Lots of people have wondered about how we can possibly unwind the housing mess. I just got one of those pit of the stomach sinking feelings. Ponder the following and please talk me out of it.
As F@cked Borrower after FB starts to falter the banks will need to do something. I always thought it would be the old fashioned foreclosure but now I'm not so sure. Banks like money, the more the better. If they foreclose they won't make any money, they lose. Instead the banks are going to do the unthinkable, they'll renegotiate the loans lower. The logical goes like this; instead of 3-6 months of no payments and then 60 cents on the dollar the banks will turn their $500k, ARMs into $400k fixeds. Better $2000/mo for the next 29 years than the alternative. And who gets screwed? The people that were smart enough to not get in the scam. My investment income goes lower, my opportunites to buy low are fewer and even my home is devalued by this process. The same b@stards that caused this mess benefit.
21 comments:
I thought all the loans were funded via mutual funds? banks only do the initial funding and then resell the loan to some bond fund like a lot of people have in their 401k's and the banks get 1/8 of a point in servicing the loan? Doesn't this mean that the banks can't just renegotiate the loans because they are owned by investors holding shares in a mutual fund? Even if banks own some loans, the money didn't come from depositors but from borrowed funds. banks always borrowed money at the low wholesale rates and then made money on the spread. So renegotiating may not be possible if it means negative cash flows for the next 30 years.
Anon, Think about it. If what you say is true it would be impossible to refi. The MBSecs are near always callable.
I see you read my link on Calculated Risk.
http://www.slate.com/id/2132094/
I see you read my link on Calculated Risk.
Honestly, no. Great minds do often think alike but I gladly you give you credit for the first call. This from the person who called the "Silent Spring" last October.
this would be a good idea for the banks,but i don't think they can do it...one reason being that the drop in prices will be as irrational as the boom,and i think panic will set in.why refi a 300k k house for 400k?
I'm wondering, if you're the bank, how could you set about making this work as a system?
Start with a single household. How do you say, well, we'll more or less forgive (via renegotiation) this much; is that all right (it's a negotiation)? And a little light goes on in the eyes of the FB. Shucks, they say, we can't really pay that much; how about half that? Then the bank says, no, it's the first figure, or we foreclose. They have to resort to the threat of foreclosure at some point in order to demand anything, don't they?
Now step back and look at the meta-picture. FB family one just renegotiated, and now four other families on the block decide to get in on the action. They know what the first family did and set out to game the system.
Moreover, maybe the first FB family sees others getting a better "deal" and chooses to have problems paying again after another 10 months. Well, we thought we could manage it but we can't really hack it. Could you slice off a little more from the debt? Thanks ever so much.
Suddenly the bank is in this weird world where no one has an incentive to work harder, or to save to pay back. On the contrary, people now hide their assets in mattresses and bury them in the back yard in order to hide their ability to pay from the financial system to which their poor bank belongs. Volumes of wealth disappear into a cash-only black market and pretty soon the bank can shut up shop for good.
All right, I'm a novice at this, so I'm probably off base a bit. Offhand though if there were these kind of opportunities to get free money (forgiveness) as an FB I think I could come up with something similar pretty quick.
Ahhhh, grasshopper you describe the run up in reverse do you not? Does not the winter follow the summer? Yes, grasshopper you see the truth but with one warning. You see grasshopper "forgiveness" is not without price. The Federal government calls forgiveness income. Thus grasshopper it does no good to get a great deal compared to a deal you can live with. Still it we who were careful that will suffer. You cannot get blood out of the stone so you use the stone to pulp the flower.
It's not mutual funds who provide the funding, but the idea is correct. Frequently mortgages are packaged as securities (collateralized debt obligations) and sold to investors. Or sold to Fannie Mae, who places the govt-backed stamp on them and resells. Since the banks are offloading these mortgages so quickly and investors have been so hungry for yield, risk and underwriting standards are nil.
I don't think it's going to happen exactly as you've outlined, but I unfortunately think you are correct in spirit. There WILL be some kind of bailout. Fannie Mae related and Fed funded. At the moment I'm not sure what that bailout will look like yet. But you're also correct it's going to screw the minority of non homeowners.
Fed could:
- buy houses on the open market directly (no more m3 reporting makes this easier)
- place a floor under bonds and CDOs.
- creative solutions such as handing out downpayments or offering 100% financing at 2%.
Banks repeat past mistakes. It's their M.O. Many, many, banks have been around for a long time. Banks also repeat past successes. They'll work out what they can, and dispose of what can't be made to *credibly* perform.
If the guy has no income, three properties, and has only given them 1.5% of the loan value in the last year, they'll get the mess off their books ASAP. Foreclosure is the second option, but in many cases, it will be a close second. Bank examiners will use FDIC as both the carrot and the stick to get banks to perform. Maybe the feds want to bail it out, but competing banks paying higher premiums for bailouts will put at least as much pressure on the examiners to get the lesser performing banks in line. I see another round of bank consolidations in the near future.
The funny thing is, it is different this time. I know of at least one SoCal bank that kept adjustable rate loans and sold off fixed rate ones when rates were low. They might know something we don't. Or maybe this is their Waterloo. In any event, if you want to know what they will do when the market turns, look at what they did last time.
I have no idea what the GSEs and other issuers of MBS did last time, so I don't know what they might try to work out. But you better put up a convincing case if you want your bank to let you slide.
To Robert (and echoing incessant_din above), the point I was trying to get at was that I don't see how the exact type of bailout you describe --- banks renegotiating mortgages in favor of the FB --- could really work from the bank's point of view. Seems to me they'd be lopping their own legs off. And you're right, the federal government could still exact a pound of flesh from the FB if renegotiated mortgage is held to be legally equivalent to debt forgiveness, but that doesn't result in a workable scenario for the banks that I can see.
At any rate I don't contest your larger point --- I expect that there will be some form of mercy for the FB whose name is legion, which will also be a form of theft from the sensible saver, whose name is me. (In deference to Aesop I guess I should have signed myself ant instead of grasshopper ...)
The logic behind "gnawing off one's leg to escape the trap" is a possibility IMHO. The last thing banks want is real estate. If things go a sour as we all expect they are already going to be carrying too many properties. The banks will have an incentive to do anything to keep payments flowing instead of adding to their repos. They will look at the situation from a total systems perspective. If they repo and resell they are looking at a lot of upfront expenses and lost time and in the end the banking system will only be seeing a much smaller cash flow. If instead the renegotiate then the banks will see uninterupted cash flow at the lower levels they would have to settle for anyway. And that assumes there are repo buyers, by renegotiating they've got the buyer in hand. I guess maybe the simpiler model works as an analogy. If you are a landlord and renting out a house, when things go bad you are left with either kicking the renter out or accepting a lower rent that they can pay. If the renting market is soft it would be better to accept lower rents than go through the effort and expense of evicting, cleaning, showing and possibly renting at the new lower price anyway.
it's a good line to follow, so to continue with free thinking...
These CDOs are owned by investors of all classes: banks, individuals, hedge funds, foreign governments, etc. To default would kill the entire financial system.
So... The Fed could set up an RTC to take on the foreclosures. In essence accepting the risk on all those CDOs. And simply print money to do it.
This way all appearances are kept up. The bond holders get paid and the borrowers walk. And since the Fed/new RTC now owns those houses, they don't have to panic sell. They can hold on, even provide jobs to maintain/manage them, etc. No RE crash! Noone has to panic sell, just hand the keys over to the new Fed/RTC.
Something along those lines I'm thinking.
Interesting about that bank keeping the ARMs and selling the Fixed. Good from an inflationary standpoint. Only bad if they assume the borrower won't pay it back. But then again, if they're expecting the Fed to bail them out...
Banks are regulated and regulators look at the value of their portfolios. Banks might want to do this, but regulators won't permit it.
However, what the non-bank portfolio holders might do is unpredictable. They will have to take losses either way.
Interesting idea Robert and great commentary thread. Especially liked that link to the Slate article. May have to post about it myself...
-O
How would the adjusted price loan show up in comps if it didn't involve the usual deed title transfer? Just wondering about the mechanism for price impact.
Loan balances don't show up in comps at all. Prices will adjust because of houses in foreclosure overhanging the market. Buyer perception of comps is what will drive down the price.
"Loan balances don't show up in comps at all. Prices will adjust because of houses in foreclosure overhanging the market. Buyer perception of comps is what will drive down the price."
That what I suspected. So if the trend is more towards these bank/FB deals, this will tend to cloak (or muddle) public (free market) access to home valuation. Banks would end up having an edge on knowledge.
ChickLit,
Exactly. Banks don't want to let their bad loan exposure go public. Banks will have other loans like this one. The attempt will be to keep things quiet. It will work for a short time but just like Realtors® and Days on Market the ruse will stop working eventually.
2 problems with your scenario: bank regulators, and bank shareholders. Banks can't just roll over distressed loans without incurring huge losses, eroding their capital, and inviting takeover by regulators. Banks will wait to the last moment to avoid a loss, which favors more distressed foreclosures and fewer voluntary workouts.
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