An article by Clive Crook at the Financial Times which focuses on the inconsistencies (one might say hypocrisies) and failings in the subprime rescue plan announced last week. Because this program will provide only limited relief, he foresees that more rescue efforts, with costs to taxpayers, will follow.
From the Financial Times:
“This is a private sector effort, involving no government money,” Hank Paulson, US Treasury secretary, said last week, announcing the deal he had just brokered among representatives of mortgage-security investors and mortgage-service companies to freeze interest-rate resets on some loans. He emphasised that the compact was voluntary. “The industry standards announced today do not change the nature of responsibilities in the servicing industry – servicers will continue to modify loans when it is in the best interests of investors.” In short, he said, it is a “market-based approach”.
Give the man some credit for using that term without laughing. Is there a housing-finance market on the planet that is more pervasively manipulated and distorted by government than that of the US – even before this latest intervention?
Start with virtually unlimited tax relief on mortgage debt. Throw in the two giant “providers of liquidity”, Fannie Mae and Freddie Mac, key enablers of the mortgage securitisation surge, operating in the background under implicit government guarantee, with transactions accounting for 40 per cent of US mortgages on their books. Do not forget the Federal Housing Administration, the government mortgage insurer (6m loans and counting), which the administration has just asked to take on a much expanded role. And now this.
Totting up the explicit and implicit cost of these programmes, the mind reels. The tax deduction alone is nearly $80bn a year. It is a little late for a market-based approach.
Alphonso Jackson, secretary of housing and urban development, was less circumspect than Mr Paulson. “Today’s announcement is of national and global import,” he began. “As we move into midwinter, when the chill of the season often silences the hope in our hearts, these actions today will warm the hearts of Americans caught in the swirling subprime crisis.” That is how you sell a policy. “We must never forget that these homeowners have invested themselves and their money in their homes … They want real solutions. They want to know that we are thinking of them … that we care … that we are doing something.” Quite so, and this is where “doing something” has led.
What does this heart-warming, globally significant, limited and strictly voluntary agreement to serve the interests of investors in mortgage-backed securities actually do? It is concerned with a subset of a subset of the problem. Some 1.8m of the mortgages recently granted to subprime borrowers (ie those with poor credit) have adjustable rates and are due to reset in the next two years. An unknown number are not yet in delinquency, but might be when this happens. The fear is that house-price declines would then accelerate, with further dire implications for the availability of credit and the stability of financial markets. The complex deal proposes to freeze the resets on some of these loans, and offers help for some borrowers in switching to more affordable (often FHA guaranteed) loans.
This could have been done, and to some degree would have been, without Treasury involvement, since investors prefer lower rates for a while to foreclosing on properties with zero or negative equity. The real point of the agreement is to lay out a standard approach to modifications that would have happened piecemeal – a template that can be widely applied, easing some of the administrative burden that case-by-case renegotiation of the securitised mortgages would otherwise entail. Crucially, the consensual aspect of the plan is intended to minimise the litigation risk that mortgage servicers would otherwise face in modifying terms without investors’ specific approval.
It would be surprising, nonetheless, if dissenting investors did not challenge these modifications in court.
Normally it falls to conservatives to cry “moral hazard” when policies such as this, expressly designed to reward imprudent behaviour, are announced. This time, the indispensable Barney Frank, the Democratic chairman of the House financial services committee, is leading the chorus. As he points out, the plan bizarrely confines its promised assistance to borrowers with poor credit histories. More than a third of mortgages currently in foreclosure were granted to prime borrowers; and, of those, more than half were adjustable-rate loans. Under the Paulson scheme, prime borrowers who get into trouble when their teaser rates reset will have to refinance, if they can; otherwise, they are on their own. Borrowers who struggled to improve their credit scores before taking out their mortgages are going to feel aggrieved. In many cases, the reward for those efforts will be eviction.
An evidently reluctant Mr Paulson took fright at the gathering storm and decided that he had to act. The unavoidable consequence is that the administration now owns the problem in a way it did not before. As the housing slump worsens, as it seems bound to, and a chill once more silences the hope in voters’ hearts, the measures announced so far will be deemed (even more than they have been already) unfair and inadequate. It will be too late then to say: “This is none of our concern.”
From now on, every mortgage foreclosure will be seen as proof of the policy’s failure – and partly the administration’s fault. Merely to address the most obvious anomalies in the new arrangements, more comprehensive and more generous assistance seems likely before long. In other words, the massively distorted and mismanaged US housing-finance market is going to get more so. And taxpayers had better prepare to be mugged.
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Be prepared…….
“Lock and Load”
“From now on, every mortgage foreclosure will be seen as proof of the policy’s failure – and partly the administration’s fault.”
Same thing when there are flight delays it seems.
Investors may have a better chance of footing the bill than taxpayers. The Paulson plan was their shot–and the Bush administration’s shot–at resolving the problem on their own terms, and it won’t solve anything. They’ve shown the extent of their willingness to compromise without compulsion. The political climate will only grow worse for them, especially as they were eager participants in an essentially corrupt system of mortgage lending that has already “mugged” many borrowers.