgages in bankruptcy, their negotiating leverage outside bankruptcy would change as well.
Most importantly: By trying to make the mortgage workout a one-time deal, does it stall the kind of legal change that would clean up the mortgage industry and that would help families whether they are the only one in trouble or one of two million?
I don't like the bankruptcy plan (though I believe the reform is a good one) since it forces people into bankruptcy which has a lot of negative side effects and some people might prefer a foreclosure to the bankruptcy process.
December 2, 2007 5:36 PM | Reply | Permalink
it stall the kind of legal change that would clean up the mortgage industry...
well, you want real-estate prices to stay artificially high so things won't be "cleaned up."
the problem with housing: incomes aren't rising as fast as mortgage payments; i.e. that's a systematic problem that won't go away.
I, for one, won't be buying a house because home debters want me to pay off their equity loans as well as the house and property.
I doubt congress will outlaw equity loans but, in my opinion, they certainly won't help long term price appreciation unless salaries go up and debt can be passed from one person to the next. of course, if salaries go up, we have inflation and nobody likes that either-- especially the middle class.
in the end, both bankruptcy legislation and frozen interest rates are needed because if a home has negative equity and the home debter has to move and nobody wants to buy their debt, then bankruptcy or a short sale will be needed to offload that debt.
To boldly go...
December 3, 2007 7:36 AM | Reply | Permalink
Bush is only trying to keep the lid on it till he's out of office. He would never go against the interests of the lenders, and he would never consult a Congress that wouldn't hold him accountable anyway. (He has a strong-man's sense of pride.) But, this doesn't speak to the longer-term trend. Two things you can count on in the emerging political environment:
1. Financial security will increasingly be shifted from post-Boomers to those who are Boomer-aged and older. Medicaid Part-D was a shot across the generational divide.
2. Financial security will increasingly be shifted from aspiring homeowners to homeowners. But, this will mostly be a reflection of #1.
Redistribution follows political clout. The real, long-term battle in American politics will not be red state vs. blue state or urbanites vs. suburbanites. It will be intergenerational and housing costs will be a key flash point. That doesn't mean the Democratic Party and people like Prof. Warren won't care about the interests of post-Boomers. They will. They just won't be able to do anything about them until post-Boomers threaten to take down the party. But, it will take 10-15 years from now before enough post-Boomers are frustrated enough to deliver their political weight en masse. And, the degree to which the party can respond will depend on the degree to which it has rid itself of reliance on corporate donations.
December 3, 2007 10:07 AM | Reply | Permalink
The principal advantages of the Paulsen approach over a bankruptcy-based, write-down-the-mortgage-to-depressed-value approach are (1) the bankruptcy approach requires a bankruptcy filing which citizens find undesirable and only invoke as a last resort; and (2) the write-down-the-mortgage approach will cause financial institutions to impose high down payment requirements to protect against the write-down risk, thus reducing financing to lower and middle income people and delaying home purchases for upper middle class people, and even upper class earners who do not have parents' contributions to assist the first purchase. The write-down-the-mortgage approach will also gut the home equity loan market for the same reason, which will impact home renovations, college funding and other ways in which ordinary people try to advance their station in life in modest ways.
I hope that the bankruptcy-based approach will fall by the wayside as it is a classic example of the cure being worse than the disease. I also hope that any reform will be limited to owner-occupied properties and not speculators and provide no relief for borrowers who misstated their income on their applications, of whom there are many, probably too many to prosecute.
I think strong enforcement of laws already in place will solve much of the existing problem. The only reforms we need are (1) requiring states to license brokers,(2)requiring deferral of loan broker and originator compensation until some reasonable time has passed during which the loan is performing and (3) providing (a) a brief stay of any foreclosure of a primary residence and (b) an equally brief publicly funded examination of the loan being foreclosed to determine whether the borrower and the lender complied with law at the time it was made and that the lenders' charges are correct. If so, then there should be no relief to the defaulted borrower. If a law was violated, then relief shold be granted but by definition no further laws are needed.
December 3, 2007 12:24 PM | Reply | Permalink
Good observation. The problem with your approach is that it is reasonable (and should have been championed by Democrats five or ten years ago when they were busy mostly looking the other way). As it stands now, lenders and homebuyers want government to let them off the hook plain and simple. (Bush is siding with lenders, Democrats with homebuyers.) For Democrats, this can only be done as part of a major "reform" package sold to us under the guise that A) most borrowers were "misled" and, B) the idea that, if we don't "take action now," it will hurt us all worse in the future. It's amazing how much foresight we have when the $h!t finally hits the fan.
We couldn't see it coming, but--now that it's here--we know just how far it could go.
December 3, 2007 1:06 PM | Reply | Permalink
I have no objection whatsoever with Prof. Warren acting as a lawyer -- that is, representing her sub-prime mortgage clients to the best of her ability and to the exclusion of interesting herself in broader economic issues. But Paulson & Bush's and the media's crocodile tears are phony -- PR fluff intended to take our eye off the ball and to prevent us from participating in the decision of what the government should do to bail out the financial markets.
Paulson's plan, the details of which are unannounced, is no more and no less than a straightforward attempt to protect the banks' balance sheets in order that those banks be able to continue to finance the economy in the near future.
We may agree that the banks' capital must be preserved, but we should be asking what cost the banks and their highly paid managers should be paying for the "bailout," the need for which they are responsible.
December 3, 2007 1:44 PM | Reply | Permalink
Odd thing to say.
I am a boomer and own my own house having payed off the mortgage some time back. What kind of political warfare do you propose? Price controls. Rent controls. Seizure through eminent domain and reselling as affordable housing?
December 3, 2007 1:59 PM | Reply | Permalink
Re: (2) the write-down-the-mortgage approach will cause financial institutions to impose high down payment requirements to protect against the write-down risk, thus reducing financing to lower and middle income people and delaying home purchases for upper middle class people, and even upper class earners who do not have parents' contributions to assist the first purchase.
First time purchasers can obtain financing through the FHA with as little as 3% down. Lenders can't change that and since the FHA basically insures the loan against default they have no real incentive to do so.
Re: I also hope that any reform will be limited to owner-occupied properties and not speculators
One reform I would urge however: renters should be protected when their landlord is foreclosed on. At a bare minimum, 60 days notice should be required before a renter can be evicted from a foreclosed property. Better still, the mortgage holder should be required to honor the lease through its term as long as the renter continues paying rent.
December 3, 2007 5:54 PM | Reply | Permalink
No one saw it coming. Our top cop -- Ben Bernanke -- needed a private seminar with the banker quants in August so he could learn what the hell a SIV is.
Or, when credit is easy and volatility is low, no money manager ever lost his job for taking on heightened risk. In that environment being conservative -- not keeping up with one's peers -- leads to a quick and certain retirement. As long as the good times roll, there are profits to be made and bonuses to be awarded. When the music stops, to switch metaphors, the losses will be someone else's. It's always OPM that's at risk.
December 4, 2007 12:30 AM | Reply | Permalink
I am a boomer...
folks like my grandmother drop a buck in the collection plate at church and think they're being generous. the intergenerational fight will be the elderly getting mad at the youth for not being principled enough to take care of them and the youth will get mad at the elderly for paying them the wages of a slave.
To boldly go...
December 4, 2007 11:09 PM | Reply | Permalink