Housing Bailout
A monstrous housing bill has been passed by the House, bailing out mortgage companies and irresponsible borrowers (and incidentally, a few deserving individuals in lieu of collateral benefit). This summary by NPR is essential read.
The main provision seeks to help homeowners facing foreclosure. Here is how it is claimed to work:
- Homeowner originally bought the house for 300K in Las Vegas in 2006
- House value has plummeted to 200K in 2008
- Lender agrees to lower mortgage to 90% of current value (i.e. 180K). Write off 120K.
- Homeowner eligble for lower rate FHA loan for the 180K.
- FHA pays off Lender 180K. Takes the loan onto its books.
- Home prices stabilize because homeowner can afford low interest 180K, avoiding foreclosure.
- Taxpayer does not incur any cost since the homeowner is going to pay back 180K on the taxpayers book with interest.
As always, you cannot get something for nothing. The something comes from the bankers who need to write off 120K. Why would they do that? The argument is the following:
- Lender refuses to write off 120K.
- Home goes into foreclosure. Current value of home is 200K.
- Prices continue to fall, bank still has the house on its books, but the value of the home is now only 150K.
- Bank would have been better off by taking the 180K on offer from Uncle Sam.
Here comes the first snag in the happy happy, joy joy story.
- If the lender expected the prices to stabilize around 180K or higher, he/she would refuse to lower the mortgage, thus precipitating the foreclosure regardless.
- If the lender expected the prices to plummet, he would get rid of the mortgage, but the taxpayer would be on the hook for an asset whose value of plummeting.
So either the homeowner loses or the taxpayer loses. Guess who is not on the losing side irrespective of what happens?
Finally, there is no reason to suspect that everyone is going to play as envisioned in the congressional fairy tale. So here is how I see it actually playing out:
- Homeowner originally bought the house for 300K in Las Vegas in 2006
- House value has plummeted to 200K in 2008
- Bank and/or owner gets a spurious appraisal showing value of the home as 290K
- A sea of murky appraisals shows up as another run up in asset prices, marking a significant false bottom. Politicians and Realtors hail success. Get reelected.
- Bank agrees to lower mortgage to 90% of 290K, i.e about 260K.
- Bank pockets 260K (depending on how long the home owner has been paying mortgage, they may actually make a profit, instead of the 40% loss they rightfully deserve).
- Homeowner gets a new FHA loan for 260K.
- After a year, home price is still 200K. Homeowner finally gets the math, walks away from the home.
- Taxpayer is saddled with a 260K debt backed by a deteriorating asset.
- Panic sets is ("If even the government cannot save us, then who can!"). Asset prices start going down again.
Good Job Congress.
Bottom line, housing will not bottom until data shows that congressional intervention has failed. Congressional action has converted a potential collapse of financial institutions into a potential collapse of the long term vitality of this nation. In trying to prop up property prices, it has put a wrench in to the engines that power long term asset appreciation.
The main provision seeks to help homeowners facing foreclosure. Here is how it is claimed to work:
- Homeowner originally bought the house for 300K in Las Vegas in 2006
- House value has plummeted to 200K in 2008
- Lender agrees to lower mortgage to 90% of current value (i.e. 180K). Write off 120K.
- Homeowner eligble for lower rate FHA loan for the 180K.
- FHA pays off Lender 180K. Takes the loan onto its books.
- Home prices stabilize because homeowner can afford low interest 180K, avoiding foreclosure.
- Taxpayer does not incur any cost since the homeowner is going to pay back 180K on the taxpayers book with interest.
As always, you cannot get something for nothing. The something comes from the bankers who need to write off 120K. Why would they do that? The argument is the following:
- Lender refuses to write off 120K.
- Home goes into foreclosure. Current value of home is 200K.
- Prices continue to fall, bank still has the house on its books, but the value of the home is now only 150K.
- Bank would have been better off by taking the 180K on offer from Uncle Sam.
Here comes the first snag in the happy happy, joy joy story.
- If the lender expected the prices to stabilize around 180K or higher, he/she would refuse to lower the mortgage, thus precipitating the foreclosure regardless.
- If the lender expected the prices to plummet, he would get rid of the mortgage, but the taxpayer would be on the hook for an asset whose value of plummeting.
So either the homeowner loses or the taxpayer loses. Guess who is not on the losing side irrespective of what happens?
Finally, there is no reason to suspect that everyone is going to play as envisioned in the congressional fairy tale. So here is how I see it actually playing out:
- Homeowner originally bought the house for 300K in Las Vegas in 2006
- House value has plummeted to 200K in 2008
- Bank and/or owner gets a spurious appraisal showing value of the home as 290K
- A sea of murky appraisals shows up as another run up in asset prices, marking a significant false bottom. Politicians and Realtors hail success. Get reelected.
- Bank agrees to lower mortgage to 90% of 290K, i.e about 260K.
- Bank pockets 260K (depending on how long the home owner has been paying mortgage, they may actually make a profit, instead of the 40% loss they rightfully deserve).
- Homeowner gets a new FHA loan for 260K.
- After a year, home price is still 200K. Homeowner finally gets the math, walks away from the home.
- Taxpayer is saddled with a 260K debt backed by a deteriorating asset.
- Panic sets is ("If even the government cannot save us, then who can!"). Asset prices start going down again.
Good Job Congress.
Bottom line, housing will not bottom until data shows that congressional intervention has failed. Congressional action has converted a potential collapse of financial institutions into a potential collapse of the long term vitality of this nation. In trying to prop up property prices, it has put a wrench in to the engines that power long term asset appreciation.
Comments
http://www.investorsinsight.com/blogs/john_mauldins_outside_the_box/archive/2008/07/28/the-paradox-of-deleveraging.aspx
- how do we measure the appropriate price for the assets that the treasury will/should buy
- shouldn't it be seen from a profit perspective i.e. you shouldn't be exchanging treasury paper for it with low yields but change a higher interest rate as a penalty, so as to not be seen as bailing out anyone