Bad Mortgage Reform – Implemented Of Course

The government has finally acted to address the increasingly bloody residential real estate markets.

In a plan that includes a refund check to taxpayers, the government also agreed to lift the loan limit that Freddie Mac and Fannie Mae can purchase, which basically has the effect of lowering interest rates for loans above the previous cap of $419k up to the new cap which approaches $700k.

BUT

There is a catch: this does not apply to evenly across the board. In a sick twist that will have the effect of basically giving a government guarantee to help prop up those with more wealth in real estate, the loan caps are only lifted for communities where the average house price is greater than the previous cap.

The details are discussed in this article:

Stimulus Plan Aids Buyers of High-Priced Homes

The article suggests rightly that the markets feeling the most pain in the crash are are those in California and elsewhere where the median home does not currently qualify for federal mortgages.

However, the value of these homes also represents the relative wealth in these communities. Sure they are getting hurt now, but they also likely had a greater rate of appreciation in the bubble. They benefited from the excesses of Wall Street originated mortgages, but rather than letting the market correct these excesses with a reversion in prices, the Government is basically using taxpayer dollars (in the form of an implicit backstop for Freddie and Frannie) to bail out these overpriced assets.

Perhaps I am being a bit harsh, but a more equitable solution would have been to increase the cap across the board so that communities that have not yet realized the “American Dream” of ridiculous home values could have any chance to compete with the inflated values seen in the markets that will benefit from this rule.

Or better yet, the government could leave its too-late overly-simplified solutions on the sidelines until it came up with a more comprehensive rescue package like one suggested by Bank of America this week which envisioned the government buying mortgages and renegotiating with current occupants to prevent unnecessary foreclosures and wasted resources. Such direct social service seems to better represent the role of government in trying times like this rather than trying to play master of a market that is badly broken and clearly deeply misunderstood by most.

4 thoughts on “Bad Mortgage Reform – Implemented Of Course

  1. Glen Reading

    On the subject of jumbo mortgage bailout packages and the overall tendency of nanny-state bureaucrats to “fix it till it’s broken”, I generally agree that free markets should have been allowed to work. The idea of an artificial offset to the natural risk/reward relationship is contrary to the best interests of the great majority of Americans. That said, I have two points for your consideration:
    First, the mortgage mess did not happen in a vacuum. Responsible borrowers could be just as adversely affected by a significant decline in housing prices as their foolish neighbor who bought a house they couldn’t afford. This willingness to suspend rational thought and ignore basic financial principals was facilitated by the people who should have known better in the first place: fund managers and debt traders. After the tech bubble, it is hardly conceivable that the lessons of history could be so quickly forgotten by the “brightest minds” on wall st. There is no ‘new economy’!
    I would love to see these people fired and stripped of their compensation packages for flagrant violation of their fiduciary responsibility to investors. But, that won’t do any of the rest of us any good. Declining home values accelerated by desperate sellers reduces the value of my home regardless of my payment history. The overall liquidity shortage combined with the loss of equity directly impacts my ability to use the accumulated value in my home for various investments, and to make it even better if the problem truly affects the rest of the market it might reduce my income or erode its value with higher inflation.
    Second, given that the outbreak is quickly becoming an epidemic it is time for some governmental intervention. After all their hands are not clean in all of this either. Many policies force, or at least pressure lenders to make loans to default prone borrowers. However, I think I have a solution. At the most recent 30 yr. bond auction the government found a far weaker market than they expected. http://www.smartmoney.com/bn/ON/index.cfm?story=ON-20080207-000982-1625
    So to get us out of this mess the government, through Fannie and Freddie, can offer the banks a deal. The government will buy the loans that are currently in default, and loans that are at risk of default for the cash value of the loan, so long as the bank also sells enough A-paper loans with the sub-prime notes to greatly reduce the overall portfolio risk. Then the government can securitize the risk with new 30 year bonds. Their rate could be less that the current mortgage rate to give the homeowners a fighting chance to make payments, but higher than the current 30 year, given the 150 basis point spread between the two rates.
    Most people probably won’t like the idea but I’m not interested in going down with the ship if it’s not even my boat.

    Reply
  2. DAL

    To the first point: the “appreciation” that you benefited from was caused by the irrational exuberance. Why shouldn’t you also share in the downside as prices come back down to reality?
    That would be like the government buying everybody’s Pets.Com shares at $50 before they went to $0 because the jerks at GS pumped them and they shouldn’t have.

    To the second point:
    Interesting idea. As I mention in the post, I think some kind of direct intervention through a “secondary market” creation is a good idea. One issue with the specific suggestion you make is that it is hard to tell what is “A” any more, but I do think people should be thinking along these lines for solutions.

    Thanks for the thoughts and keep ‘em coming!

    Reply
  3. Glen Reading

    Dal,

    Your point is well taken, however I would like to draw an important distinction between the housing/mortgage crisis and your stock analogy. I live in an area that maintained relatively sane price increases while other parts of the county were skyrocketing. While my home did not appreciate at the same rate as markets in Miami or Southern California, I am exposed to the risk of prices dropping to levels below the usual price fluctuations. I realize, of course, that my real estate investment is subject to the same risk/reward relationship inherent in any market transaction. That being said, I stand to be harmed by the irresponsible actions of others. The housing situation is not completely analogous to your Pets.com example.

    Perhaps the most important difference is in the purchase itself. I did not purchase a security trading at 300 times earnings whose spokesman is a used gym sock.

    I would not want the government to bail out shareholders of pets.com, primarily because the government did not incentivize the purchase of those shares. The blame for unqualified people being able to purchase homes they had no business buying does not rest solely with politicians looking to boost overall home ownership rates for political gain, but it’s a good place to start.

    In any event, I want to congratulate you on a superior blog. A greater knowledge of financial principals by the general population can only help lessen the severity and frequency of these issues in the future.

    Regards,

    glen

    Reply
  4. DAL

    Glen,
    Thanks for the additional thoughts. Although surely not a 300x p/e, the growth in most markets has indeed been extreme. I point you to my earlier post graphing the boom: A Picture Is Worth (-)Trillions.

    I agree, though, that the analogy does not hold for the markets where the excesses have been moderate. However, I would be surprised if the current downturn would have as much impact in your market (let’s hope that is the case).

    That said, as I think back to the original point of this post – your observation exacerbates the idiocy of the current “market specific” cap adjustment. In other words, it is likely that those markets with the highest prices also exhibited the most arguably irresponsible behavior, and they are the very ones benefiting from the current bailout.
    I do think it is unfair that the retrenchment is catching many people unawares and in a dramatic fashion. Let’s hope that more creative and comprehensive solutions emerge to help the many – like you – who stand to lose way too much if we don’t do something.
    Thanks for reading.

    Reply

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