Tag: mortgages

It Was those Bad Speculators That Drove the Housing Bubble….

A recent report from the Federal Reserve Bank of New York examines the role of speculators in driving the housing bubble. Setting aside the fact that almost everyone who bought a house was “speculating” to some degree, the researchers focus on those who were buying homes they did not intend to live in.

Some have already tried to paint this study as proving the government had little to do with the housing crisis. To their credit, the study’s authors do not go that far. Others, Mark Thoma for instance, show no such constraint:

“This is pretty far away from the (false) story that Republicans tell about the crisis being caused by the government forcing banks to make loans to unqualified borrowers.”

Of course, I’m sure that even Thoma knows that he’s set up a straw-man. Does anyone really believe that the Community Reinvestment Act and the Government Sponsored Enterprises housing goals were the only factors behind the crisis? Perhaps if the New York Fed really wanted to understand the crisis, it should look in the mirror.  It would seem reasonable to me that three years of a negative real federal funds rate might have had some impact on the housing market, particularly in encouraging speculators. After all, the Fed was basically paying people to take money.

None of this takes away from the role that Fannie and Freddie played in the housing market. For mortgages they purchased directly, Freddie’s investor share increased from three percent in 2003 to seven percent in 2007. And this ignores the massive volume of private label mortgage backed securities purchased by Fannie and Freddie. I think its reasonable to believe some of those were investor loans. In addition, the FBI has reported that the most frequent form of mortgage fraud has been borrowers stating the loan was for a primary residence when it was not.  But then it would be impolite of me to suggest we actually prosecute borrowers who committed fraud.

As I argued over two years ago, the relatively high percentage of foreclosures that are driven by pure speculators should make us question the many efforts to slow or stop the foreclosure process. If so many of these foreclosures are speculators, then why do we continue to protect them from losing the homes? They gambled, they lost. It’s time to move on and let the markets continue to adjust.

Now, one can continue to blame private sector actors for following the perverse incentives created by government. After all, the banks didn’t have to make the loans and the borrowers didn’t have to take the money. But it should be the primary objective of public policy to get the incentives correct. It should by now be crystal clear that all of the massive speculation in the housing market didn’t “just happen”—it was the result of massive government distortions in our housing and financial markets.

 

Raising Interest Rates to Help the Housing Market

Last week I offered a few proposals to help move along the housing market. Given the need for brevity, the rationales for each were short. As almost all of them were counter to the conventional wisdom, they do merit a little more explaining, in particular the suggestion to raise interest rates.

Before I could offer a further discussion of the fact that the mortgage market is driven by both demand and supply, Daniel Indiviglio at the Atlantic was quick enough to provide much of that detail. Rather than repeat his analysis here, which I agree with, let’s focus on a few other points.

David argues that “at rates like 4 percent, those loans had better be pristine if the bank wants to ensure that its default risk is covered by the small amount of interest it receives.” Let’s dig a little deeper. What lenders care about are real rates. With inflation running approximately 2 percent, the real return on a prime mortgage today, before credit cost, is around 2 percent. But today about 3.5 percent of prime loans are in foreclosure. Assuming a 50 percent recovery rate, 1.75 percent is needed to cover credit losses. Even in good times, prime loans foreclosure at about a 0.6 percent rate. With subprime foreclosures running about 14 percent, you’d need to charge at least 9 percent to break-even in real terms. At today’s rates, lenders are barely breaking even on prime loans, they’d bleed money if they charge similar rates to subprime borrowers.

But then why don’t lenders just charge higher rates for the higher risk borrowers? After all that’s what they did during the bubble years.  Well a lot has changed since then. For instance, in 2008 the Federal Reserve, under the Home Ownership and Equity Protection Act (HOEPA), lowered the threshold for what is considered a “higher-cost” mortgage, from treasury +8 percent, which excluded much of the market, to prime mortgage +1.5 percent, which under current rates makes anything over 5.5 percent a “high cost” mortgage. When Congress passed HOEPA in 1994, it shut down that segment of the market, due to what is tremendous litigation risk. Now the Fed’s extension of HOEPA has done the same for much of the mortgage market. According to the Fed, 22 percent of the market was “higher-cost” in 2005. After the new regulation, that share had fallen to 2.4 percent in 2010. Yes the housing bubble and credit crisis would have shrunk that market, but by almost 90 percent? And yes, many of those loans we didn’t want to come back, but many we did.

The point here is that the Fed actually does impose, via legal risk, a de facto ceiling on mortgage rates. If we want to bring back housing/mortgage demand among higher risk borrowers, which were a significant source of demand, then the Fed would be wise to suspend its current HOEPA rules. If we don’t want to bring that demand back, then fine, just stop complaining about a weak housing market. As an aside, I was of the view in 2008 and still today that the Fed lacked legal authority for its 2008 HOEPA rule, but then the Fed has rarely let a lack of legal authority get in its way.

Random Thoughts on Obama’s New Mortgage Plan

In case you missed it, President Obama gave a big speech out in Las Vegas about both his “jobs” plan and a new plan to help underwater borrowers re-finance their mortgage. First, let’s recognize that it is not really “his” plan. The proposal is being issued by the Federal Housing Finance Agency (FHFA), an independent regulator that the President is supposed to have no control over. Frankly, I find it troubling for a president to be so involved with an independent agency. If a president was out giving speeches when the Federal Reserve changed interest rates, we would all call that bizarre. It is no different here. As someone involved in drafting the law that created FHFA, I can say Congress considered, and rejected, the option of having this agency accountable to the president.

On to the substance. Perhaps most striking is that this plan does nothing for the housing market. Does it increase demand for housing? No. Does it reduce the supply of excess homes or help move the massive shadow inventory? Again, No. Does it even help those most in need? No. It is available only to those who have already had a mortgage for over two years, are current on their mortgage, and have missed no more than one payment per year. Basically helping only those that do not need any help.

The logic of the plan is that by reducing mortgage rates, you reduce monthly payments, which would increase consumer spending. The flaw in that logic is that while a mortgage is one person’s liability, it is another person’s asset. So you are simply making one party wealthier while making another poorer. It is not clear that the impact on aggregate spending should be anything other than zero.

Most troubling about the the plan, is that the program it is based upon, HARP, is likely illegal. Both the Fannie and Freddie charters require that if a loan is above 80 percent loan-to-value, it must have mortgage insurance. Yet the heart of HARP is a waiver of this requirement. Apparently FHFA claims these are not “new” loans, but just modifications. In that case why in the world would you modify a loan that is current and does not appear in any danger of default. Sadly one of the many things lost in the financial crisis is a basic respect for the rule of law. Our financial regulators have too often embraced a culture of lawlessness in name of saving our financial system (with little to show for it).

Do Forced Mortgage Writedowns Create Wealth?

Matt Yglesias recently added his voice to the long running calls for principal reductions on underwater mortgages.  His argument is that such would create additional spending.  Or as he puts it, “I think that if people in Phoenix got a principal writedown on their mortgages, they’d have more disposable income and might go to the bar more.”

What Matt, and others calling for forced principal reductions, miss, or choose to ignore, is that while a mortgage represents a liability to the borrower, it is an asset to someone else.  Matt’s logic, which I agree with here, is that an increase in one’s net wealth (via a reduction in one’s liabilities) should increase one’s consumption.  To complete the analysis, however, we must extend that same logic to the holders of the asset, so that a reduction in the value of their asset (the mortgage) should reduce their spending.  Taking x from A and giving x to B is not going to increase A+B.  To assert otherwise is to engage in Enron-style social accounting.

Now if you want to argue that the borrower has a higher marginal propensity to consume than the investor (say, a retiree living off a pension) then provide some support for that position.  It is just as likely that those on the losing end will take efforts to protect themselves from this loss, decreasing overall social wealth.  So what one has to show is that the marginal propensity to consume for the borrower is so much larger than that for the investor that it offsets any costs from the investor trying to protect his investment from theft.

Now if you simply favor redistribution of wealth for its own sake, just say so.  If you hate investors and love defaulting borrowers, then just say so.  Personally, I don’t believe the role of government should be to take from A to give to B.  I just ask that we stop pretending, in the absence of compelling evidence, that redistribution of wealth is the same as wealth creation.

SEC vs. Goldman Sachs: Legislation by Demonization

The Obama administration thinks it has discovered the perfect formula to cram legislation through in a hurry:  Demonize some prominent firm within an industry you plan to redesign, and then pass a law that has nothing to do with the accusation against the demonized firm.  They did this with health insurance and now they’re trying it with finance.

With health insurance, the demon was Anthem Blue Cross Blue Shield of California, which Obama accused of raising premiums by “anywhere from 35 to 39 percent.” Why didn’t some curious reporter interview a single person who actually paid 39% more, or quote from a letter announcing such an increase?  Because it didn’t happen.  Insurance premiums are regulated by the states, and California wouldn’t approve such a boost.  Yet the media’s uncritical outrage over that 39% rumor helped to enact an intrusive, redistributive health bill that has nothing to do with health insurance premiums (which remain regulated by the states).

Today, the new demon de jour is Goldman Sachs, a handy scapegoat to promote hasty financial rejiggering schemes  The SEC’s suspiciously-timed civil suit against Goldman looks as flimsy as the last month’s health insurance story.  It also looks unlikely to win in court.

As Washington Post columnist Sebastian Mallaby explains, “This is a non-scandal. The securities in question, so-called synthetic collateralized debt obligations, cannot exist unless somebody is betting that they will lose value.”  In such a zero-sum contest, big investors who went long knew perfectly well that other investors had to be taking the other side of the bet.  Goldman lost $90 million by betting this CDO would go up; John Paulson went short.

Columnists have moralized about the unfairness of the short investor (Paulson) negotiating the terms of this deal with a long investor, ACA Management, which had the last word. This too, notes Mallaby, “is another non-scandal.  An investor who wants to bet against a bundle of mortgages is entitled to suggest what should go into the bundle. The buyer is equally entitled to make counter-suggestions.  As the SEC’s complaint states clearly, the lead buyer in this deal, a boutique called ACA that specialized in mortgage securities, did precisely that.”

Like the earlier fuming about Anthem California, this new SEC publicity stunt is likewise irrelevant to the pending legislation.  Congress hopes to get standardized derivatives traded on an exchange. But synthetic collateralized debt obligations dealing with a customized bundle of securities could not possibly be traded on an exchange, and would therefore be untouched by reform.

Losses sustained by a few financial speculators on one exotic derivative had nothing to do with starting a global recession in December 2007 or the related financial crisis of September 2008. The core of the latter crisis was mortgage-backed securities per se, yet Goldman was only the 12th largest private MBS issuer in 2007.  Fannie Mae and Freddie Mac were and are the biggest risk; any reform that excludes them is a fraud.

The SEC’s dubious civil suit against Goldman is a wasteful diversion at best. It has nothing to do with the Obama administration’s suicidal impulse to impose more tough regulations and taxes on banks to encourage them to lend more.

[Cross-posted at NRO’s The Corner]

Is the Obama Mortgage Foreclosure Plan Legal?

While considerable attention has rightly focused on the failure of President Obama’s various mortgage foreclosure plans to actually lower the rate of foreclosures, few have bothered to even ask whether the plan is allowable under the TARP statute.

Alex Pollock at AEI first raised this issue during testimony before the Congressional Oversight Panel.  Alex’s point is that TARP only allows the modification of mortgages that are actually acquired by the government.  Recall the original purpose of the TARP was to buy “troubled assets.”  In managing those assets, Congress required the executive branch to come up with a plan to assist the borrowers behind those troubled assets.

Apparently unlike the Treasury department, I believe we should go back to the language of the statute in determining what it allows and doesn’t allow.  Section 110(b)(1) is quite clear:  “to the extent that the Federal property manager holds, owns, or controls mortgages, mortgage backed securities…” Nowhere else in TARP is there any other ability to establish a mortgage modification program.  In using TARP funds to pay for modifications of loans not owned by the federal government, the Obama administration is acting far outside of its legal authority under TARP.

Many, including myself, have criticized the TARP as a massive delegation of spending power from Congress to the Treasury Department.  Such delegation is, in my mind, clearly unconstitutional.  However, even within such a broad delegation, there are parameters in which Treasury must act.  Treating TARP as simply a large pot of money to spend however Treasury chooses is nothing short of illegal.

Good News on Housing!

The Wall Street Journal reports that some mortgage insurers and lenders are beginning to relax their down-payment requirements, so that buyers in some parts of the country can now borrow 95% instead of 90% of a property’s value. Buyers who can’t come up with even a 5% down payment can turn to the Federal Housing Administration, which will make loans with as little as a 3.5% down payment. Unsurprisingly, the FHA is increasing its market share.

Meanwhile, the Treasury department is pressuring mortgage companies to reduce payments for many more troubled homeowners, averting foreclosures. So, good news: people who lack income and assets will be able to take out loans to buy houses, and if they can’t make the payments they signed up for, the government will pressure their lenders to accept lower monthly payments in return. We’re back on the road to easy, universal homeownership.

Oh, wait.