US Subprime Rate Freeze

[adrock3215]

As a side note, what do you guys think about the Bush administration freezing the subprime loans rate for five years and the continuous interest rate cuts by the FED? Do you think it would make a difference to the current crisis? Or would it lead to further problems down the road? If so, what are the potential problems?

To your second question: Bush is holding a press conference on subprime now, and is going to announce details of his "plan" to fix the subprime market. He has talked about providing relief to borrowers through a variety of methods so far, none of them including freezing or lowering property tax rates or payments. I guess that is no surprise. I think Paulson is speaking after Bush as well, so maybe more intricate details will come out.

I trade stocks for a living and every time Bush comes on to speak (about 3-4 times per week) the market treads water or gets smacked down. Kind of irritating.

Edited December 6, 2007 by softwareNerd
Added quote block, before splitting topic

[KendallJ]

As a side note, what do you guys think about the Bush administration freezing the subprime loans rate for five years and the continuous interest rate cuts by the FED?

The freeze is a price control, pure and simple. No different than a govt setting the price of potatoes or gasoline.

[softwareNerd]

This so called "deal" between the government and lenders has been touted as something that's good for both the lenders and the borrowers. The argument goes thus: when a borrower with very low (or negative) equity in a home defaults, the lender will lose a large percentage of their loan. So, it makes sense for the lenders to cut the borrowers a deal, as long as the deal increases the chances that the borrower can repay (i.e. a temporary break). Better for the lender to give up a few percentage points for a few years, than take a huge loss. The lender thus takes a small loss, in the hope of not taking the larger loss that comes from default and sale of the property.

The question, of course, is: why do lenders need the government to tell them this? If it is really in their interest, why can't they do this themselves?

Could it be that the government is using coercion? Here's what is happening: the government holds all sorts of power over the lenders. The lenders aren't taking this action that is supposed to be in their interest. Now, the government talks them into it? Possibly some coercive force is involved?

There is an additional wrinkle to this: the government is not even talking to the real lenders. Many of these loans have been parcelled into securities and sold on. There are people all over the world that hold the final loan. You could hold it, I could, and some folk in Europe, Japan and China could hold huge chunks of it. Therefore, the real lenders aren't being consulted here.

The details of this "deal" aren't clear, so the following is speculative.

The companies that administer the loans on behalf of the ultimate lenders all over the world, have some discretion, by contract, to cut borrowers some slack. However, they cannot do so if they are not acting as "good faith" agents of the lender. If they give a whole lot of borrowers a break that does not make business sense (or is borderline), they could be sued by the people who hold these loans. So, as part of this "deal" the government might enact legislation that declares, by fiat, that this particular "deal" will be considered to be good business sense, and the lenders may not bring action against the administrators. There was some mention of this in a few articles, but the details are not well publicized yet.

[Scott_Connery]

It does seem like a big middle finger to all those people who bought fixed rate mortgages within their budget. If I had known I could have gotten a freeze on a low introductory rate ARM, I certainly wouldn't have done the responsible thing and gotten a fixed rate loan that was a few percent higher.

Edited December 7, 2007 by Scott_Connery

[adrock3215]

I agree with Scott. I purchased a home last year with a 30-year fixed, and I feel like I am the borrower who was duped, not one of these "subprime" borrowers. I could be locked in to a much lower monthly payment for the last year plus the next 5 years.

Funny how Paulson can work at Goldman Sachs for years, packaging and selling these exotic securitized mortgage products all over the world knowing how risky they were, and then come to Washington and "fix" the problem he had a major part in creating. I suppose this plan is going to help Goldman significantly, maybe that is why he is doing it. All the securitized mortgages that these investment banks are holding off of their balance sheets will increase in value. Maybe the Republicans don't want to see this housing slump occur on their watch, because the elections are just around the corner.

The worst part of this is that borrowers who should have been forced out of their homes are going to be remaining in homes they cannot afford. Because these homes do not come on the market, property values are not going to be allowed to correct themselves. They are going to be kept at artificially high inflated prices. This punishes many people who have been saving and waiting for prices to become more affordable before they buy. Essentially, these responsible people will lose the oppurtunity to own a home because of this mess they had no part in.

[adrock3215]

Has anyone ever seen 61 economists agree on something? Written yesterday....

http://www.freedomworks.org/econletter/20071206.pdf

Open Letter to the United States Congress:

We, the undersigned economists, write to strongly advise against excessive new

regulations or federal interventions as a response to current trends in the housing market. Market

corrections have already begun, with financial institutions writing down bad debts and adopting

new lending standards to avoid future foreclosures. Legislation to create new underwriting

standards will reduce competition and restrict consumer access to credit. Additionally, efforts to

bail out or shore up lending institutions create a moral hazard that would slow the adjustments

required in the marketplace.

Government solutions, as opposed to the current market correction, would create changes

whose effects will linger long into the future. Legislative proposals have included expanding the

role of government sponsored enterprises, mandating new underwriting standards, allowing

bankruptcy courts to rewrite the terms and conditions of mortgage contracts, and expanding

liability to those who securitize loans. These proposals would fundamentally alter the workings

of the mortgage market, leaving consumers with fewer choices when seeking to buy a home and

potentially increasing taxpayer exposure for bad loans.

It is important to realize that the market for subprime mortgages has provided consumers

with greater access to credit and new opportunities for home ownership. Current laws provide

the necessary authority to address abuses that have occurred and, in light of recent market

activity, lenders have already responded with tighter standards to avoid potential foreclosures. In

fact, more than 80 percent of all sub-prime mortgages continue to be paid on time.

Opposing excessive new regulations is important as the subprime mortgage market

adjusts to existing market conditions. Access to such mortgages has provided more benefits than

harm to consumers, and through market discipline, lending institutions are taking the necessary

steps to address the problems that have emerged. Forcing taxpayers to bear the costs of this

adjustment is unwarranted and reduces the incentives for financial institutions to correct past

behavior. Additionally, new regulations or underwriting standards will restrict consumer access

credit and hinder the market’s correction.

Sincerely,

Michael Alexeev, Indiana University

Charles W. Baird, California State University – East

Bay

L. Dwayne Barney, Boise State University

John J. Bethune, Barton College

Don Bellante, University of South Florida

Samuel Bostaph, University of Dallas

Bruce Caldwell, University of North Carolina -

Greensboro

Noel D. Campbell, University of Central Arkansas

Bryan Caplan, George Mason University

John Conant, Indiana State University

Eleanor D. Craig, Delaware University

Richard Ebeling, Foundation for Economic Education

James R. Edwards, Montana State University –

Northern

Frank Egan, Trinity College

Frank Falero, California State University

Price Fishback, University of Arizona

Arthur A. Fleisher, III, Metropolitan State

College of Denver

Fred Foldvary, Santa Clara University

B. Delworth Gardner, Brigham Young University

James F. Gatti, University of Vermont

David E. R. Gay, University of Arkansas

Erik Gartzke, University of California - San Diego

Adam Gifford, Jr., California State University

Micha Gisser, Rio Grande Foundation

Charles J. Goetz, University of Virginia School of Law

Peter Gordon, University of Southern California

Gerald Gunderson, Trinity College - Hartford

Frank Hefner, College of Charleston

Robert Heidt, Indiana University School of Law –

Bloomington

David R. Henderson, Hoover Institution

William D. Hermann, Golden Gate University

Melvin J. Hinich, University of Texas – Austin

Mark Hirschey, University of Kansas

Steve Horwitz, St. Lawrence University

James L. Huffman, Lewis & Clark Law School

Thomas R. Ireland, University of Missouri – St. Louis

Michael C. Jensen, Harvard Business School

David L. Kaserman, Auburn University

George G. Kaufman, Loyola University Chicago

David N. Laband, Auburn University

Deepak Lal, University of California - Los Angeles

Philip LeBel, Montclair State University

Dwight R. Lee, University of Georgia - Athens

Bill Marcum, Wake Forest University

Barry J. Seldon, University of Texas at Dallas

Stephen Shmanske, California State University – East

Bay

William F. Shughart, II, University of Mississippi

David E. Spencer, Brigham Young University

Courtenay C. Stone, Ball State University

Richard J. Sweeney, Georgetown University

Thomas C. Taylor, Wake Forest University

Clifford F. Thies, Shenandoah University

Edward Tower, Duke University

Leo Troy, Rutgers University – Newark

T. Norman Van Cott, Ball State University

Robert Whaples, Wake Forest University

Gary Wolfram, Hillsdale College

DeVon L.Yoho, Ball State University

Stephen T. Ziliak, Roosevelt University

Affiliations for identification purposes only.

[softwareNerd]

Maybe the Republicans don't want to see this housing slump occur on their watch, because the elections are just around the corner.

That is almost certainly part of the motivation. Note, however, that folks from both sides of the "aisle" have been calling for some type of government intervention. The government could have intervened in other ways: they could have made this deal cover more people (they've excluded sub-prime borrowers who already delinquent -- which is about 22% of all sub-prime borrowers); they could have frozen rates for a broad set of borrowers, not just those with extremely low equity; they could have given special tax-credits to people who are "at risk"...and so on.

Most of the plans that the Democrats wanted would have been even worse. That is a repeated theme of Republican presidents. They have the same principles as the Democrats, but try not to "go to extremes", and try to have a solution that they'd term more "market" oriented.

A few years ago, it was Mr. Greenspan who was adivsing people to go into ARMs rather than fixed rate mortgages. Another feather in the his cap!

All the securitized mortgages that these investment banks are holding off of their balance sheets will increase in value.

To the extent that this is true, it makes the case in favor of this deal. If allowing these poor creditors a little more time to pay up will actually ensure a higher ultimate cash inflow, and if that warrants a higher valuation for these mortgages, then the deal is a win-win for the banks and for the creditors. The downside comes if one takes a longer term perspective: in the future, will this encourage more people to take ARM, thus undercutting potential future profits. [The whole argument about "moral hazard", and how that chips away at expectations.]

Because these homes do not come on the market, property values are not going to be allowed to correct themselves. They are going to be kept at artificially high inflated prices. This punishes many people who have been saving and waiting for prices to become more affordable before they buy. Essentially, these responsible people will lose the oppurtunity to own a home because of this mess they had no part in.

True.

Still, the main point I want to make is this: to the extent that such a deal had been crafted by the lenders, without any coercion from the government, and to the extent it does not depend on the government changing what previous private contracts stipulated, to that extent, the deal is just fine.

[adrock3215]

That is almost certainly part of the motivation. Note, however, that folks from both sides of the "aisle" have been calling for some type of government intervention. The government could have intervened in other ways: they could have made this deal cover more people (they've excluded sub-prime borrowers who already delinquent -- which is about 22% of all sub-prime borrowers); they could have frozen rates for a broad set of borrowers, not just those with extremely low equity; they could have given special tax-credits to people who are "at risk"...and so on.

Most of the plans that the Democrats wanted would have been even worse. That is a repeated theme of Republican presidents. They have the same principles as the Democrats, but try not to "go to extremes", and try to have a solution that they'd term more "market" oriented.

Yeah, that's absolutely true. Hilary's plan that she outlined on CNBC the other day was horrendous. Imagine if we get "Meathead Mitt" Romney in office with his private-equity experience in Bain Capital. He gives lip service to markets but I get the feeling when listening to him that he is in favor of a large amount of government intervention when "markets fail."

A few years ago, it was Mr. Greenspan who was adivsing people to go into ARMs rather than fixed rate mortgages. Another feather in the his cap!

Ha. Interesting link. I had heard from various sources that Greenspan had endorsed ARMs, but I had never heard it in the context he said it in. What he said was not incorrect. He simply stated a fact. Anyone who took out an ARM in the late 90's or before 9/11 would have benefited greatly and would have had a substantially less payment amount while the Fed repeatedly cut its rates. In addition, he stated that a borrower could have taken an ARM out and lost on it as well. Anyway, I don't think anyone saw Greenspan on TV and went "Oh, wow honey, Greenspan said ARMs are great. Call our mortgage broker and tell him we don't want that 30-year fixed anymore, we want an ARM!"

Still, the main point I want to make is this: to the extent that such a deal had been crafted by the lenders, without any coercion from the government, and to the extent it does not depend on the government changing what previous private contracts stipulated, to that extent, the deal is just fine.

Agreed.

[softwareNerd]

Paulson's press release on this issue is here. A groups that represents many large investors in mortgages (The American Securitization Forum), has released detailed guidelines.