Later today George Bush will announce his administration’s plan to deal with the subprime meltdown. Instead of a change in the law, this is a voluntary deal negotiated with some large mortgage lenders and mortgage servicers. If it works, it’s a slick deal for the lenders. But it may be too small to do any good. The plan has two features that shape the whole deal:
1) The lenders decide who gets the benefits and who doesn’t. This seems to be the Goldilocks Game. If the borrower is too cold (not credit worthy even for the teaser rate), no deal. If the borrower is too hot (could pay on the reset), no deal. Only borrowers who are just right (can pay currently, but can’t pay more) will get the deal. And the mortgage servicer decides who gets to be Goldilocks.
2) No permanent solution. People will have up to five years at teaser rates and then they are on their own. The only way this doesn’t recreate the mortgage crisis down the line is if families can figure out on their own how to refinance into sustaintable (usually fixed) mortgages. Refinancing means more people heading to mortgage brokers and more fees, etc.
The no-stripdown aspect is crucial. Lenders (actually investors now holding SIVs) will forgo interest increases for up to five years, but the homeowner remains liable for the full amount of the principle, fees and interest, regardless of the value of the property. If this works, the lenders get much more than they would have gotten in foreclosure on these properties, they can ratchet up the value of their weaken portfolios of CDOs and SIVs, and they can declare the crisis has been averted.
A huge part of the subprime market was for 100% financing, which, in reality was more like 110% Loan-to-value because of fees that were also rolled into the financing. Of course, those valuations were based on a rising market. In a falling market, a huge proportion of subprime mortgages are now in the 125% LTV territory — “below water” in the foreclosure parlance. The current “deal” will have homeowners paying off all the mortgage debt or facing foreclosure once again.
Whether you think that homeowners ought to pay all of the debt or not, regardless of the value of the property, it doesn’t make much sense from a families’ point of view to do so. Those who can’t pay will walk away. That means property values will continue to sink and foreclosures will continue to rise. In other words, the crisis isn’t over.
One other note: There’s no talk about the infrastructure for this deal. Those who live in the bankruptcy world know that estimating ability to pay through evaluation of debtors’ income and expenses is tough. Right now the mortgage servicers don’t have enough trained people to answer the phones. I talked with someone from the office of a state attorney general yesterday who said that even when they call and explain that they are investigating, they can’t get through. Good luck for the average homeowner trying to get a workout.
OK, one more note: Investors — the ones whose interest payments are being negotiated away here — aren’t all at the table. This is a deal in which some lenders who hold some debt and some mortgage servicers are planning to give away their own collection rights along with the right of some third parties who have not consented. The lawsuits will fly thick and fast over this.
And the last note: Much as I would like to see some sort of “fix” happen to the mortgage market, I find it ironic that the borrowers it would help most are those who are not already in default, i.e., the ones who have the least urgent need for relief. The lenders really need to address the problems of those whose rates have already re-set, and who may have already missed a payment or two. These folks are still headed for foreclosure.
By making the reach of the deal too narrow and by not offering any permanent solution, this deal isn’t likely to stop the slide in home prices or halt the wave of foreclosures. Without that, the lenders’ portfolios will still stink, and they will lose the benefits of their own slick deal.
