Why the plan won't work
This is the scenario the government is up against... and this is why it is doomed to fail.
Let's consider your average citizen, John Doe. John's MAGI is $100,000 per year (just to keep things easy). Normally, he'd figure that he could afford to buy a $300,000 house using a 30-year, 6.5% rate with nothing down. Just the mortgage (no taxes, no PMI, no homeowner's insurance) payment would be $1900 a month. No problems yet.
Along comes creative financing. John gets offered a 3% IO teaser rate which resets in 3 years. John can still afford to make a payment of $1900 a month. No need to worry about the reset... he'll just refinance out and take his equity out right before the rate resets. After all, home prices always go up and interest rates always stay low, right? So for the same $1900 a month, John goes out and buys a $760,000 house. Still no problems yet.
Credit changes. Home prices stop appreciating. In fact, they depreciate. Interest rates rise. John can't refi out. His rate resets, let's say to 9%. He has to start paying principal as well. His payment skyrockets to $6400 a month. That is an increase of 237% folks. Predictably, John falls behind quickly. His lender prepares to swoop in. Problems abound.
President Bush steps in. He'll let John refi into a government guaranteed standard 30-year mortgage at 6.5%. John's payments fall to $4800 a month. That's 25% less than they were, but still 153% more than he signed up for. Problems persist.
John can't make the payment. He defaults. Now, instead of having the lenders repo the house and sell it at a loss, the government repos the house and sells it at a loss. Which means Wall Street walks away unscathed. You and I get to pay for John's idiot mistake.
Or John can make the payment. He has a 760k mortgage with a huge payment each month. He's house poor. From now until forever. He can't afford anything but the house. Oh yeah, and the house that was worth 760k? It is worth substantially less now because his majors couldn't make their payments. So he can't even sell the house to get out from under the obligation because of all the negative equity he's built up. But hey, at least he has his house. And nothing else. And again, Wall Street walks away unscathed.
"Saving" these mortgages, isn't going to help the homebuyers. They need to get out. Bankruptcy is ugly and it is never the preferred method of rectifying a wrong, but it is the only way that they can walk away from the obligation. Who ought to pay for the mistake? The lender or every John Doe in America that stayed within his means?
Let's consider your average citizen, John Doe. John's MAGI is $100,000 per year (just to keep things easy). Normally, he'd figure that he could afford to buy a $300,000 house using a 30-year, 6.5% rate with nothing down. Just the mortgage (no taxes, no PMI, no homeowner's insurance) payment would be $1900 a month. No problems yet.
Along comes creative financing. John gets offered a 3% IO teaser rate which resets in 3 years. John can still afford to make a payment of $1900 a month. No need to worry about the reset... he'll just refinance out and take his equity out right before the rate resets. After all, home prices always go up and interest rates always stay low, right? So for the same $1900 a month, John goes out and buys a $760,000 house. Still no problems yet.
Credit changes. Home prices stop appreciating. In fact, they depreciate. Interest rates rise. John can't refi out. His rate resets, let's say to 9%. He has to start paying principal as well. His payment skyrockets to $6400 a month. That is an increase of 237% folks. Predictably, John falls behind quickly. His lender prepares to swoop in. Problems abound.
President Bush steps in. He'll let John refi into a government guaranteed standard 30-year mortgage at 6.5%. John's payments fall to $4800 a month. That's 25% less than they were, but still 153% more than he signed up for. Problems persist.
John can't make the payment. He defaults. Now, instead of having the lenders repo the house and sell it at a loss, the government repos the house and sells it at a loss. Which means Wall Street walks away unscathed. You and I get to pay for John's idiot mistake.
Or John can make the payment. He has a 760k mortgage with a huge payment each month. He's house poor. From now until forever. He can't afford anything but the house. Oh yeah, and the house that was worth 760k? It is worth substantially less now because his majors couldn't make their payments. So he can't even sell the house to get out from under the obligation because of all the negative equity he's built up. But hey, at least he has his house. And nothing else. And again, Wall Street walks away unscathed.
"Saving" these mortgages, isn't going to help the homebuyers. They need to get out. Bankruptcy is ugly and it is never the preferred method of rectifying a wrong, but it is the only way that they can walk away from the obligation. Who ought to pay for the mistake? The lender or every John Doe in America that stayed within his means?
posted by Fresh at
3:34 PM
21 Comments:
That is exactly right, thats why bush is stepping in to help these idiots. He looks sympathetic and helps these fucking idiots, but really is just saving all his rich friends from taking huge losses.
Doug,
That is a great example you provided and in that situation, the borrower is going bankrupt regardless. Consider another hypothetical that is also very real. You have a house in KC. Say Waddell lays you off because some yahoo blows up the money fund or something. You get a job in New York or someplace and you are all set to move. Except, you cant sell your house because within a 2 mile radius there are 50 other houses up for sale, many of which were foreclosed. You cant afford two mortgages or 1 mortgage plus rent. Maybe you can rent your house out except the rental market will be crushed from the excess supply from homes like yours. You've been responsible and honest but now are looking at forclosure because of yahoos all around you. What do you do beside hope that American Century is hiring? Do you not think that many will find themselves in similar circumstances?
Banks used to have an incentive to work with borrowers because they had the loans on their balance sheet. It made more sense write down a loan 10% on renegotiated terms than 20% when the house is auctioned. Now that they have sold off the loans, they have little incentive to renegiate terms. The relationship between borrowers and lenders has changed such that it increased the stupidity on the way up and will increase the damage on the way down.
If you think sitting back and watching people get torpedoed will rectify the situation without severe lingering and unintended consequences, I think you are kidding yourself. A market failure will have ramifications none of us can contemplate. It is the main asset for most people. Seriously, if there is no bailout and it gets seriously bad, I would guess we will ALL be unemployed. Silver will be the first because the 401k spigot will cease to as people need to tap it for personal consumption. And most of us will not get new investment jobs because they wont exist. Write me off as an alarmist but nothing scares me more than a housing collapse - well nuclear war but I digress. I dont think it will happen and the high probability of a semi-successful bailout or Fed led intervention is a significant reason why. A healthy job market is another although that can change in a hurry.
Ignoring Bush's plan for a second, there are undoubtedly many plausible scenarios that dont involve bailing out Wall Street, at least not fully. If the pols want to bail out wall street, well they will. I could care less - it is a secondary issue. What I dont want is a housing slowdown to turn catastrophic. This moralizing about stupid people taking out stupid loans is just the sort of attitude that is going to lead to decisions that make a bad situation worse. It's not like Adam Smith's great invisible hand is only going to apply the consequences to those who acted with disregard. We are all going to pay the consequence. How about we keep it manageable?
Cid,
I appreciate you trying to put the shoe on the other foot, but I would let you know that I won't be the first fired...Fidelity has never had a layoff in its research staff due to market conditions...ever. Its a private company that answers to no one but the man upstairs, and Ned has no interest in running a firm that fires and hires based on market conditions. In addition, I don't think people will be willing to just jump in and take the 15% to 20% haircut necessary to remove funds out of their 401k. However, none of that matters b/c I don't plan on staying here too long anyways. In addition, I will not be affected b/c I rent...never had a inkling of interest in buying a house as I think its a ridiculous use of capital. Buying a house is no different than renting except for you can write off your interest payments and can capture equity appreciation in market bubbles. However, in the long run homes have only appreciated at a 1% real rate and more or less kept up with inflation. In addition, a home has numerous additional costs that renting does not have i.e. plumbing, utilities issues, heating / air conditioning issues / 3% to 5% transaction fees both on the way in and way out / & most importantly rent does not have the liquidity drain that homes do. Now I understand you can build up equity in a home but I could simply pay the interest only option aka renting..and use the capital that I would put up for principal and invest it in securities like wheat futures, gold, TEVA stock, which btw cid i was pitched rather convincingly on the other day, etc. The point is that I think I can earn a better return on my capital investing in financial and real assets that lack the liquidity / high transaction costs issues associated with residential real estate. Long story short, I think the american public is undereducated, especially on issues of money & interest rates and have been lied to about this concept of the American Dream being owning your own house. I say fuck that. My American dream is to live in a country that truly practices what they preach about capitalism, free markets, and small gov't - i.e. what the country was founded on and how it used to be, not a country with an all powerful central bank that manipulates markets & sets the price of money, increasing numbers of social programs (at an accelerating rate) such as medicare, medicaid, welfare, social security, widespread home bailouts, big brother tactics like the IRS / wiretapping and spying on their own citizens / monitoring of email & internet records of citizens / record amounts of regulation / legislation that tells us what we can and can't do - only to protect illegal profits / ridiculous subsidies to the agriculture lobby that only benefits certain people and not the US at large / wars that are not backed by the citizens of the US or the world that only benefit a select group of individuals, etc.
I find it comical that so many praise capitalism and free markets on the way up and then beg for Big Brother to save them on the way down.
I AM A LIBERTARIAN, I DON'T WANT THE GOV'T TO TELL ME WHAT DRUGS I CAN AND CAN'T TAKE, I DON'T WANT HELP WHEN I MADE THE WRONG DECISION WITH MY MONEY AS I HAVE HAD MARGIN CALLS CALLED ON ME FOR MAKING WHAT PROVED TO BE WRONG DECISIONS WITH MY MONEY AND I PAY MY BILLS TO CASINOS. ACCEPTING ADVERSE CONSEQUENCES OF OUR ACTIONS TEACHES US TO BE CAREFUL AND INSTILLS RISK AVERSION....GOV'T INTERVENTION...ALSO KNOWN AS THE GREENSPAN (AKA THE DEVIL HIMSELF) PUT... AND MASSIVE LIQUIDITY RESCUES PROMOTES AN INCREASING AMOUNT OF RISK TAKING AND RESULTS IN NO RISK PREMIUMS IN THE MARKETS b/c INVESTORS ALL OPERATE ON THE ASSUMPTION THAT THE GOV'T / FEDERAL RESERVE, which is not part of the government as it is a private corporation, WILL SAVE THEM
WHEN THEY GET THEMSELVES IN TROUBLE.
FUCK THAT...I would never buy a house unless I had enough money that i could have two or three paid for in cash or else I was 100% confident that the house was located in the city that I wanted to spend a great deal of my life in as I have never been a believer in home ownership being a true investment.
Regardless, I appreciate you trying to evoke some empathy, but just completely disagree with how our country continues to look more and more like Russia each year.
bb
Cid,
Your post proves why gold is the only currency. Bush may be able to bail out housing, build dams in New Orleans, support the trade deficit, bail out U.S. consumers and house owners with the printing press, but good old Adam Smith will still control the price of oil, gold, silver, platinum, copper, corn, and wheat.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a5lhZkEauCu8
I also will never, ever understand why keeping someone in a house up to their ears in debt is a good thing.
Some banks still have an incentive to work with borrowers because they are servicing the loan... and as our good friend Matt Kelly would tell us, it costs approximately 4-5x as much to service a defaulted loan than it does a current loan. Not to mention that places like S&P are modeling 50% recovery rates on foreclosed homes after real estate commissions, foreclosure costs, etc. The last thing that ANY bank wants to do is take you to BK. Not because they are empathetic to you, but because it is expensive to them.
In your situation, Cid, I ought to lose my money. I was never under the impression that home ownership was a get rich quick scheme with 0 risk. However, I will note that I am smart enough to negotiate for signing bonus, real estate commissions, etc. That plus savings should prevent me from ever having to worry about a default. And I only borrowed 1.8x our combined pre-tax income for 2007. Or approximately 1.5-1.7x my guesstimated combined pre-tax income for 2008. The key difference is that I made a conservative financial decision in purchasing a home. I could easily take a 10% m2m and not worry about bankruptcy. In another 6 months, I'll be able to take a 20% m2m without any fear of bankruptcy.
I actually agree with Ben a little bit on his home buying thesis. I never realized what a money pit owning a home is. That said, I definitely needed the tax shield and I like the leverage in home ownership. I'm comfortable with it. Even if I lose.
BTW, this probably goes without saying, but 1.5-2.0x is a far cry from 5.0-8.0x.
Silver,
Your rigid adherance to libertarianism is noble and perhaps correct. Certainly it is more intellectually pure than my melting pot idealogy. I will only ask you consider a couple of points, which I have tried to make but continually fall on deaf ears - not just by you but all libertarians.
The populace will allow themselves to be stepped on only so much - even if they deserve it. Fairly or unfairly, when they believe they are being taken advantage of excessively, they will react. In this country it comes in the form of New Deals and Great Societies. Marginal tax rates go from 35% to 90%. All sorts of anti business laws get passed and unions gain clout. Consider giving a little to save a lot. Moreso than the end of the world bullshit I was spewing last night, this is my key message.
You are right, and that is why I cannot stand this country. Give me Liberty or give me gold.
I just realized why Ben is a closet Democrat. F it. Buy gold and then root for all the socialist handouts, corporate bailouts, and federally sponsored agencies that you could possibly want.
Theoretically I am betting that the government will turn on the press.
I win either way. Yippee for me. I love this country. Bailouts for everyone. Helicopters that spit out money. Forcing other countries to float their currency. Increasing the balance of payments. Pork. Yippee. I love it. Turn it on.
Matt,
In other countries the rich end up getting shot. It is the Marie Antionette/Czar Alexander factor. I'll take taxation over the guillitine any day.
Let them eat cake!
Cid,
You keep citing history like its 100% relevant to today.
First, I never decided to take the energy to refute your analysis of why the US is most definitely an empire and why using the 300yr decline of the roman empire as a point of refute makes no sense at all. Think about how much quicker everything is done today - i.e. i can call my buddy in japan, then fly to london in 5hours - less if i was on the concord - and then have a video conference with a diamond miner in Africa in London. The world moves much faster now than 2000 years ago and it would make sense that an empire would fall much faster today.
Real quick here is the definition of Empire:
nation-state that dominates other nation-states and exhibits one or more of the following characterisitics:
1) Exploits Resources from the Lands it Dominates (Iraq, Saudi Arabia, China, Africa, Ecuador, Panama, etc. etc.)
2) Consumes Large Quantities of Resources - Amounts That Are Disproportionate to the Size of its Population Relative to the Rest of the World and other Nation-states (i.e. We Consume 25% of the world's oil and represent only 5% of the world's population, etc.)
3) Maintains a Large Military That Reinforces its Policies When More Subtle Measures Fail (i.e. The US Army is by Far the Largest in the World and when the CIA, Economic Route, & United Nation / World Banks etc. fail the Military Goes In -> IRAQ Comes To Mind Here??? Anybody?)
4) Spreads it Language, Literature, Art, and Various Other Aspects of it Culture Throughout its Sphere of Influence (i.e. the world speaks english - its actually #1 priority to train all police, hospital workers, etc. in China english before 2008 olympics. i.e. Hollywood Exports over $20bn & growing in Movies to Other Parts of the World. i.e. everyone in the world knows the New York Yankees and why its the best selling hat in the world even though most of the world have very low baseball participation rates)
5) Taxes Not Just its Own People, but People in Other Countries (i.e. we issue debt for labor / oil / metals / etc. and then issue more debt to inflate away the original issue aka "THE GLOBAL IMPERIAL TAX"
and my personal favorite and likely most important piece today...
6) Imposes its Own Currency on the Lands it Controls (I don't need to go there on the USD World Reserve Currency issue - its been beat to death on this blog)
7) The Empire is Controlled by Either an Emperor or Else Small Band of Elite Individuals that have control over the gov't and the media. (This is a little more subtle, although George Bush has made it more obvious, but there is definitely an elite group that hail from the Ivy League / Best Schools in Europe that you can find at the highest ranks of corporations, gov't, media and all work together and shift in and out of each other - aka Robert McNamara was top man at Ford in Detroit, President of the World Bank, Secretary of State of the United States, and held a high position on the Council on Foreign Relations. In addition, I think the Federal Reserve fits this bill also as the leader is not elected, answers to a secretive group, and maintains ENORMOUS POWER.
SINCE THE US FITS EVERY PIECE OF THE NECESSARY PARTS FOR AN EMPIRE, I CAN CONFIDENTLY SAY THE US IS AN EMPIRE.
Silver,
Given I have a BA in History, I am biased. That said, everything is based on history. Whether it is making comparisons to ancient Rome, personal experience from 5 years ago, looking at margin trends from the last 4 quarters or examining daily price correlations over the last 12 months it is all history. The only difference is how you evaluate it and what factors take on more or less relevance. I cite older history because I think human behavior doesnt change a whole lot and people forget common relationships that havent been recently pertinant but yet are still relevant. I believe in behavioral finance and what I just articulated is largely based on behavioral concepts. As such, I am looking for relationships that people are missing for one reason or another. Some of the thoughts are quirky and some of them are in the Economist. Some of them are useful and some of them I regret 2 minutes after posting. So it goes.
I am heading to Lambeau Field so wont be checking in for a few days. Skewer me as you wish.
Bro, all my buddies are at lambeau. And my parents are coming. Now I am really hating life.
El Cid,
You are totally correct to look at history. I love history and am a student of history as well. I agree with your view of the Marie Antoinnette effect, but think the phrase goes "History never repeats itself, but it always echoes."
El Cid,
You are totally correct to look at history. I love history and am a student of history as well. I agree with your view of the Marie Antoinnette effect, but think the phrase goes "History never repeats itself, but it always echoes."
HISTORY, n. An account mostly false, of events mostly unimportant, which are brought about by rulers mostly knaves, and soldiers mostly fools.
History is merely a list of surprises. It can only prepare us to be surprised yet again.
History is the science of what never happens twice.
History will be kind to me for I intend to write it.
By the way, for those that are curious, that is Ambrose Bierce, Kurt Vonnegut, Paul Valery, and Winston Churchill, respectively.
Can the yellow metal hit $800 today?
Post a Comment
Subscribe to Post Comments [Atom]
<< Home