The Homa Files

Ken’s Take:

Cuts through all of the rhetoric to the root cause: (1) the government “encouraged” bad loans   (2) the government allowed bundling of loans into MBSs (mortgage backed securities)  (3) the government provided an implied guarantee to the MBS bundles via Fannie and Freddie —GSEs ( government sponsored entities)  (4) the MBS bundles were resold up the financial food chain — separating their risk from their origination (5) the MBSs established a platform for very highly leveraged financial derivatives (e.g. CDOs, default swaps)  (6) when home prices peaked, the derivatives lost value and couldn’t support the associated borrowings, creating — in effect — the mother of all margin calls.

Dems are at the root of the problem, but the GOP isn’t blame free.  The Community Reinvestment Plan was a Dem brainchild, Clinton authorized the bundling of subprime loans, and Frank-Dodd-Reid have stopped regulation of Fannie and Freddie.  But, Bush also pushed for “a culture of (home) ownership” and had a GOP Congress until 2006 that should have been able to force greater regulation on Fannie and Freddie.

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From IBD: “America’s Second Wake-Up Call!”, Oct. 10, 2008

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Do you know the real cause of the out-of-control subprime loan mess that’s creating so much fear and hurting every American?

In 1995, President Clinton mandated new regulations that coerced banks to make significantly more subprime loans to inner-city residents previously viewed as unqualified buyers in high-risk areas. Many subprimes were variable-rate loans made without down payments or documentation of borrowers’ incomes. Banks were rated on how well they complied and faced big fines if they didn’t do what government regulators wanted.

The government’s worst decision was allowing and encouraging banks, for the first time, to bundle these subprime loans in giant packages with prime loans. These packages were then sold to other investors as safe because they were government-sponsored by Fannie Mae and Freddie Mac. The first of these government-encouraged packages came to market in 1997.

For the banks, the loan bundles were profitable because they could be sold quickly and thereby absolve the banks of any risk in the loans they made.

The banks could then use the money to make even more of these lower-quality, government-required loans, and Fannie Mae and Freddie Mac bought them with virtual abandon.

It evolved into a Big Government pyramid scheme . In short, this was yet another well-intended, government-designed and run program that failed miserably and had the usual unintended consequences.

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September 2003: Treasury Secretary John Snow, in testimony to the House Financial Services Committee, recommended that Congress enact legislation to create new agency to regulate and supervise financial activities of housing-related government entities to set prudent and appropriate minimum capital requirements.

Rep. Barney Frank, the committee’s ranking member, strongly disagreed, saying: “Fannie Mae and Freddie Mac are not facing any kind of financial crisis . . . . The more people exaggerate these problems, the more pressure there is on these companies, the less we’ll see in terms of affordable housing.”

• April 2004: Rep. Barney Frank ignored warnings, accusing the administration of creating an “artificial issue.” “People pay their mortgages,” he told a group of mortgage bankers. “I don’t think we are in any remote danger here. This focus on receivership, I think, is intended to create fears that aren’t there.”

• July 2005: Senate Majority Leader Harry Reid rejected legislation on reforming Fannie and Freddie. “While I favor improving oversight by our federal housing regulators to ensure safety and soundness, we cannot pass legislation that would limit Americans from owning homes and harm our economy in the process,” he said.

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Full article:
http://www.ibdeditorials.com/IBDArticles.aspx?id=308530236252361

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Ken’s Take:

1) It never pays to buy at the peak — unless somebody is staking you — and the government is ready with a safety net.

2) Nobody that I know is good as calling the peak.

3) 2005-2007 … 3 years that will live in infamy … with their lessons forgotten by 2012

4) Remember: the mortgage mess is highly concentrated to California, Florida, Nevada, and Arizona.

5) Also remember: 1/3 of 75 million are owned free & clear of any mortgages

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http://online.wsj.com/article/SB122351316270117559.html

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Ken’s Take:

1) The headline in the WSJ says “1 in 6 underwater”.  I’m more impressed that almost 85% of home owners owe less than their home is worth, and that almost 1/3 own their houses free and clear — with no mortgage balance at all.

2)  Though home prices have slid 13% in the past year or so, they’re up over 70% since 2000.  That’s not bad appreciation.

3) McCain went long-ball last nite with the mortgage buy-back proposal. Note that Congress enacted a “foundation” bill in July that provides a framework for doing so.

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Excerpted from WSJ: “Housing Pain Gauge: Nearly 1 in 6 Owners ‘Under Water’, October 8, 2008

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The majority of homeowners still have equity, and even among those who don’t, many continue to make their mortgage payments on time.

In contrast with the 12 million home borrowers estimated to be under water, 64 million have equity in their homes. These include 24 million households who own their homes free and clear, and 40 million whose homes remain worth more than is owed on them.

About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth.

The comparable figures were roughly 4% under water in 2006 and 6% last year, Among people who bought within the past five years, it’s worse: 29% are under water on their mortgages.

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The result of homeowners being “under water” is more pressure on an economy that is already in a downturn. No longer having equity in their homes makes people feel less rich and thus less inclined to shop at the mall.

And having more homeowners under water is likely to mean more eventual foreclosures, because it is hard for borrowers in financial trouble to refinance or sell their homes and pay off their mortgage if their debt exceeds the home’s value. A foreclosed home, in turn, tends to lower the value of other homes in its neighborhood.  As home values slip, growing numbers of would-be borrowers lack sufficient equity to refinance. The falling values also make mortgage lending look riskier to banks, spurring them to tighten credit standards.

Even for folks with equity in their homes, some borrowers fret that declining prices and tighter lending standards could make it hard for them to tap their equity.

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Prices are back to 2003 levels in the San Diego and Boston metropolitan areas, and back to 2004 levels in Las Vegas, Los Angeles, San Francisco, Fort Lauderdale, Fla., and Minneapolis.

Among mortgages on one- to four-family homes, 9.16% were a month or more overdue or were in foreclosure in the second quarter.. That compared with 6.52% a year before and was the highest level since the association began such surveys 39 years ago.

Most mortgages in default were issued in 2006 and 2007, when lending standards were loosest and the housing market was peaking. Many who bought then made small down payments or none, so they had little equity in their homes from the start.

In July, Congress enacted legislation designed to help borrowers who owe more than their homes are worth by allowing them to refinance into a government-backed loan, provided their mortgage company forgives part of their principal. It’s not clear how many borrowers the program will help, because before reducing the principal, lenders would almost always try first to freeze or reduce borrowers’ interest rate to make payments more affordable.

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How much pain homeowners feel varies greatly from place to place. The most severe drops in home values are in parts of California, Florida, Nevada, Arizona and other areas where speculation pushed prices up and builders far overestimated demand.

On a national basis, home prices peaked in mid-2006 after rising 86% since January 2000, according to the First American index. Since peaking, that index has fallen 13%.

The declines have made homes more affordable, bringing prices in many areas closer to their long-term relationship to incomes. In the second quarter, the median home price of about $203,000 was 1.9 times average pretax household income. That was close to 1.87 times income for 1985 through 2000, prior to the housing boom.

http://online.wsj.com/article/SB122341352084512611.html

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Ken’s Mega-Take: McCain rolled this grenade out last night, but didn’t explode it for impact. 

After researching the terms and conditions (below), I think McCain may be on to something.  A potentially good deal for the economy, but not clear to me how many votes it wins. The mortgage mess is concentrated in a few states:  McCain has Arizona locked and has no chance in California; but plan could help in  Florida, Nevada, Ohio. 

Keep in mind that only 75 million homes are “owned”, and 85% of folks are “above water” and making their payments (1/3 of homeowners own their homes free and clear of any mortgages). There could be backlash from honest, hard-working folks who don’t want slackers and cheats bailed out — whether on Wall Street or down-the-street.

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Excerpted from Politico.com: “McCain proposes bailout for homeowners”,  10/7/08 

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Qualifiers

The McCain “American Homeownership Resurgence Plan ” would be available to mortgage holders that:

1)  live in the home (primary residence only)

2) can prove their creditworthiness at the time of the original loan (no falsifications)

3) provided a down payment

Ken’s Take: Excludes investor-speculators, frauds, and folks who never had any equity in the home … I think the program is limited to the right group

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Structure

The new mortgage would be an FHA-guaranteed fixed-rate mortgage at terms manageable for the homeowner.

The direct “cost” of this plan would be roughly $300 billion, the amount of homeowners’ “negative equity” in some homes.

Funds provided by Congress in recent financial market stabilization bill can be used for this purpose; indeed, by stabilizing mortgages, it will likely be possible to avoid some purposes previously assumed needed in that bill.

The plan could be implemented quickly as a result of the authorities provided in the stabilization bill, the recent housing bill, and the U.S. government’s conservatorship of Fannie Mae and Freddie Mac.

Ken’s Take:

1) What if “they” can’t qualify under the revised terms?  What if housing prices continue to decline and the homes go back under water ?

2) The initial cash out flow to buy the loans will be greater than $300 billion … but the eventual “cost” will only be the buy-out of the negative equity.

3) I like the idea of buying a mortgage versus buying a derivative based on a pool of mortgages owned by a trust and serviced by a third party.  At least I can understand where the money is going.

4) Reminder: in July 2008, Congress enacted a program to do just this — save for the government eating the lost equity

5) By my recollection, this is essentially the business that Fannie and Freddie were originally commissioned to transact.

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Political Talk

AMERICAN HOMEOWNERSHIP RESURGENCE PLAN

McCain said he will direct his Treasury secretary to implement an American Homeownership Resurgence Plan (McCain Resurgence Plan) to keep families in their homes, avoid foreclosures, save failing neighborhoods, stabilize the housing market and attack the roots of our financial crisis. America’s families are bearing a heavy burden from falling housing prices, mortgage delinquencies, foreclosures and a weak economy.

“It is important that those families who have worked hard enough to finance homeownership not have that dream crushed under the weight of the wrong mortgage. The existing debts are too large compared to the value of housing. For those that cannot make payments, mortgages must be restructured to put losses on the books and put homeowners in manageable mortgages. Lenders in these cases must recognize the loss that they’ve already suffered.

The McCain Resurgence Plan would purchase mortgages directly from homeowners and mortgage servicers, and replace them with manageable, fixed-rate mortgages that will keep families in their homes. By purchasing the existing, failing mortgages, the McCain Resurgence Plan will eliminate uncertainty over defaults, support the value of mortgage-backed derivatives and alleviate risks that are freezing financial markets.”

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Source article:
http://www.politico.com/news/stories/1008/14377.html

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Excerpted from WSJ: “The GOP Blames the Victim”, Thomas Frank, Oct. 1, 2008

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“Capitalism sure is fragile if subprime borrowers can ruin it.”

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We hear from some on the right that the disaster on Wall Street was the handiwork not of those with unbridled pecuniary motives but of Fannie Mae and Freddie Mac, which were government-sponsored enterprises and therefore partially exempt from market discipline and of theoretical necessity the sole culprits.

There is no doubt that Fannie and Freddie enabled the subprime neurosis, but for certain conservatives they are virtually the only malefactors worth noting.

The dirge goes like this: Fannie and Freddie were buying up subprime mortgages, and they were doing it for (liberal) political reasons. Mortgage originators thus had no choice but to hand out mortgages like candy. Had market forces been in charge, loans would, no doubt, have been administered with (more) rigor and sternness

Bill Black, a professor of economics and law at the University of Missouri-Kansas City and an authority on the Savings and Loan debacle of the 1980s, … points out that, for all their failings, Fannie and Freddie didn’t originate any of the bad loans — that disastrous piece of work was done by purely private, largely unregulated companies, which did it for the usual bubble-logic reason: to make a quick buck.

Most of the mistakes for which we are paying now, Mr. Black told me, were actually made “by four entities that under conservative economic theory should have exercised effective market discipline — the appraisers, the originators of the mortgages, the rating agencies, and the investment banking firms that packaged the subprime mortgage-backed securities.” Instead of “disciplining” the markets, these private actors “served as the four horsemen of the financial apocalypse, aiding the accounting fraud and inflating the housing bubble.” It is they, Mr. Black says, who “turned a crisis into a catastrophe.”

Ah, but truth is no ally to a conservative with his back to the wall. So much more helpful are the trusty narratives on which the movement was built. So when we have dispatched this first canard, we learn from other conservatives that it is the sub-prime people who are to blame; that by taking out loans they couldn’t possibly pay off, these undesirable borrowers have ruined us all.

Full article:
http://online.wsj.com/article/SB122282690823092989.html

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Ken’s POV:

Bailing out greedy Wall Streeters irks most folks– me included.  So does bailing out people who lied on their mortgage application (even if coached to do so by an unscrupulous originator), who put little or no money down, and made few if any payments (some of which may have been interest only — at low teaser rates).  These folks are culpable, too.  “Keeping them in their homes” is nonsense.  What makes them “their” homes ?

Denying government’s role in encouraging the drop in loan criteria is also nonsense.  Fannie and Freddie played a  mega-role in creating the crisis.  Period.

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Excerpted from The Washington Post, “They Just Don’t Get It”, by Steven Pearlstein, September 30, 2008

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The basic problem is that too many people don’t understand the seriousness of the [financial and economic] situation.

Americans fail to understand that they are facing the real prospect of a decade of little or no economic growth because of the bursting of a credit bubble that they helped create and that now threatens to bring down the global financial system.

Politicians worry less about preventing a financial meltdown than about ideology, partisan posturing and teaching people a lesson.

Financiers have yet to own up publicly to their own greed, arrogance and incompetence. And leaders of foreign governments still think that this is an American problem and that they have no need to mount similar rescue efforts in their own countries.

In the coming weeks and months, all of these people will come to understand how deep the hole really is and how we’re all in it together.

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Restoring real stability to financial markets will require the kind of systemic approach and extraordinary government interventions that the public has refused to authorize and finance.

In better times, the public might have put aside its reluctance in response to the strong and unified recommendation of political and business leaders.

But it is a measure of how little trust remains in both Washington and Wall Street that voters are willing to risk a serious hit to their wealth and income rather than follow their lead.

Edit by DAF

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Full article:
http://www.washingtonpost.com/wp-dyn/content/article/2008/09/29/AR2008092902762.html

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Strictly my POV:

All of the pundits are saying that the cost of the bailout will hamstring either Obama or McCain — whoever gets elected.  (see http://www.politico.com/news/stories/0908/14027.html)

McCain wouldn’t be able to cut (or hold) taxes;  Obama won’t be able to afford his expensive social programs.  I disagree — especially if Obama’s “$500 for everybody who votes for me” campaign succeeds.

First, Obama will use the cost of the program to justify even more tax increases.  The increases will hit more people and will be bigger.

Second, the $700 billion will become a permanent layer of the national debt.  It will never be paid down.  Any proceeds received from closing, renegotiating or reselling the toxic loans will simply be redeployed to other spending programs.  Think Iraq – it was originally off budget.  Now, there is talk of how to put the $10 billion per month to better use. 

Mark my words.

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Excerpted from WSJ: “Rescue Includes Steps to Help Borrowers Keep Homes”, Sept. 29, 2008

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Ken’s POV: Just imagine a non-citizen investor (e.g. a “flipper”) who lied on his mortgage application, didn’t put any money down  and hasn’t made any monthly payments.  He’ll get his mortgage adjusted.  You won’t

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The bailout package includes more aggressive steps to help troubled borrowers keep their homes by requiring the government to do more to reduce loan balances and interest rates.

The bill calls on the government, as the owner of mortgages, mortgage-backed securities and other assets backed by real estate, “to implement a plan that seeks to maximize assistance to homeowners and use its authority to encourage the servicers of underlying mortgages, and considering net present value to the taxpayer, to take advantage of…available programs to minimize foreclosures.”

Such measures could reduce monthly loan payments for homeowners and, in theory, increase the likelihood that borrowers keep up mortgage payments. It could also slow down the growing number of foreclosures.

The modifications are designed so that the payments on a borrower’s mortgage don’t exceed 38% of gross income.

* * * * *
Although the latest plan may evoke anger among taxpayers who pay their mortgages on time, economists say helping those in trouble could benefit all taxpayers by blunting the impact of the financial crisis on the housing market and local communities.

Getting borrowers back on track could help reduce the cost of the bailout to taxpayers. In recent years, troubled loan portfolios have yielded about 32% of book value, compared with more than 87% for loans in which the borrower is current.

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There are more questions than answers about how effective the government’s program will be. If the government buys entire loans.

Another crucial unanswered question is how many borrowers will be helped by stepped-up loan-modification efforts. “There’s a great deal of skepticism about the ability of modifications to improve the performance of loans.”

Deutsche Bank recently looked at subprime loans packaged into securities, most of which were modified in 2008. It found that roughly 35% of the loans were at least 60 days past due roughly six months after the modification.

“Investors think these loans will all redefault in a year or a couple of years and the losses will be higher.” Historically, modifications haven’t done that well.

One fear is that if mortgage companies or the government, is too liberal in offering help, more borrowers who might otherwise stay current on their loans will fall behind to get a better deal. “What we don’t want to do is undertake some kind of program that changes the behavior of those many, many people who undertake extraordinary effort to pay their mortgage and make sure they can stay in their home.”

As many as 40% of homeowners, or about 20 million households, will owe more than their home is worth by the time the housing market stabilizes.

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Full article:
http://online.wsj.com/article/SB122265697254684627.html?mod=article-outset-box

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According to Rasmussen Reports, only 25% of voters favor the bailout plan.  Obama supporters are most skeptical of it. (More data and the link are below)  All of which creates an bold political opportunity fo McCain — as articulated by Dick Morris.

Note: Probably by the time your read this, the die will have been cast — one way or another.

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Excerpt from: “MCCAIN’S TRUMP CARD”, Dick Morris,  New York Post, September 28, 2008

During Friday’s debate, John McCain assiduously and inexplicably avoided using the issue that might have won him the debate and the presidency: opposition to a taxpayer-funded bailout of the financial crisis.

Congress is about to pass – and the president is about to sign – a bill that the American people detest by 2:1 margins. When Americans realize that there is, indeed, an alternative to handing over $700 billion to financial institutions as a reward for their failure, opposition to the idea will swell even further.

The bailout ideas proposed by the House Republicans and trumpeted by former Speaker Newt Gingrich make eminent sense. Indeed, they make so much sense that it is as if the roles of the parties have been reversed. It is the Republicans who are demanding that the banks and financial institutions pay for their own bailout, granting them only a mixture of loans and premium-paid insurance, while the Democrats want to pass the hat among the taxpayers to buy their dirty paper.

In an unusual act of political foresight and skill, the normally dead-headed House Republican leadership has crafted a platform that can carry the party to victory in November. All that remains is for the Party’s candidate – and perhaps even its president and Treasury Secretary – to get on board. McCain can recover at the negotiating table the economy issue he lost in Friday’s debate. He needs to have the courage of his convictions and insist on a bailout without requiring taxpayer-funded purchase of defunct mortgages from failing institutions.

The difference in the bailout plans is, of course, largely cosmetic. Dead paper is dead paper whether it is on the books of the government, purchased from banks, or on the books of the banks, insured by the government. The game is the same: Through loans or grants fund the deficient debt service on the defaulted mortgages until homes can recover their value in the cyclical real estate market.

Loans are politically viable. Purchase of bad debt with tax money is not.

The Democrats and our politically-challenged president have failed to appreciate the difference between spending and lending. Treasury Secretary Paulson can be excused for not realizing it. Politics is not his thing.

But John McCain must realize the crucial distinction and must use his leverage to stop a taxpayer-funded bailout, insisting instead on loans and insurance.

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If McCain stands firm, the Democrats will either have to pass the bailout package on their own, without Republican votes, and rely on Bush’s signature on the bill to provide a fig leaf of bipartisanship – or they will have to cave in and pass the Republican package.

Either way, McCain comes out ahead.

If he gets his way, he gets credit for the bailout. If he doesn’t, he can spend the campaign attacking Obama and the Democrats for spending $700 billion of taxpayer money.

If the Democrats don’t adopt either course and play a game of chicken with the Republicans, their Congressional status as the majority party dooms them to taking the blame for any ensuing collapse.

Voters can count. They know that Reid and Pelosi are Democrats and that they control Congress. With this power comes responsibility.

And if the Democrats do nothing – that is they fail to use their majorities to pass a bailout or to cooperate with the Republicans in adopting the GOP version of the package – it is they who will get the blame for the catastrophe which will follow.

The Democrats don’t dare take that chance.

The cards are dealt for John McCain. All he has to do is have the guts to do what he didn’t have the courage to do in the debate: Play the hand.

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Full article:
http://www.vote.com/mmp_printerfriendly.php?id=1115

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From Rasmussen Reports, Sept. 27, 2008

The more voters learn about the proposed $700-billion taxpayer-backed Wall Street rescue plan, the less they like it.

Just 24% of U.S. voters now favor the plan first proposed by Treasury Secretary Henry Paulson [and modified by Congress] … 50% oppose it, and 25% are undecided.

72% say they have followed stories on [the financial crisis], including 37% who say they have been following the news Very Closely.

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House Republicans, who regard the unprecedented government involvement in the financial markets as nothing short of socialism, are demanding significant downsizing of the plan and other changes.

The White House and Democratic leaders argue the plan to buy up bad mortgage debt from private firms is the surest way to free up credit for all Americans, but many GOP legislators fear the potential losses to taxpayers. Congressional Democrats are worried about voter opposition to the plan and don’t want to pass it without significant Republican support.

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Both men and women oppose the bailout plan two-to-one. Likely McCain and Obama voters reject the plan by similar margins, although Obama supporters are slightly more skeptical.

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Full Report:
http://www.rasmussenreports.com/public_content/business/general_business/support_for_bailout_plan_now_down_to_24

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When the deal gets revealed — later today or tomorrow — check to see if the House Repubs had any impact on the final legislation.  If they didn’t, uh-oh.

Here’s a handy checklist of what they wanted.

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Excerpted from Rasmussen Reports: “A Paulson-Cantor Plan Is a Win-Win for Taxpayers”, Lawrence Kudlow, September 26, 2008

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Basically, the House Republicans want a “cleaner” bill with

1. Inclusion of a federal bond insurance guarantee for straight mortgage-backed paper, financed by private-sector insurance premiums. (The “Cantor Plan”)

2. Removal of the ACORN slush fund   [Ken’s POV: Ostensibly, this provision is to provide more affordable housing to certain communities.  That’s the policy that got us into this mess to start with.  ACORN is Obama’s major mobilizer for voter registration.]

3 Removal of the so-called union proxy to run a slate of corporate directors

4. Requirement that all profits from the Treasury rescue mission must be used to reduce the national debt — 100 percent. [Ken’s POV: This is key … otherwise, the $700 billion will become a permanent layer of national debt — with any paydown simply diverted to other programs]

5. Removal of authority to  bankruptcy judges for setting mortgage terms and interest rates  [Ken’s POV: Otherwise, non-citizens who lied on their mortgage apps and never had an ability to repay loans will be getting more favorable terms than their neighbors who played by the rules]

6.  Elimination of the  so-called government equity ownership of banks … because it effectively creates a corporate tax increase on banks at a time when they are struggling.

7. Scaling back the Treasury secretary’s request for $700 billion … or at least phasing it in.

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Full article:
http://www.rasmussenreports.com/public_content/political_comentary/commentary_by_lawrence_kudlow/a_paulson_cantor_plan_is_a_win_win_for_taxpayers

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Excerpted from WSJ: “What’s the Real Cost of the Bailout?”, Sept. 26, 2008

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Assume Hank Paulson gets his $700 billion appropriation.  And, assume he then spends it all, immediately, buying up the financial toxic waste that is rapidly destroying the banking system.

How much would that actually “cost” taxpayers?

The Federal government pays just 4.34% interest on long-term, 30-year loans. So the government could borrow this money for 30 years at a cost of just $30 billion in interest per year.

To put that in context, that is about one-fifth of 1% of our gross domestic product. One-fifth of 1%.

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Obviously, the story doesn’t just end with the interest cost. When you take out a loan, you’ve got to be able to repay the principal in due course as well.

Let’s take a worst case scenario. Let’s imagine Uncle Sam borrows $700 billion to buy these assets and never gets a single penny of it back. Let’s imagine this paper ends up completely worthless. So instead he has to tap taxpayers to pay off part of the principal every year for 30 years, until the loan is all redeemed.

How much would that cost per year?

Try $42 billion. That’s the interest and principal repayment.

That’s less than one-third of 1% of our annual gross domestic product. That’s the true, annual cost of this bailout. Not $700 billion.

And that’s the worst case scenario. That’s assuming Uncle Sam never gets back one penny on these assets. In reality, the Treasury will certainly get some of its money back and will probably get most.

It may even make a profit. Someone with deep pockets, the ability to borrow long-term money for just 4.34%, and the expertise to analyze today’s distressed mortgage market could make an absolute killing here.

Full article:
http://online.wsj.com/article/SB122245659564179649.html

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Ken’s POV

The author’s “worst case” is hardly the worst case. The worst (and most likely) case is that the $700 billion becomes a permanent layer of the national debt, i.e. any potential pay-down just gets diverted incrementally to other spending programs.  If so, the full cost of the program is the value of the perpetual annuity stream of interest payment — which is $700 billion [$30 / 4.34%].

Why is the worst case the most likely?  Think Iraq spending — the $10 billion per month.  It was originally ex-budget. Now, at least one presidential candidate is talking about repatriating the $10 billion per month into domestic spending programs.  Suddenly, ex-budget becomes on-budget.

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Excerpted from IBD: ” Good Intentions Paved The Road To Subprime-Stoked Meltdown”, September 23, 2008

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You need to go back — way back — to 1977, and the Jimmy Carter presidency.

It was then, for the best and purest of reasons, that well-meaning members of Congress brought the Community Reinvestment Act … “to eliminate the practice of redlining by lending institutions.”

In the 1970s, redlining” was widely seen as the cause of housing disparities between white and black Americans.

The redlining theory: Banks set up shop in low-income areas, took deposits, then lent the funds to richer areas — leaving poor and minority communities starved of housing and capital.

President Carter saw CRA as a way to end the supposed practice of redlining …  nd bringing African-Americans into the American dream.

Unfortunately, this well-intended law eventually led to a housing boom based on shoddy loan practices, a subsequent bust, and the financial mess we are in today.

Initially, the CRA was supposed to not just lend to poor areas, but to do so “consistent with safe and sound lending practices.” That latter key proviso was ignored as CRA was implemented.

The CRA forced banks and savings institutions — then, far more heavily regulated than today — to make loans to poor, often uncreditworthy minority borrowers.

Banks were required to keep extensive records of their minority lending practices. Those that didn’t pass muster could be denied the right to expand their branches, merge with other banks, or boost lending in new markets.

If a community group decided a bank was operating in bad faith, it could affect the bank’s “CRA rating” — the scorecard for how well it was doing as a minority lender.

Banks became pliable, easy targets. No bank CEO wanted to be maumaued as an enemy of the poor.

Later, in the Clinton era, Fannie Mae and Freddie Mac got involved — buying up bad loans from banks, and securitizing them for sale on world markets. The seeds of the subprime meltdown were planted.

As of last year, the homeownership rate among all Americans was 68.1% — up from 63% in 1970. For black Americans, it’s up from just below 42% in 1970 to 47.2% last year. It’s still below 50%, and still the lowest of any minority group.

Full editorial:
http://www.ibdeditorials.com/IBDArticles.aspx?id=307061229501695#

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Excerpted from RealClear Politics.com:”The Mortgage Mess Began on Main Street”, Steven Malanga, September 24, 2008

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Ken’s POV: Should foreclosed speculators be bailed out?  No.  Should folks who lied on their applications get bailed out?  No.  Should folks who made no downpayment — and sometimes no payments at all — be bailed out?  No.  Should folks who couldn’t qualify for conventional loans then (or now) — about 80% of all subprimes — get them at favorable rates now? No.  Should honest, hardworking folks who got duped or are experiencing some extraordinary hardship get relief?  You bet.  Wonder how many of them there are ….

Here are some facts …

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Article Extract:

Journalists like simple stories with clear-cut villains who are easy for readers (and journalists themselves) to recognize. And so, as the financial crisis has brought Wall Street to its knees in recent weeks, it’s become so much easier for journalists to cope. Time Magazine, for instance, tells us in its current issue that Wall Street “sold out” America.

It’s easy to forget that this mess began with a heap of bad mortgages made by American consumers who never came within a hundred miles of the card sharps on Wall Street. The inability (and in a good deal of cases, the unwillingness) of these same ordinary Americans to pay back these loans, many of which are sitting in mortgage backed-securities held by institutions around the world, helped tilt us toward this systemic threat to our financial system. And even as we focus on bad bets and lousy leverage ratios on Wall Street, these toxic mortgages continue to unwind, and as they do, we are getting a better look at how they were made—and it’s not pretty.

If it wasn’t clear before, it should be now, that speculation and fraud—much of it on the part of borrowers—were rampant.

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The FBI says that reports of suspicious mortgage activity increased by 10-fold from 2001 through 2007.

70 percent of subprime loans that default before they reset (exactly the kind that trouble the market right now) contain some kind of misrepresentation by the borrower, lender or broker, or some combination of the three.

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One big category of deception has been so-called ‘no-doc’ loans, where a borrower agrees to pay a slightly higher interest rate in exchange for not documenting his income. Originally designed for the growing number of self-employed workers in America who don’t have ready documentation from an employer, these mortgages became known as ‘liar loans’ because many people without sufficient income used them to qualify for financing they otherwise couldn’t get. One lender that compared what 100 applicants claimed as income on no-doc loans to what they reported to the IRS on their tax returns found that in 60 percent of cases borrowers were exaggerating their income by as much as half.

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Fraud reports are most common on properties near the coastlines, that is, in places where there is an enormous amount of speculation and where many purchases are for investment purposes.

Speculators are a big part of the problem. As the housing market rose, more people got into the game of betting on higher prices by purchasing homes which they intended to flip quickly without ever occupying. As this became a popular form of investing, applicants starting lying about their intentions. They were trying to fool developers who grew wary of selling too many homes in new developments to people who would never occupy them, since these are the buyers most likely to walk away from a mortgage when the market turns down. This form of misrepresentation accounts for 20% of mortgage fraud.

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Whether they were cheating or not, speculators clearly played a big part in the mortgage mess. The vast majority of delinquent mortgages and homes in foreclosure continue to be in a handful of states where the housing bubble was largest and where speculation was common, led by California and Florida, which together accounted for a whopping 58% of all subprime adjustable rate mortgages that went into foreclosure in the second quarter of this year.

And while the rate of new foreclosures for subprime ARMs in the quarter was a whopping 6.63%, for traditional fixed-rate mortgages, it was only 0.34%.

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We seem to have had a generation of mortgage borrowers who at the least didn’t understand the types of loans they were taking out, and at the worst were committing fraud themselves.

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References and full article:
http://www.realclearmarkets.com/articles/2008/09/the_mortgage_mess_began_on_mai.html

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Excerpted from Heritage Foundation:”Subprime Mortgage Problems: A Quick Tour Through the Rubble”, by Ronald D. Utt, April 3, 2008

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Note: Best recap I’ve found re: the current mortgage mess.

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The collapse of the subprime mortgage market in late 2006 set in motion a chain reaction of economic and financial adversity that has since spread to nearly all sectors of the economy, as well as to global financial markets, has created depression-like conditions in the housing market, and has led the American economy to the brink of recession.

In response, many in Congress and the executive branch have proposed a number of new federal spending and credit programs that would greatly expand the role of government in the economy.

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How the Problem Started

These problems had their origin in the mid-1990s when mortgage lenders reduced the previously strict financial qualifications needed to acquire a mortgage to buy a house by offering credit-impaired households mortgage loans, albeit at higher interest rates to compensate for the greater risk. Despite the many different forms these mortgages would ultimately assume–no down payment, interest only, negative amortization, etc.–they were designated “subprime” because of the checkered credit histories of the households using them.  Despite the risk associated with these subprime mortgages, many mortgage lenders further relaxed their underwriting standards and in the process introduced even more risk into the system, some of it motivated by fraud and misrepresentation.

As a consequence, the availability of risky loans soared from the late 1990s through 2006. In 2001, newly originated subprime, Alt-A, and home equity lines (seconds) totaled $330 billion and amounted to 15 percent of all residential mortgages. Just three years later, in 2004, these mortgages accounted for almost $1.1 trillion in new loans, equal to 37 percent of the total. Their volume peaked in 2006 when they reached $1.4 trillion and 48 percent of the total. Over a similar period, the volume of mortgage-backed securities (MBS) collateralized by subprime mortgages increased from $18.5 billion in 1995 to $507.9 billion in 2005

In turn, the looser lending standards allowed previously unqualified borrowers to become homeowners, and the homeownership rate soared from the 64 percent range of the 35 years prior to 1995 to an all time high of 69 percent in 2004. While most celebrated this accomplishment, the consequence of lending to riskier borrowers under diminished underwriting standards led to an escalation in the number of loan defaults beginning in 2006, followed by an escalation in the number of foreclosures. Because many of these loans had been repackaged into mortgage-backed securities, the growing default problem soon spread to investors in the national and international financial markets where these instruments were sold.

The first to suffer was the housing market, where new construction and the sales of both new and existing homes plunged. This was soon followed by a decline in home values, which in turn worsened the financial problems in the mortgage market by reducing the value of the collateral securing these loans. As many subprime borrowers now found themselves owning a house worth less than the debt owed on it, the incentive to default increased, and by the end of 2007, more than 17 percent of subprime borrowers had fallen behind in their loan payments.

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Implications for the Economy

After reaching the more than 1.7 million new units started in 2005, single-family housing starts in February 2008 fell to a seasonally adjusted annual rate of 707,000 units, less than half the level of production two years earlier. On a year-over-year basis, the decline in starts was 40.4 percent.  Sales of new homes fell precipitously over the same period. After reaching 1,283,000 units in 2005, they fell in February 2008 to a seasonally adjusted annual rate of 590,000, less than half the level of 2005 and down 29.8 percent from February 2007. For existing homes, sales peaked in 2005 at 7,076,000 units, fell to 6.4 million in 2006, and by February 2008 had fallen to a seasonally adjusted annual rate of 5 million, nearly 30 percent below the peak levels of sales during 2005.

After two years of declining activity in the housing market, many are hopeful that the bottom has been reached and that the market will soon revive, but this seems unlikely. The subprime default and foreclosure problems first emerged at a time when the economy was healthy, most borrowers were employed, and housing values were stable or rising. In 2008, home prices and sales are falling, some borrowers may soon confront unemployment, tightened credit standards will exclude many from homeownership, and the number of subprime mortgages resetting to higher payments will be greater than the number that reset in 2006 and 2007.

As a consequence, the homeownership rate is likely to fall from its record levels near 69 percent to something closer to the long-term historic norm of 64 percent. This trend in turn implies a greater number of lost homes coming onto the market at a time when sales are depressed.

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Notwithstanding the constituent and lobbyist pressure to do something costly and do it quickly, the history of government intervention in housing markets and the economy has not been one of notable success. .

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Full article:
http://www.heritage.org/Research/Economy/wm1881.cfm

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