Teaser Freezer Burn

Pretending bad loans aren't bad loans fixes nothing

Jeff Taylor | December 6, 2007

Given the amazingly complex world of high finance—full of derivatives, hedges, and tranches—Treasury Secretary Henry Paulson last week hit upon a stunningly simple plan to fix the nation's subprime mortgage mess: Lie. And don't just lie, but get everybody together and agree to lie, thereby making the lie become truth.

The fiction Paulson and the major banks are promoting is that extending the low "teaser rates" initially offered to many subprime borrowers fundamentally will help them and—here is a big lie—transform them from bad loans to good.

Put another way, if the problem of bad subprime mortgages was caused by delusion over lending risk, this latest solution enshrines delusion as the defining characteristic of the American banker—backed by a facile enabler in Uncle Sam and his trillions, of course.

Financial risk analyst Chris Whalen calls Paulson's plan "appalling." Whalen's Institutional Risk Analytics zeroed in on the banks' unwillingness to acknowledge risk in their lending portfolios back in 2005. Now he sees the so-called "teaser freezer" plan as an attempt to put Humpty Dumpty back together again and build a floor underneath uncertainty in the financial sector. Except that he estimates around one-third of teaser borrowers will default anyway, a measure of just how dumb lenders are in handing out loans to people with bad credit.

"It is probably in their best interest to walk away. They have no equity," Whalen says of the hapless borrowers.

The possibility of their underwater borrowers actually taking a walk terrifies the banks, however. Banks would have no choice but to write down and make real phantom losses lurking just off their books. What to do? How about pretending that the loans aren't actually bad. How do you do that? Pretend that the borrowers can pay them back. How do you do that? Pretend the teaser rate is the real rate. Presto, problem solved.

At this point, some adult would ideally step in and say, "no, that's fraud." But clearly Treasury is not that mature. And it appears the Fed has resigned itself to some form of greater idiocy coming out of Congress on the subprime front that maybe, just maybe, the teaser freezer can head off.

However, the stubborn fact remains that banks will lose money on teaser rates. Regulators and investors both know this. Who exactly are we trying to fool? Besides inattentive voters.

Meanwhile, by allowing big banks to keep their rot off the books, the potential exists for it to continue to spread. Whalen and other experts have wondered for months about losing the ability to price risk, or even recognize it given the complexity of the constructs floating around financial markets. The Paulson fix only exacerbates the problem by continuing to assert that real world constraints do not matter. And the stakes are already high.

"We could lose a money center bank next year," Whalen warns.

Should you duck your head out of Treasury's "let's pretend" camp for a second, one notices that there are major legal obstructions to rewriting millions of loan contracts by federal fiat. Contrary to the wish of some in Congress, mortgage lending is still largely an activity engaged in by two private entities, each of whom assume very specific obligations. This is not a federal program to be tweaked at the margins. Real estate lending contracts are a dozen pages long for a reason. And each contract is different yet just as legally binding, depending on a given state's law. That's right, state law.

It is unclear how federal action to extend low-low teaser rates can square with state lending laws which may require an actual change in the underlying contract. Unless the idea is just to do this all informally, with a notification letter from lender to borrower and as long as federally chartered banks get approval from their federal regulators to pretend.

After all, what is a little lie between friends?

Contributing Editor Jeff Taylor is a writer in Charlotte, North Carolina.

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|12.6.07 @ 2:34PM|#

Political pandering to financially imprudent people at its worst.

|12.6.07 @ 2:42PM|#

My opinion hasn't changed. Borrowers and lenders alike, You made that bed, you lie in it. A few mortgage brokers going belly up would be an appropriate lesson for others in the business.

Dave B.|12.6.07 @ 2:45PM|#

|12.6.07 @ 2:52PM|#

A better solution would be to eliminate the whole bankruptcy (a polite euphemism for theft) system and bring back debtors prisons. The threat of being punished rather than rewarded for defrauding the banks would have dissuaded people from signing most of the non-performing loans currently strangling our economy.

Xmas|12.6.07 @ 2:54PM|#

The banks to get something, they get the houses. They'll then have to auction off the houses for their real value and take the difference between mortgage and sale price as a loss.

The homeowners that can't pull the full mortgage rate are stuck in a very bad situation. They are paying too much for something that they will never own. They should dump the house and try to rent someplace for less than they're paying for their teaser rate monthly mortgage payments.

FYI, if I understand this rate freeze thing correctly, the qualifications for it are going to be very restricted.

|12.6.07 @ 2:56PM|#

A better solution would be to ....bring back debtors prisons.
The only problem is that only puts one side of this equation of idiocy in prison. Both are at fault and culpable.

robc|12.6.07 @ 2:57PM|#

Dave B,

I think that is the idea. The other problem is, that while foreclosures are up, it is at a level the banks can (barely) handle. If there is a big surge, the banks wont be able to handle the influx of foreclosures. So, by freezing the teaser rate, it gives a chance to get things under conrol.

If, for example, the rate is froze for 5 years (that is what I heard earlier today), some of the people will be in a situation to refi or pay the higher rate within 5 years. Some will still be foreclosed on, but spread out over the 5 years. Thus the surge of foreclosures will be smaller in 5 years and may occur at a time with a stronger housing market, making it easier to absorb the foreclosures.

I think thats the theory. I still dont think its a good idea. But better than a government bailout.

|12.6.07 @ 2:57PM|#

I'm probably misunderstanding the article here, but if people are going to default on loans when the teaser rates end, wouldn't it be smart to extend the teaser rates on existing loans, so that you're at least getting something?

I haven't read this particular article, but I have read a number of others on topics like this.

part of the problem seems to be that the people who issued you the loan originally then packaged that loan up into a bundle and sold pieces of it to investors and hedge funds.

What you have left is merely a company contracted to service the loan, but the owner of the loan isn't really in the lending business and don't really care to get into negotiating and re-doing the terms of individual loans.

In order to renegotiate terms you would need trained people to look at each individual loan and examine whether or not the borrower is worth renegotiating and likely to repay under better terms or if they are just way over their head and were just a bad risk to begin with.

The funds/entities that now own these loans have neither the inclination, expertise or ability to do this. So in essence they are stuck with these bad loans

|12.6.07 @ 2:59PM|#

toshiro_mifune

How are both sides culpable? The lenders offered a contract: "We'll loan you $X, and you agree to repayment according to this schedule and conditions". The borrowers agreed to the contract and are now failing to fulfill their obligations. The lending institutions are completely blameless.

robc|12.6.07 @ 2:59PM|#

if I understand this rate freeze thing correctly, the qualifications for it are going to be very restricted.

Mine too:

1. Subprime loans, so even the teaser rates are high.
2. Teaser period ends between Jan 1 2008 and July 1 2010.

There are probably some other restrictions too. Maybe only people who are up-to-date on current payments or something.

Shannon Love|12.6.07 @ 3:01PM|#

I think the goal here is to try to stretch out the foreclosures over a longer time period to prevent a knot in the python pulse that would disrupt the financial system at large.

But the first rule of finance is that time is money. Giving people more time pay cost money and in this case, lots and lots of money. Where is that money coming from? I'm betting that bankers and borrows aren't tossing the sofa cushions for change.

robc|12.6.07 @ 3:02PM|#

Illiterate J

There is a risk on all loans. If the lending institutions took more risk than they can financially afford then they have a share of "blame". Not in a legal or moral sense, but in a "they deserve to go under" sense.

toshiro_mifune|12.6.07 @ 3:02PM|#

The lending institutions are completely blameless.

Bullshit, they get their asses bailed out by the Fed via rate cuts & overnight repos, deflating the value of the dollar to paper over their losses. You and I eat that bill.

|12.6.07 @ 3:04PM|#

On the one hand, many lenders/mortgage brokers were deceitful. IN many cases people who qualified for better loans /terms were offered subprime loans and LIAR loans and no-doc loans.

Many mortgage brokers also make money of off the spread. That is, if you as a borrower qualifed for a loan at say 6%, but they instead got you to sign up for a loan at 8%, the mortgage broker got to keep that 2% of the total loan amount. This is something that mortgage brokers don't have to disclose to the borrower and they aren't required to offer the best rates that the borrower qualifies for. So many borrowers believed they were getting the best rates they could get.

On the other hand, many borrowers were stupid. They didn't shop around and compare rates and due the type of due diligence they should have.

toshiro_mifune|12.6.07 @ 3:05PM|#

robc, pretty much on the head. The only problem is Citi, JP, BAC, et al. will not be allowed to go under.

ChicagoTom - There is a lot of blame to go around on this.

|12.6.07 @ 3:06PM|#

The mortgage fairy has granted every sub-prime lender a wish. Magic happens!!

|12.6.07 @ 3:07PM|#

How are both sides culpable?

Many lenders were offering large loans to people who weren't qualified.

Any institution that gives out no-doc / LIAR loans is culpable of bad risk assessment/management and deserves to go under.

|12.6.07 @ 3:08PM|#

ChicagoTom - There is a lot of blame to go around on this.

Absolutely -- greed on both sides caused this.

People wanted houses they couldn't afford.

Lenders wanted to charge extra and ignore the risk.

Everyone seemed to believe that the housing market will just keep going up up up.

toshiro_mifune|12.6.07 @ 3:15PM|#

Magic happens!!
I'd put money down that this plan turns around to bite them on the ass. The least it should do is force rates higher to compensate investors for the risk, as well as really killing the secondary market.

I doubt that the plan will have much affect on foreclosures associated with the reset spike that started in 11/7. This unfortunately leaves the foreclosure issue up in the air as a campaign issue on `08, where we may get some truly boneheaded solutions.

|12.6.07 @ 3:17PM|#

I am not sure if anyone else has thought of this but it hit me the other day that the banks fucked themselves when they shoved bankruptcy reform through Congress. Back when you could actually get out from under your debts through bankruptcy, people who could not pay their debts would go through Chapter 7, raffirm their mortgage, keeping their equity through a state homestead exemption and write off all of their credit card debt. Now people can't do that anymore. They can't write off their unsecured debt and are stuck paying them even if they go into bankruptcy.

Think about the effect this has. Most people who are in trouble paying their mortgages also have credit card debt. If you can't get out from under your credit card debt through bankruptcy, what are they going to do? One thing they can do is walk away from their secured debt and eliminate those payments. That is exactly what they are doing. If you can't declare bankruptcy and get out from under your credit card debt, you can walk away from your home loan and move into a cheaper place and save money that way. With the bankruptcy law as it is, defaulting on your mortgage and moving into a cheaper place is really the only way to lower your monthly payments and start to get out of debt. My guess is that that bankruptcy reform is causing a lot of people to default on their mortgages than would have had the old law been in effect.

Basically the banks shifted the defaults from credit card loans to home loans. They screwed themselves and I have no sympathy for them.

|12.6.07 @ 3:20PM|#

Attacking bankruptcy laws in general (as "theft") is not a sound libertarian position. Bankruptcy laws protect creditors as well as debtors by helping enforce priorities among creditors and preventing preferences and chaos. Lack of predictably enforced bankruptcy laws is one of China's big problems. Now, as to whether present bankruptcy laws are optimal--I wouldn't try to argue that.

I'm probably misunderstanding the article here, but if people are going to default on loans when the teaser rates end, wouldn't it be smart to extend the teaser rates on existing loans, so that you're at least getting something?

I've worked for a finance company and a bank. One of the basic principles of collection is "your first loss is your best loss".

Continuing to lend at a money-losing rate means effectively discounting the value of your loan. If the market is going downwards, you are going to wind up taking a larger loss by hoping things will turn around.

What they seem to be proposing here is hiding their losses.

If this goes through, I predict there will be a scandal within 2 years concerning executives who used the time bought by this program to unload their shares in lending companies before the company went under.

Wow. I'm really disappointed with the libertarians these days. How is there no mention of the Fed's role in all of this mess? Why were the banks so willing to hand out loans? Oh, I don't know, maybe cheap and easy money?

Government created the problem and is now trying to fix the problem. It is a monetary issue. Where are the austrians?

I spent 4 years in mortgage banking working in default - foreclosure, bankruptcy, etc.

Many people on this thread display inaccurate assumptions about mortgages, lending and whatnot but I generally agree the teaser freezer is a stupid idea.

toshiro has much correct and the banks should be taken to task for stupid lending practices (even though many of the banks at risk did NOT originate many of the loans at issue - they simply bought the paper).

All that said, the thousands of foreclosures I oversaw convinced me of one thing...a decent percentage of them (while not a majority) were simply too stupid to own a house.

By far the greatest percentage of people that should never have owned a house? Anyone with an adjustable rate mortgage.

Big Nanny|12.6.07 @ 3:26PM|#

The only time anyone that would qualify for a conforming loan would receive a sub-prime loan is if the loan officer worked at a place that only offered sub-prime loans. What ChicagoTom was talking about is called yield spread and you cannot increase a borrowers rate 2% in yield speread, some but not that much.

|12.6.07 @ 3:29PM|#

If this goes through, I predict there will be a scandal within 2 years concerning executives who used the time bought by this program to unload their shares in lending companies before the company went under.

I hadn't considered that. It makes sense.

toshiro_mifune|12.6.07 @ 3:29PM|#

...many of the banks at risk did NOT originate many of the loans at issue - they simply bought the paper
Agreed, but it wasn't just banks that bought the paper; local govt., schools, pension funds, etc.
There is a lot of pain about to be spread around.

And we still haven't really heard all that much about the off-book & lvl 3 asset losses related to this mess, `08 should be a fun year.

montaigne I'm pretty disappointed too. Reason should have been screaming about this much louder that it did.

"By far the greatest percentage of people that should never have owned a house? Anyone with an adjustable rate mortgage."

Maybe so, but why did the bank make a loan like that in the first place? Maybe they are stupid and greedy. Certainly some of that. But also, maybe they were being maomaoed by creeps like Jessee Jackson for not lending enough to minorities and in poor areas? It wouldn't surprise me at all if a decent portion of these loans were given out in the name of "minority empowerment" or some such none sense.

look on the bright side- for once, the federal action didn't involve new laws, new regs, or having the money taken out of our pockets. all they did was put a plan out there for the banks to gobble up.

a stupid plan, yes, but at least operating mostly in the private sector.

|12.6.07 @ 3:31PM|#

(even though many of the banks at risk did NOT originate many of the loans at issue - they simply bought the paper).

Caveat emptor, anyone?

|12.6.07 @ 3:33PM|#

But also, maybe they were being maomaoed by creeps like Jessee Jackson for not lending enough to minorities and in poor areas?

When I was shopping for a loft, they were really pushing interest only loans. This is for white yuppies and not poor black folks.

|12.6.07 @ 3:37PM|#

"When I was shopping for a loft, they were really pushing interest only loans. This is for white yuppies and not poor black folks."

Why were they pushing it if they weren't making money off of it or think they they were going to make money? Basically they were betting on the housing market rising forever. If you assume the value of the condo will go up, then an interest only loan is fabulous for the bank. Either the person pays it and they make money that way or the person defaults and the place sells and the loan is paid off and the bank still makes money. Their bet on the housing market didn't work, so now they are stuck, to which I say "too bad, sometimes life is like that". I don't understand why the government is doing anything about this. Let the people find new homes and the banks lose their money.

|12.6.07 @ 3:38PM|#

I'm probably misunderstanding the article here, but if people are going to default on loans when the teaser rates end, wouldn't it be smart to extend the teaser rates on existing loans, so that you're at least getting something?

One problem with this is that lenders bundled the loans and sold them to investors, while setting an expectation of certain returns (based on interest rates). Some investors are already talking about filing lawsuits if the teaser freezer changes the terms of those contracts and reduce returns (by extending the teaser rates - investors were counting on the subsequent rate hikes to earn their money).

Ultimately, everybody would win if people that qualify and can afford it renegotiate into new fixed mortgages, and everybody else goes back to renting. However, as noted above, there's plenty of blame to go around, and nobody's willing to accept their share.

toshiro_mifune|12.6.07 @ 3:38PM|#

John - A lot of sub-primes were pushed as "affordability products" for houses/condos/co-op that would have otherwise been out of a buyer's reach, thus inflating the bubble further.

|12.6.07 @ 3:40PM|#

The only time anyone that would qualify for a conforming loan would receive a sub-prime loan is if the loan officer worked at a place that only offered sub-prime loans

Loan officers are not the same as mortgage brokers, right?

I'm pretty sure Mortgage brokers have a pool of lenders and have more variance in the products they offer.

What ChicagoTom was talking about is called yield spread and you cannot increase a borrowers rate 2% in yield speread, some but not that much.

I dunno the exact limits on how much the rate can be increased, but the fact that it can happen without any disclosure is a shitty thing. Even it its a .25-.5% increase

|12.6.07 @ 3:42PM|#

ChicagoTom,

Many mortgage brokers also make money of off the spread. That is, if you as a borrower qualifed for a loan at say 6%, but they instead got you to sign up for a loan at 8%, the mortgage broker got to keep that 2% of the total loan amount. This is something that mortgage brokers don't have to disclose to the borrower and they aren't required to offer the best rates that the borrower qualifies for.

Let's say 6% is par, that is nobody originating the loan makes any money at that rate, and 8% pays 2 points. Fine, great. Nobody will be originating loans at 6%, unless they are charging the borrower 2 points. Everybody will be originating loans at 8%. It is not as if there are banks originating loans at the rate that they are offering at par wholesale. Originating costs money on top of the money that the interest will pay over the life of the loan.

Anyway, the important thing here is that you should email me to find out about the Chicago gathering taking place this month.

ed|12.6.07 @ 3:49PM|#

From Associated Press
December 06, 2007 3:08 PM EST
WASHINGTON - Hundreds of thousands of strapped homeowners could get some relief from a plan negotiated by the Bush administration to freeze interest rates on subprime mortgages that are scheduled to rise in the coming months.

"There is no perfect solution," President Bush said Thursday as he announced an agreement hammered out with the mortgage industry. "The homeowners deserve our help. The steps I've outlined today are a sensible response to a serious challenge."

adrian|12.6.07 @ 3:51PM|#

so is the gov assisting in any way? Fed lowering rates?

|12.6.07 @ 4:02PM|#

Feds are probably gonna lower rates either a 1/4 or 1/2 next week.

|12.6.07 @ 4:04PM|#

I don't get the LIE LIE LIE part of the argument.

If the mortgage company doesn't reset the rate, but actually continues to charge the teaser rate, it isn't a lie to say that the mortgage really is at the teaser rate.

If the homeowners are paying their mortgage every month at the teaser rate-cost, it is not a lie to say the loan is still good if the rate stays at the teaser rate.

John,

Good point about the bankruptcy bill. I saw it made on DailyKos a few days ago.

|12.6.07 @ 4:05PM|#

"The homeowners deserve our help. What a sop--compassionate conservatism at its worst. Btw, iiuc, only those with fico below 660 may qualify for the frozen teaser rate--those above are sol.

What kind of a message are they trying to send?

|12.6.07 @ 4:07PM|#

Joe,

The problem is that the teaser rate was never supposed to be the "real" rate--it was only to draw people in, who otherwise would not have been able to.

Russ 2000|12.6.07 @ 4:07PM|#

John - A lot of sub-primes were pushed as "affordability products" for houses/condos/co-op that would have otherwise been out of a buyer's reach, thus inflating the bubble further.

Well you're both right. People were shopping for homes one step up above their means. Poor people were shopping in lower-middle class neighborhoods, and yuppies were shopping the high class district.

I have 7 years to go on my mortgage and I am continually amazed at the number of RE-FI offers I get in the mail. Not home equity loans, re-fi's. Including my current mortgage company. Why the fuck would I want to re-fi with only 7 years to go? If I was in desperate financial straits I'd be looking for a cheaper place to live, not a fe-fi.

Big Nanny|12.6.07 @ 4:08PM|#

I work for a broker. We have access to lots of lenders, you would never see anyone that qualified for a conforming rate get a sub-prime deal here. Some companies have offices that are owned by sub-prime divisions of larger banks. They often only have access to Sub-prime loan programs. As far as yield spread goes, it is either that you you pay points up front, and it does show up on your settlement statement.

Russ 2000|12.6.07 @ 4:09PM|#

Re-fi-fo-fumble.

|12.6.07 @ 4:09PM|#

The statement that people who don't have any equity should be expected to "just walk away" from the HOMES is just about the dumbest thing I've ever read. Where do you imagine these people, who already spent the money they saved up for a down payment and who don't have equity for another down payment are going to go?

That's the sort of statement you hear from someone who continues to believe in Rational Economic Profit Maximizing Man.

JR|12.6.07 @ 4:10PM|#

It's interesting how people ignore the fact that parties to a contract may renegotiate the terms if it's mutually beneficial. Unfortunately, because these are homes we attach a huge sentimental value and expect government to do something.

|12.6.07 @ 4:19PM|#

John, you are simply wrong about "empowerment" loans being part of this.

Jesse Jackson has spent a great deal of time over the past decade WARNING ABOUT and DECRYING sleazy loansharking like this.

The "empowerment loans" you're talking about , and which urban activists support, are subsidized fixed-rate loans. There has been no-none-zero-zilch-nada involvement of community empowerment groups in this traveshamockery.

As a matter of fact, the programs you're talking about are promoted as a way to give poorer people a financing option other than the sleazy mortgage companies' snake oil.

How angry could I possibly be? These banks extended all kinds of credit, which pushed the housing market up and up and up. Now when it turns out that people really couldn't afford that housing market, the Fed wants to prop that phony housing market up. I swear developers and real estate investors must be making direct payments to government officials. Big ones, too.

Russ 2000|12.6.07 @ 4:20PM|#

Where do you imagine these people, who already spent the money they saved up for a down payment and who don't have equity for another down payment are going to go?

Apartments. Lots of vacancies out there from the landlords who didn't get in the condo-conversion craze, not to mention the empty condos being held by speculators who would be happy to rent their units out since the re-sale market is way down.

robc|12.6.07 @ 4:22PM|#

The statement that people who don't have any equity should be expected to "just walk away" from the HOMES is just about the dumbest thing I've ever read. Where do you imagine these people, who already spent the money they saved up for a down payment and who don't have equity for another down payment are going to go?

An apartment. Also, in the case of many, many subprime loans, they didnt save up for a down payment. Which is why the dont have any equity.

VM|12.6.07 @ 4:22PM|#

"That's the sort of statement you hear from someone who continues to believe in Rational Economic Profit Maximizing Man."

(addendum: who's sliding happily along the DEMAND KURV!)

but... but... but... I thought all markets cleared all the time... *wails. sobs. runs off*
:)

Big Nanny|12.6.07 @ 4:24PM|#

"Where do you imagine these people, who already spent the money they saved up for a down payment and who don't have equity for another down payment are going to go?"

Down payment? That is sooooo pre-9/11.

Rational Economic Profit Maxim|12.6.07 @ 4:24PM|#

joe, I exist.

|12.6.07 @ 4:25PM|#

madpad,
I agree with you re: people who got ARMs. The day I lost respect for Greenspan as a human and economist was the day he said that ARMs would be a good investment for some homeowners when interest rates were at their lowest point in decades. ARMs are great investments if you expect interest rates to go down (like the early 80s). I can understand Joe and Jane Sixpack not understanding exotic mortgages, but when the nation's top banker is pimping bad financial decisions to 'roid up the economy, it's just shameful.

|12.6.07 @ 4:26PM|#

What you have left is merely a company contracted to service the loan, but the owner of the loan isn't really in the lending business

Bingo. By extending the teaser rate, you are taking value out of the pockets of the people who repurchased the loans.

I think people who own mortgage-backed loans or loan portfolios that are devalued by this idea have an excellent case for a regulatory taking.

It's interesting how people ignore the fact that parties to a contract may renegotiate the terms if it's mutually beneficial.

I don't think we're talking about the parties renegotiating anything here. I think this is a state mandate that teaser rates be extended in some cases, to the detriment of the current loan owners (who almost certainly aren't the people who made the loan in the first place).

|12.6.07 @ 4:27PM|#

Where do you imagine these people, who already spent the money they saved up for a down payment and who don't have equity for another down payment are going to go?

Many if not most subprimes are part of 100% financing packages.

Russ 2000|12.6.07 @ 4:27PM|#

The "empowerment loans" you're talking about , and which urban activists support, are subsidized fixed-rate loans. There has been no-none-zero-zilch-nada involvement of community empowerment groups in this traveshamockery.

Not ture. It's not like sub-prime mortgages are the only ones being foreclosed. Subsidized mortgages increased demand which raised the prices of homes, thus making the 10% down payment you saved turn into a 7% down payment. And a subsequent downturn in prices turned that 7% equity into negative equity (owning more than the house is worth).

|12.6.07 @ 4:30PM|#

Freezing the teaser rate:borrowers::Cutting Fed Funds rate:banks

Discuss

|12.6.07 @ 4:35PM|#

Let's say 6% is par, that is nobody originating the loan makes any money at that rate, and 8% pays 2 points. Fine, great. Nobody will be originating loans at 6%, unless they are charging the borrower 2 points. Everybody will be originating loans at 8%. It is not as if there are banks originating loans at the rate that they are offering at par wholesale. Originating costs money on top of the money that the interest will pay over the life of the loan.

highnumber,
I'm not sure I completely understood what you said...so apologies if this reply doesn't address your point.

My point was that the loans were in fact available at the better rates, if some of the borrowers would have shopped around, and the lender would be making money and the broker would be makign their commisions. But with the spread yeild, the lenders were telling the brokers ..psst if you lock them into a higher rate and we will give you a higher commision. Even though the lender would have still loaned you money at the better rate. It was a case of instead of offering the best rates you qualified for, they would try to offer you worse terms if you were willing to accept them.

Most people believed that the mortgage broker is trying to find you the best rate possible, but this isn't the case. Instead some(many?) brokers were trying to find you the highest rate you would accept while still having you believe you are getting a good deal.

It's not as if the better rates weren't available and you couldn't get them.

Also, I emailed you at the email account linked to in your name

|12.6.07 @ 4:37PM|#

joe | December 6, 2007, 4:09pm | #

The statement that people who don't have any equity should be expected to "just walk away" from the HOMES is just about the dumbest thing I've ever read. Where do you imagine these people, who already spent the money they saved up for a down payment and who don't have equity for another down payment are going to go?

That's the sort of statement you hear from someone who continues to believe in Rational Economic Profit Maximizing Man.

They aren't going to walk away into a new house. They will likely rent or considering it will be hard for them to pass a credit check to get an apartment they will move in with family. As for downpayments, many people didn't pay one. Or if they did the revolved it out to pay debts or pay for new home expenses like furniture and appliances. The new appliances will go with them and will be used as collatoral while staying with relatives.

Poor people understand the shell game and the only way to win most cons is to leave while you still have something.

They understand that the interests of their bank and their own rarely intersect. If they bank wants you to keep the house, you probably don't want it.

Full disclosure, I live in the Midwest, in a modest sized home with a plain vanilla 30-year fixed owned by the bank of issue.

Bingo. By extending the teaser rate, you are taking value out of the pockets of the people who repurchased the loans.

Only if you believe that there is value in defaulted loans.

Extending the teaser and keeping a payer might be a better deal than having someone default and having to pay to foreclose and sell the property at a discount

highnumber|12.6.07 @ 4:44PM|#

ChicagoTom,

I was mostly babbling to get to the point that you email me. I'm out of the mortgage biz, so I don't really care to get into these discussions, not no more.

VM|12.6.07 @ 4:50PM|#

Chicago Tom:

it's in honor of Fyodor.

(last year he played at Cals - when it snowed quite a bit)

|12.6.07 @ 4:54PM|#

Highnum and VM :

I will talk to the wife and see if she is interested. It sounds like a good time.

VM|12.6.07 @ 5:00PM|#

great! hope to see you at the gathering ere the concert begins!! wives/spouses,significant others are all welcome!

|12.6.07 @ 5:10PM|#

Russ2100, robc,

People who own their homes and making their mortgage payments are not going to give up "the American dream" and move into an apartment if they can afford to stay in their homes.

Even in Rational Profit Maximizing Economic Man would do so.

Also, robc, while some of these loans were zero down, most were not. Homeowners with no equity are much more likely to be people who made a down payment, and have subsequently seen the value of their homes decline.

|12.6.07 @ 5:12PM|#

R C,

By extending the teaser rate, you are taking value out of the pockets of the people who repurchased the loans.

Not if extending the teaser rate keeps people from defaulting entirely. I'd rather get 3/4 of a loaf than none.

This is George Dubya I Don't Have Any More Accountability Moments Bush pushing this through. If you think the investment houses aren't on board, you're nuts.

|12.6.07 @ 5:14PM|#

Russ 2000,

What you wrote at 4:27 is all true, but remember: foreclosure isn't a consequence of people being turned upside down on houses they are staying in and making payments on.

So your conclusion that there are a lot of people in the subsidized end of the loan industry being foreclosed on as a result of this does not follow.

|12.6.07 @ 5:39PM|#

"A better solution would be to eliminate the whole bankruptcy (a polite euphemism for theft) system and bring back debtors prisons"

--This is the heart of the libertarian philosophy, the rich only enhance control and the poor become poorer...The #1 white collar crime has been lending fraud for the past several years...and yes maybe people who couldn't afford the loans shouldn't have taken them...then again maybe they were laid off, became ill, divorced etc...AND FUNDAMENTALLY, taking advantage of somebody because you can and because they don't know better does not make you a good person and sometimes should make you a criminal.

|12.6.07 @ 5:41PM|#

This is what we call 'The Ownership Society'-(trademark)

Russ 2000|12.6.07 @ 5:51PM|#

So your conclusion that there are a lot of people in the subsidized end of the loan industry being foreclosed on as a result of this does not follow.

I didn't make that conclusion. My conclusion was that the subsidized end exacerbated the problem by raising prices.

|12.6.07 @ 5:57PM|#

Seems to me that a repo of a house would increase the inventory(supply), thereby lowering the price (value), not only of the available houses but all other houses in the neighborhood. Since most of us are not selling, our home values would decrease, reducing our tax burden. When the supply is increased the demand will surely follow but now (temporarily) at a lower price, 'til the inventory clears the market. As a home owner, I really have no concern about the hidden value in my home, I do have a concern about the property taxes. Foreclosure is a necessary way of discovering the maladjustment of resources.

Russ 2000|12.6.07 @ 6:16PM|#

our home values would decrease, reducing our tax burden.

Depends on who's doing the valuing.

Russ 2000|12.6.07 @ 6:22PM|#

I'll also point out that when demand was increasing, one entity actually did the economically stupid thing and lowered their prices.

|12.6.07 @ 6:24PM|#

This is another great example of what Sir Humphrey called "Politician's logic" on the show Yes, Prime Minister

Something must be done.
This is something.
Therefore, we must do it.

|12.6.07 @ 6:28PM|#

If both the borrowers and lenders are for this and it doesn't cost taxpayers any money (that is, it actually prevents a bail out), I'm having a hard time finding a reason to be against this. It's one of the less bone-headed government solutions in a while.

I guess jimmy smith's argument is valid that preventing foreclosures will artificially keep home values, and therefore property taxes, inflated. However, my local housing market is in the toilet and my property taxes haven't gone down a bit. Do they ever go down?

|12.6.07 @ 6:31PM|#

mk

Something must be done.
This is something.
Therefore, we must do it.

That is the best summary of the rationale for most government programs I have ever seen.

I'd laugh if I wasn't crying so hard.

Russ 2000|12.6.07 @ 6:48PM|#

...and it doesn't cost taxpayers any money

That's a misleading way to put it. It may not cost any TAX money, instead it'll cost money from your retirement investments. This really just amounts to Countrywide, Washington Mutual, etc al hoping that the price hit their stocks take won't be as big as the income hit from bad loans and foreclosure prices. Re-read the second post at 3:20 pm.

Paul|12.6.07 @ 6:56PM|#

This is the worst idea since Abraham Lincoln said "I'm tired of kicking around the house, let's go take in a show"

Next thing you know, there'll be price controls and five-year plans. Doh!

Paco|12.6.07 @ 7:01PM|#

E-Trade recently sold a couple billion of there so-called "AAA" paper for 25 cents on the dollar. Do you think the Buyers of that junk want work out the loan or foreclose and sell the house for fifty cents? Rinse and repeat? Lawyers are going to make fortune, the bankers get screwed. Loaning money to people who can;t pay it back is bad business.

Paul|12.6.07 @ 7:02PM|#

Where do you imagine these people, who already spent the money they saved up for a down payment

bzzzt! Wrong. Many people in the sub-prime market paid either little or no down payment. That's how this runaway train got here in the first place.

We can argue about accountability, who's to blame, who was misled, and which homeowners simply breezed past the literally dozens of forms you have to sign (as mandated by federal law-- you know the ones, those forms which inform you of the conditions of the loan-- those forms which were mandated because someone somewhere complained 25 years ago that 'they didn't know x') plus ignored all of the obvious financial warning signs as they drove their mercedes stationwagons deeper into the blizzard of a bad loan.

But these loans are bad, and propping them up is the worst thing that can possibly happen now.

Paul|12.6.07 @ 7:04PM|#

Loaning money to people who can;t pay it back is bad business.

Not when the government bails you out.

You know, like building a house on a dirt bluff in a known storm zone is no longer considered a bad idea. There was a time...

|12.6.07 @ 8:20PM|#

paul, the gov't is not bailing anyone out here. for once. yet.

|12.6.07 @ 9:43PM|#

"Somehow this package of dodgy debts stops being a package of dodgy debts and become a Structured Investment Vehicle."

"Yes, we called it the "High-Growth Enhanced Leverage Fund"."
"Oh, that sounds very good!"
"Well, yes. No one would buy it if we called it "Unemployed Black Man in a String Vest in Alabama Fund.""

That's the major problem right there. The whole thing was a house of cards that got built higher and higher through the financial engineering wizards. Everyone was happy: the banks were happy, because they could get all the dubious stuff off the balance sheets and hand it over to someone else, having pocketed a nice percentage for their financial engineering, the mortgage people were happy, because they were continually getting commissions (plus the stuff was out of their hands and they didn't have to worry about it), the rating agencies were happy because they got a lot of business virtuously rating CDOs etc. according to quantitative finance with the computers wugga-wugga-wugging in the background, the pension funds were happy because they had all these nice CDOs and SIVs with "AAA" stamped all over them, and the hedge funds....well, the hedge funds were happy to take a gamble. Plus there was this nice thing called "default insurance" which was supposedly put into place and made them all feel nice and virtuous and prudent. After all, real estate prices were continuing to rise, what could possibly go wrong?

|12.6.07 @ 10:03PM|#

I'm reading a lot of odd stuff on this thread so I'll jump in. As I mentioned before, I spent 4 years working in mortgage default.

To clear up some misconceptions...

Most of the loans we're talking about are "Option" ARMs - not typical ARMs.

They come with lots of shady and confusing language that dupe even sophisticated borrowers. They are often sold fraudulently or poorly explained and they are extremely expensive to refinance due to heavy prepayment penalties.

Options ARMs are so complicated quite frankly- and I don't say this lightly - they should probably be illegal. They are designed by people who can't (in anything approaching a rational mindset) actually believe the borrowers will be able to pay off. These loans are designed from short-term thinking and they are destined to fail.

Lenders like them because they look good on the revenue statements and because mortgage insurance and a robust default industry make the losses in a rising real estate market pretty much zero.

Unfortunately, now that home prices have leveled off - and in some cases fallen, banks are thinking they might have screwed themselves because mortgage insurance might not cover the shortfall.

Most excellent article here:

http://www.businessweek.com/magazine/content/06_37/b4000001.htm

Most libertarians - even if they don't like regulation - will readily admit that one of the bare minimum tasks of the government is to protect its citizens from fraud.

These loans, if not downright fraudulent, are often damn close. So I think, instead of coming up with idiotic band aid schemes like "teaser freeze", the government ought to stay out of the regulation side and haul some arrogant pricks in suits up to capital hill for some explanations.

Mark Bahner|12.6.07 @ 10:27PM|#

In February he got a flyer from a broker advertising an interest rate of 2.2%. It was an unbeatable opportunity, he thought. If he refinanced the mortgage on his $500,000 home into an option ARM, he could save $14,000 in interest payments over three years. Burger quickly pulled the trigger, switching out of his 5.1% fixed-rate loan.

Geez, it's hard to believe anyone can be so ignorant that he couldn't see how this loan could not possibly make sense. And he even had a ridiculously low 5.5% to start!

Mark Bahner|12.6.07 @ 10:29PM|#

Oops, 5.1%! That's got to be close to the lowest rate ever in the last 7 years.

Mark Bahner|12.6.07 @ 10:42PM|#

The retired couple from the Salinas (Calif.) area needed to tap about $50,000 in equity from their $385,000 home to cover mounting expenses. Billy, 66, a retired mechanic, has diabetes. Carolyn, 61, has been caring for her grandchildren, 10-year-old twins, since her daughter's death in 2000. The Shaws have a fixed income of $3,000 a month that will fall by about $1,000 in November after Billy's disability benefits run out.

Holy smokes! A $385,000 home on $3,000 (and later $2,000) a month! That's just not ever going to work.

|12.7.07 @ 1:41AM|#

Reading all this, one conclusion is unescapable:

Mortgage companies and banks were making loans they knew would fail. They did so deliberately.

After all, with a forever rising market, you got a year or two of payments (even at a low rate) THEN you got to repo the house and sell it for a good profit.

From the lender's perspective, it worked like this -- the lender buys a house. Some poor schmuck THINKS he bought the house, but the lender did. The schmuck pays the lender for a year or two for the oppurtunity to keep an eye on the house while it's value appreciates, then he gets kicked out and the lender sells the house for a profit. The lender makes money for the year or two he's "invested" in the house, and then makes even more when he sells.

Any because of the cool financial instruments, the risk was always someone else's.

|12.7.07 @ 3:48AM|#

The real idiocy of this "relief" plan is that it makes no real sense for someone who would have been foreclosed on to now hold onto the house. Say they have a 500K mortgage, and perhaps it's now 600K with a second, on a house that today is worth 300K. Why toss mortgage payments (and taxes and maintenance costs etc.) down a rat hole for 5 years and then lose the house anyway. These are liabilities for the vast majority of these borrowers, not assets. Which leads me to believe this is all cooked up in a desperate attempt to keep housing prices from taking the real, ugly plunge that's coming until we're through the election. That and sheer, blindingly dumb political grandstanding. Duh. P.S. of course it won't work, as credit dries up and the glut of inventory piles up anyway.

|12.7.07 @ 8:31AM|#

If investors who had been buying all of this paper get burned by this, then then current credit crisis could get much uglier, as these funding sources find other places (and other countries) in which to park their money. Think Argentina a few years back.

Oh, and the first sentence of Jeff Taylor's post struck me: Given the amazingly complex world of high finance-full of derivatives, hedges, and tranches. In the spirit of Enron, I have come to assume that any financial transaction that cannot be easily understood is probably shady in some way. There seems to have been a lot of passing off of junk paper to investors who let their greed (not necessarily a bad thing) get ahead of their brains.

highnumber|12.7.07 @ 8:39AM|#

Most of the loans we're talking about are "Option" ARMs - not typical ARMs.

That's totally wrong. Few of the loans were option ARMS. Most were subprime ARMS.

|12.7.07 @ 8:46AM|#

Indeed, the massive failure of Option ARMs will be the next shoe to drop. Subprime is only a part of the mess, and simply the first part to fail.

|12.7.07 @ 12:16PM|#

This catastrophe is strongly predicated on the fact that the loans were sold as securities...So some of the companies who made loans did not have to worry about making good loans, they simply sold their loans off after making them.

|12.7.07 @ 12:23PM|#

I stand (somewhat) corrected by highnumber, but my criticism still stands.

Many of the people were approved based on qualifying at the introductory rate rather than the cap rate, so lender already knows these loans are - at best - a crap shoot.

Years of data already show that while conventional and near-prime loans have a default rate of 1-2%, traditional ARMs have a default rate of 5%. Add subprime borrowers and the default rate is already looking like 15-19%.

Anyway you slice it, it all starts with the decision by the banks to offer these loans in the first place. They did it knowing...

1. the prevailing rate of failure and

2. the factors that increase the likelyhood of failure (bad credit risks) and

3. the possibility of losses due to a downturn in home values.

|12.7.07 @ 12:31PM|#

Regarding down payments, most people who made down payments were in the neighborhood of 3%. Sometimes that doesn't even cover closing costs, so people made a down payment but still had no equity.

|12.7.07 @ 12:42PM|#

Now I know alot of the people on this website do not look fondly upon gov't regulation...however I think that if we do not begin to start addressing the type of exotic investment instruments available now including hedge funds and certain types of securities, problems like this are going to recur.

|12.7.07 @ 12:52PM|#

Also, and I'm not certain of this and would love a comment from the more expert, but aren't many if not most of these Negative Amortization loans? So during this magical 5 year "freeze" period they'll be getting more upside-down than they are now. This should be called "well, urm...maybe they'll win the lottery!" plan. Jeepers.

|12.7.07 @ 2:33PM|#

aren't many if not most of these Negative Amortization loans

The Option ARM is...your lower interest rate is paid for by adding to your principle.

Think of it like this...prime is 5%...you want to pay 2%. The portion that's the remaining 3% is added back to your principle.

Why would any bank in their right mind make this kind of loan?

Because, the amount added to your principle is not considered interest...it's considered revenue by the bank because instead of paying loan the loan, it's increasing the principle.

|12.7.07 @ 4:51PM|#

The essential 'lie' here, in the LA area at least, is that a two bedroom bungalow is worth $700,000+. No amount of creative financing is going to fix that.

A radio show here had a guest real-estate expert (don't remember his name) who stated the problem succinctly: In many cases, the wrong people own homes.

If the market ran its course, people who cannot afford the home they purchased would move out and rent (they wouldn't be 'homeless'). The people who can afford a home, at its fair value, would stop renting and move into the vacated homes.

|12.8.07 @ 3:06PM|#

James | December 7, 2007, 12:42pm | #

Now I know alot of the people on this website do not look fondly upon gov't regulation...however I think that if we do not begin to start addressing the type of exotic investment instruments available now including hedge funds and certain types of securities, problems like this are going to recur.

The government can "address" the problems with exotic investment instruments by prosecuting fraudulent lenders to the fullest extent of the law, and by letting merely foolish lenders fall on their asses instead of giving them Fed bailouts. No regulation required.

But then again, what do I know? According to you, debtors' prison is "at the heart" of my philosophy.

|12.9.07 @ 2:35AM|#

Everything you say may be true, but you have left out one half of the story -- the effect on the housing market! The huge number of bank owned properties already on the market has lowered resale values of homes in ALL price ranges, making it difficult, or impossible, to sell homes on the retail market to avoid foreclosure. This downward spiral will not stop until the lenders do whatever it takes to reduce foreclosures.

Lost in Paradise|12.9.07 @ 7:30AM|#

I have read most of these comments and it seems that there is some diversity of opinion as to what is going on.

As a few posters have caught on, this is simple - all bubbles are quite similar. What else is there to say? Yes, if the price of housing would just go back to the bubble price, all of our problems would be gone - which is what they have been saying in Japan since 1992. So, why do us Amerikans expect this miracle within the next 5 years?

|12.9.07 @ 4:23PM|#

Good point, Lost,

It's not like this is the first time this has happened.

Banks typically get into cycles where they lend stupidly and invest riskily. As long as the guv'mint keeps it's moronic head out of it, the bad ones will get shaken out and the good ones will survive.

And Jim Cramer is an idiot.

TomR|12.9.07 @ 4:40PM|#

Each tax payer here in the UK has had £900 seized to bail out Northern Rock :@

|12.9.07 @ 5:45PM|#

Here, the U.S. government will just borrow it from an Asian bank increasing the national debt.

Or a German or a Canadian or an Australian one.

Steve B|12.9.07 @ 10:42PM|#

The comments regarding how artificially high home valuations keep property taxes high is misguided. Tax revenues for municipalities haven't increased at the same rate as property values; cities typically determine their budget, then set the tax rate based on the total market valuation for the area. You don't pay more taxes if everyone's home in your town goes up, only if your home goes up relative to everyone else's. At least that's the basic idea; towns may feel like they can increase the budget for the year if they think that the residents are wealthier due to higher home values. But my house has increased in assessed value from $250,000 to $450,000 since 1999, and my taxes have remained pretty constant at around $1650/year.

Steve B|12.9.07 @ 10:49PM|#

Furthermore: It's not like my previous post is an endorsement of this plan. For one thing, there are plenty of teaser loans out there that are not only interest only, but less-than-interest only; I received some hucksters offer in the mail the other day that promised that I could cut my monthly payments (on a 30 year fixed 5.75% loan) in half. I knew this was preposterous; reading the fine print I saw that the product they were selling me would have resulting in the principal on my loan increasing over time, until some refinance deadline loomed on the horizon. I'm assuming those types of loans would not be covered by this plan, but I'm also guessing that just keeping the current rate would not exactly be a "no loss" situation for the loan holders; the loans were purchased like bonds are traded, possibly priced higher than the face value of the loan with the assumption that a higher rate of return would be around the corner. When that return fails to be realized, the investment probably becomes underwater (never mind the valuation on the property).

|12.10.07 @ 6:10AM|#

I think this problem is 90% the fault of "lenders". The problem is that lenders did not care whether a borrower was credit-worthy because the lender was not keeping the loan anyway. Loans were packaged and sold off to "investors" in the form of CDOs. These were repackaged and derivatives of the packages were resold, ad infinitum. Everybody made lots of commissions and fees in the process. You, the taxpayer, will be left stomping out the bag full of flaming turds though.

This bailout is a bandaid on a decapitation, it just covers the gory details for a while.

|12.10.07 @ 4:41PM|#

The purpose of this plan is to hide one of the dirty little secrets behind this whole mess. A large number, (perhaps 40%)of those foreclosing can't prove that they actually own the mortgage because the securitization process is so sloppy. There have been a few instances of judges throwing out the foreclosure suit. Most morons of course don't contest it they just go along for the ride.
The goal of this plan is to have the home-owners re-sign mortgage docs to perfect the CMO owners lien on the property.

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