Bailing from the Bottom
Not technically a bail out per se, but Jeffrey Ely (via Sullivan) has a great idea that should warrant more discussion:
True just sending money is not incentive compatible. But there is no reason to bail out homeowners. Just intervene in any mortgage default. Seize the property and continue making the mortgage payments. In the short run rent the property back to the homeowner.This is what I have been advocating to my colleagues. I don't know why it is not under discussion. Before going with the arbitrary implememtation that Paulson is proposing now there should be some convincing argument that it's more efficient than this alternative. It is clearly the most direct approach and therefore should be the default (so to speak.)
I like it a lot. It keeps homeowners in their homes with a chance down the road to get those homes back, thereby keeping neighboring property values steady, and avoids the blank check payouts to the banks. It makes a lot of that "bad debt" into working debt (though still pretty bad in my book), and restores some of that predicted cash-flow up stream into all those "what the hell is that?" financial instruments everyone was so high on a few short months ago.
Anyway, thoughts? Reactions? Love it/hate it?
I like Galbraith's idea better.
I've e-mailed the above excerpt and link to my representatives with the subject line:
Bailout - Listen to Galbraith
September 25, 2008 11:13 AM | Reply | Permalink
I think there are some very pragmatic ideas in there. And this is why I am so concerned about the rush to do something, anything. They are going to get it wrong. They do not have enough time to think everything through--which is the root of all of our problems(combined with information wars).
I hope they DO take Galbraith's prescription to heart.
September 25, 2008 11:28 AM | Reply | Permalink
c4,
Galbraith and others will put forth plans that are much better than what we'll get from Congress and the Bush gang, but that's because people like Galbraith aren't looking out for the denizens of Wall Street first.
CNN is reporting demostrations around the country, people protesting the bailout.
September 25, 2008 3:15 PM | Reply | Permalink
Good point. How do we get the majority to do the same?
September 25, 2008 3:23 PM | Reply | Permalink
c4,
sad to say, but Dodd and Schumer were right there in 1999 pushing for deregulation of the financial markets,
Clinton/Dodd/Schumer = Gramm/Leach/Bliley.
"Financial Services Modernization Act" my ass, welcome to cowboy capitalism, the sharks are in the water.
September 25, 2008 4:12 PM | Reply | Permalink
c4,
sad to say, but Dodd and Schumer were right there in 1999 pushing for deregulation of the financial markets,
Clinton/Dodd/Schumer = Gramm/Leach/Bliley.
"Financial Services Modernization Act" my ass, welcome to cowboy capitalism, the sharks are in the water.
September 25, 2008 4:15 PM | Reply | Permalink
There are many who have lost their homes, and many more in forclosure, and many more near forclosure, and many more destined for forclosure.
When all this real estate is collateral for fancy leverage, the leverage unravels. But because the mortgages were bundled and securitized, there was no one distressed home owners could negotiate with to restructure their loans.
Restructuring loans happens all the time to businesses. It would have been in the interest of mortgage holders to do so with home owners.
But in recent years a very bad practice was initiated: selling used cars to poor people for whatever they could pay. Their payments were computed right at the edge of doability--if they made their payments--the seller sold a used car for a very high price. If they defaulted, the car was repo'ed and resold--this was a very lucrative way of feeding off the poorest layer of the economy.
Mortgage lenders tried the same thing with fancy subprime loans and balloons. I have heard testimony from brokers who were instructed to guide the riskiest borrowers into subprime loans. They were often encouraged to buy more house than they could afford--they were also lied to. When borrowers would ask if this was a 30 year fixed mortgage they would be told yes--even though it was a lie. Well, Caveat Emptor. Except that this is what began the great unraveling. First the subprimes failed, and the inventory began to accumulate then the people with baloons saw their home value begin to decline, and dumped them on the market, increasing inventory. As value declined, more and more people dumped their property, hoping to cash out before they lost their equity. In many cases, the rates reset, and people could not afford the new payments. Then home values declined to the point that even people with 30-year fixed mortgages simply walked away from them as the value vs obligation grew wider every month. And all the leverage unravels.
Your plan helps those people who WANT to stay in their house but cannot afford the new higher payments that happened when their subprime or baloon rates reset. Or those who lost a job, had an illness, whatever.
But it DOES NOT address the problem of people who are walking away from sometimes very expensive properties--where the pool turns green, the grass grows 3 feet high, and a crack gang move in and squats.
It DOES NOT address the problem of some forclosures that were abandoned, and then people came in and stole all the wiring, the sinks, toilets, anything of value.
If Uncle Sam buys up these properties for the original value of the loan, then Sammy must fix them all back up and maintain them until the eventually DO sell, sometimes in very distressed neighborhoods--and perhaps at a fraction of the original price.
Of course, If those who receive the property following forclosure walk away and refuse to maintain the property--there is going to be a serious housing crisis. And no fail safes were ever built in to prevent this kind of utter decomposition scenario. Anything that can keep a home owner in their property is a good long term thing. But how many want to stay in their now unsellable, cheap properties?
September 25, 2008 11:26 AM | Reply | Permalink
Excellent post!
I'd add that loan terms and conditions aren't given to the Mortgagor or Trustor until signing (at least in state using Title Insurance Co as third parties). So at the very end of the process, a legal, complicated, multi-page document is presented. Who is going to read and understand the fine print while under time constraints and wanting their new house or money from their refinance? And how many people would walk away from escrow at that point. Another issue is closing cost estimates vs actuals. Federal law requires a best estimate of cost be presented to the parties prior to close. The lender is given a per cent over run allowance Somehow loan fees are greater at close than estimated, sometimes dramatically so. Again, the borrower wants their property and bites the bullet.
Of course these issues aren't being address during the debate. Best Congress money can buy.
September 25, 2008 12:07 PM | Reply | Permalink
Yes. WE know the reason why these contracts run to 30 pages. And, as the child of an attorney, I was taught as soon as I learned to read and write never to make my mark on a contract that I did not read AND understand.
But many, many people who are doing this for the first time simpy TRUST those sheparding the process, reasoning, of course, that they could not stay in business if they were crooks, and they were experts at this stuff--so they TRUSTED.
In MY neighborhood, we have some home that were bought by foreign Arabs(read wealthy investors)--and rented out, sometimes to several families within a single family dwelling--a violation fo the neighbood homeowners association covenants--and it was a real hassle to get them to cease and desist. But my point is that it is true that a lot of homes were bought for rental purposes by people who do not live in the United States, and to whom these properties, these neighborhoods, mean nothing. NOTHING.
Most of us have to live here, work here, raise a family here. We've made a commitment. They've made an investment. Easy come, easy go.
You know, like the difference between the Pig and the Chicken at a ham and egg breakfast.
September 25, 2008 12:32 PM | Reply | Permalink
c4,
its probably cheaper to allow the homeowners to stay in the homes for a minimum rent or some other financial arrangement as a way of avoiding the costly vandalism/theft you referred to. A house that originally sold for $3 or 400,000 could easily suffer $50/75K damage.
As to the bailout, I think any deals Paulson wants to engage in must have co-signers, maybe a Senator and a Rep. from each party with an independent chair. Send Diogenes out to find an honest man to chair this group.
Any deal Paulson wants to engage in MUST have ELECTED persons signing off on it.
September 25, 2008 1:46 PM | Reply | Permalink
Yeah, I think protecting the intrinsic value of these homes and neighborhoods while we go through this expensive and lengthy healing process must be a part of the solution. Otherwise we are just chasing our tails.
September 25, 2008 3:25 PM | Reply | Permalink
We're looking down the wrong end of the telescope.
So-called homeowners who are in arrears on their mortgages are better described as "squatters in homes owned by the lenders who hold their notes." Generously, we could call them "renters" although they're probably not paying a fair rent to the lenders, currently.
It's the lenders we've got to knock some sense into.
And that means speeding up the foreclosures and getting the houses back on the market and into the hands of real landlords who have the knowledge and interest to take care of the properties and who will rent them out to households who never should have been homeowners in the first place.
September 25, 2008 12:07 PM | Reply | Permalink
Have you or yours ever been on the wrong end of the stick, e.g. lost a job, become ill, become under employed? Did you buy a house with good credit but see the value cut in half while the payment on your adjustable goes through the roof and you can rent a newer house at half the cost of your mortgage.
Another problem is rental prices going through ceiling in certain areas because the newly homeless (this includes renters) compete for fewer rentals.
September 25, 2008 12:19 PM | Reply | Permalink
. . . rental prices going through ceiling in certain areas . . . .
Don't be shy.
Give us a link that supports this over-the-top assertion, would you? And let's not use New Orleans, okay?
September 25, 2008 12:25 PM | Reply | Permalink
Rental prices have risen in the Metro D.C. area, where I live. My son now pays $2400 a month for a modest two bedroom apt quite a ways out of the city. I know Manhattan has rent control provisions. Most areas do not. My daughter pays $1800 a month for a modest 2 bedroom apt in a workingclass neighborhood of Seattle. She works for a real estate management company. She says supply is down and demand is up. And boy are they screening peoples credit ratings, now.
September 25, 2008 12:39 PM | Reply | Permalink
I know you know the old saying, c4Logic.
The plural of anecdote is not data.
September 25, 2008 12:48 PM | Reply | Permalink
Well, sure. I'm just sayin...
September 25, 2008 3:25 PM | Reply | Permalink
Play nice or I’ll take my marbles and go home!
My original reply got lost in the ether. I’m not reposting the urls. Just Goggle for the effect the foreclosure/credit crisis is having on rents. Hint; one was Forbes.com
You didn’t respond to my first paragraph.
Anyway, the dynamics of the housing bubble (i.e. overpriced real estate) has cost some investors (speculators) along with homeowners, to lose their properties to foreclosure. The homeowners’ renters (good tenants, not so good and bad), were/are forced to move by banks and must compete for a limited pool of properties (supply and demand). The foreclosed and often overpriced properties remain vacant and in various states of repair, often increasing neighborhood blight.
My daughter and her husband live in the central valley of NorCal and find themselves in reduced circumstances, (she’s working two jobs now) and can’t afford $1800/month current rent. An equivalent 4 bd house, if you can find one, rent for $2000 to $3000 a month. Smaller, cramped homes rent for $1600/1800 a month. If they qualified for a loan (they don’t), they would pay $1600/month including PITI, with 10% down, for a nice house. Problem with buying these days is the Mortgage industry burnt themselves and now demand sterling credit from buyers.
By the way, I reserve the right to pontificate on this blog and that may include some hyperbole!
September 25, 2008 1:48 PM | Reply | Permalink
You didn’t respond to my first paragraph.
Your claim -- probably correct -- that mortgagors under stress "can rent a newer house at half the cost of [their] mortgage" so obviously supported my argument that I hesitated to point it out.
I do try my best not to embarrass fellow commenters.
September 25, 2008 2:10 PM | Reply | Permalink
Your mind is set, but I'll respond with a not unusual scenario for this area. My niece and her husband, first time buyers and unsophisticated financially, bought a 40 yr old 3/2 for $295,000,no down with an 3/1 ARM. Payment was about $825/month. The mortgage, according to my niece went to $2000/month after 3 yrs. They went into default while trying to negotiate with Contrywide, who bought the paper. Countrywide played hard ball so the family moved to a 10 yr old 3/2 rental for $1500/month.
End of this blog.
Another part of this story, and part of the monetary problem we're in today concerns Countrywide and other paper holders in real estate. The house is currently valued around $150000 but Countrywide treated it as though it was still worth $295,000 (that's understandable) and continued to play hard ball.
Never did it cross Countrywides mind to negotiate and recast the loan. The husband told them he'd wanted to stay if Countrywide would lower the interest and extend the loan; Countrywide said no. The husband told Countrywide he would sign over the deed in lieu of foreclosure. Countrywide said the owners had to list the property for 30 days before Countrywide would accept the deed. Husband said, well we've vacated the premises so go forth, be fruitful and multiple. The property sits vacant and Countrywide is incurring foreclosure costs daily. Weeds have overtaken the yard and the neighborhood suffers. There are no winners in this and other similar cases.
September 25, 2008 2:55 PM | Reply | Permalink
Seems like your niece and her husband made out like gangbusters -- three plus years in a nice house for $825 a month. Can't do better than that and more power to them for sticking it to the lender who probably -- nah! most assuredly -- deserved it.
Note: As an aside unless your niece has seen mortgage assignment papers (very unlikely), she wouldn't know whether or not Countrywide "bought the paper." It's always hard to know if Countrywide is the new mortgagor or is only a servicer for an outside lender such as a trustee of a MBS, because, either way, Countrywide would talk the same talk.
September 25, 2008 4:02 PM | Reply | Permalink
$825/mo was indeed a pretty good deal.
The more interesting question (to me anyway) though is: would one or both parties—borrower and mortgage holder—be better off if the mortgage were crammed down? If just one, which one?
Of course, the answers change depending on the prices involved. But if there are some prices at which both parties benefit, it would be a good option. Unfortunately, structured mortgage-backed securities (CDOs etc) make it difficult to evaluate the benefit to the mortgage holder, since "mortgage holder" is no longer a single entity, but rather some collection of fractional entities.
September 25, 2008 7:06 PM | Reply | Permalink
Atlanta Federal Home Loan Bank CEO Richard Dorfman - Atlanta Business Chronicle:
"Rapid foreclosures, he said, will allow the markets to more quickly assess the values of real estate, re-establish confidence and begin correcting itself sooner. But that comes at the social cost of families being removed from their homes in droves. "Foreclosure is the ultimate weapon, but not necessarily the weapon of choice for lenders," he said, cautioning it wasn't necessarily the ideal mechanism for ailing banks to automatically fix their own problems. The ultimate course to find the bottom, Dorfman said, "is always imperfect and daunting," but stressed regulators and the market need to establish some consistent course of action. "What we need is consistency and enough time, vigor and intelligence to carry it out," Dorfman said. "If this is managed from a political rocking chair, we'll never get to the bottom," he said."
A man after your own heart?
I would agree that normally foreclosure could produce a truer value of a property than the bubblicious ones of the past few years but in the present environment isn't it more likely to produce undervaluations? There are still plenty of Mr. Potters out there willing to take advantage of a panic and make a family's bad situation even worse.
Also, couldn't a reactivated HOLC work as quickly to reevaluate, and restructure loans when possible, as the foreclosure process?
September 25, 2008 2:07 PM | Reply | Permalink
Just so it's clear, I have no objection and would support granting mortgage loans to the "squatters" to buy "their" homes at the foreclosure prices -- and if those prices were "undervaluations" the "squatters" would get a better price and be all to the good.
Note: Foreclosure wipes out the old debt and lets the family start over with a mortgage it can afford and a house rationally priced (between 3 and 3.5 times household income?).
Foreclosure is the only method to make the lenders act rationally and make them take the losses they were stupid enough to risk in the first place.
September 25, 2008 2:20 PM | Reply | Permalink
Emma,
Atlanta Federal Home Loan Bank CEO Richard Dorfman - Atlanta Business Chronicle:
"Rapid foreclosures, he said, will allow the markets to more quickly assess the values of real estate,
Ah yes....the market.
Someone should ask this banana, Dorfman*: Is this $700 billion bailout an example of the market working?
* "Flounder" in Animal House was Kent Dorfman
September 25, 2008 3:10 PM | Reply | Permalink
For the US government to hand over a trillion dollars of borrowed money to banks, or to home owners will have unforeseen consequences. Those consequences may be as bad or worse than letting some major banks fail due to their poor management. I don't believe this subject has been studied nearly enough to jump into any program right now.
September 25, 2008 12:51 PM | Reply | Permalink
I hear you, hoppy. Last night Bush said: "For more than a decade, a massive amount of money flowed into the United States from investors abroad because our country is an attractive and secure place to do business." I don't know why he didn't say "petrodollars" or "petrorubles" instead of "money" , but in any case a lot of inflationary cash was dumped on the US and we're paying the price. In that context I can't see how dumping more cash can solve the problem. Me, I'm bracing up for $8.00 per gallon petrol.
One other thing: deregulation translates to lack of oversight, and lack of oversight translates to "we don't really know what the problem is!"
September 25, 2008 2:47 PM | Reply | Permalink
Perhaps we are thinking about this the wrong way. Instead of using 700 Billion dollars to buy bank assets, make a 700 billion dollar tax cut to stimulate the economy. Private investors will buy up the inventory of these foreclosures. If a bank fails, so be it. They should, if they didn't have enough sense to lend responsibly. The economy will recover just fine, if the government would give back some of the exhorbitant taxes they take now.
Instead, what we are doing now is taking care of the bankers, under the presumption that the taxpayers will be "protected." Let taxpayers use the money to stimulate the economy and get us out of this mess the bankers got us into with excessive lending. Homeowners who borrowed too much will lose their homes, as they should. Lenders will fail for taking too much risk, as they should. But the economy will recover quicker if we lower taxes. Those who pay the most taxes (the middle class) will benefit the most, and they are the sector with the biggest problems in this crisis.
Jim Anderson
http://www.thejimanderson.com
September 25, 2008 9:34 PM | Reply | Permalink
I always want to compliment those who remember HOLC -- one of the New Deal programs that came in during the first months of FDR's first term, and lasted about three years.
HOLC was piggy-backed on RFC -- (english, the Home Owner's Loan Corporation was piggybacked on the Reconstruction Finance Corporation), and RFC was first established by the Democratic Congress in the last two years of the Hoover Administration, and vastly expanded by FDR. Between 31 and 33 RFC primarily recapitalized failing banks -- Hoover traded seats on the Boards of Banks for RFC loans, not the same as shares, but inside positions on management. When FDR took over, RFC was nearly without funds, FDR vastly enlarged it, and put other programs into it, such as HOLC. From 1931 through the depression, the RFC refinanced over 4000 Banks, and the HOLC that lasted from 33 to about 1936, restructured and reassigned one-fifth of the family mortgages in the US. There was a similar program in the Dept of Agriculture for Rural Housing.
HOLC was an office where an RFC employee/agent dealt directly with a home-owner with a problem mortgage -- and many Americans had problem mortgages, due to the failure of so many banks in 33. If a home-owner met minimum standards, and actually lived in the home (this was not for speculators), they walked out with a 20 year fixed rate mortgage, low interest -- and it was Government Insured. Eventually most were re-assigned to local banks and savings and loans as these were re-structured (by RFC) as performing loans. The US Government did not "profit" from this, but local Governments certainly did, because it meant they collected property tax, supporting schools, police, fire, local roads, garbage and sewage and all the rest.
HOLC also set the standard for Mortgages -- prior to 1933, most mortgages were 5 year notes with a balloon at the end, meaning that most home owners had to renegotiate their loans (and the interest rate) every five years. HOLC's 20 year loans treated home ownership as a long term investment and an equity building framework. HOLC was essentially replaced by the FHA program, which was structured to encourage new construction. (Jobs) about 1936.
An HOLC would make sense today with two conditions -- it would require that Securitized Mortgages be eliminated -- there has to be an identifiable actual mortgage holder or lender -- and it would require the kind of Capital that RFC had to work with. Because FDR's process of reorganizing banks favored locally owned banks and savings and loans, the whole structure supported community relationships among borrowers, lenders, savers, and local businesses. With FDIC covering deposits, and with a much strengthened bank examiner system, the structure worked well for about 50 years.
September 26, 2008 5:30 AM | Reply | Permalink
One of the reasons that program appeared to work was that it turned 5 year mortgages into 20 year mortgages and stretched out the amortization of the loan, lowering payments. We now have 30 year mortgages, due to that thinking, and as a result we have higher debt levels. This is what happens when you solve a debt problem with more debt. We don't need more debt - that is what caused the problem in the first place. The economy isn't going to collapse if credit freezes up. Only people who can't afford their lifestyles will be in trouble. We are addicted to debt, and withdrawal is difficult, but necessary for long term health. This bailout is going to ultimately hasten the failure of our banking system because it only digs us all deeper in debt and puts our government deeper in debt by a large margin. That is the lesson learned by many who went through the depression. Unfortunately, we have now forgotten those lessons about avoiding debt. Is it necessary that we go through another depression like the last one to learn that lesson?
September 26, 2008 10:00 AM | Reply | Permalink
If they would undo some of the bankruptcy "reforms" and let bankruptcy judges deal with some of these mortgages we could have far fewer foreclosures, the banks holding the comtgages would be much better off, as would the whole real estate situation, and no taxpayer money would have to go into those mortgages at all. The suggestion in the NY Times today that the government buy the GOOD debt and let the banks with too much bad debt fail also sounds like a good idea. When you buy something you look for something that's not already broken, why should they foist on the taxpayers what is?
September 27, 2008 11:38 PM | Reply | Permalink
...let bankruptcy judges deal with some of these mortgages
It's amazing how the running dogs of the mortgage bankers piss blood whenever anyone pushes on this.
I can only conclude that prior to the 2005 amendments, *judges were regularly giving lenders a greater than 40-50% haircut, since that's (afaik) about how they fare in a foreclosure ending with an eviction.
*Bankruptcy Judges, a repositary of rachmanes Who'da thunk.
September 28, 2008 3:35 AM | Reply | Permalink