Hope Now: Sorry, wrong number
By Julian Delasantellis
There's an old saying along the lines of "you never forget how to ride a
bicycle". Perhaps that is true, but for the US government the aphorism requires
some amendment.
After caring, coddling and cosseting the interests of America's richest and
most powerful classes for decades, it is apparently true that the government
has forgotten how to look after the interests of average middle-class and lower
middle-class folks.
The evidence of this? Amid much fanfare, President George W Bush last week
introduced the "Hope Now" initiative to help subprime mortgage borrowers
threatened with impending
foreclosure save their homes. Part of the initiative included a toll free phone
number that imperiled homeowners could call, at any time of the day or night,
to receive information that could help them begin the process of their
salvation.
Bush gave out the number. The president's spinmeisters and media handlers
probably planned this to make Bush seem more caring and considerate, more
cognizant of, as the pollsters pose the question, the interests of "people like
you". It might have worked - had the president not given out the wrong number.
On the surface of it, the program is almost redolent of a good government video
in a secondary school civics class. A problem arises, and the government moves
in the people's interest to solve it. In reality, when you actually go beyond
the surface superficiality of the headlines, you find another principle of
modern government these days. In the modern, media age, it's a lot more
important to look like you're solving a problem than to actually solve it.
It sure seemed easy a couple of years ago. The essence of banking is to act as
the financial intermediator for, and to make a profit from, bringing together
people who have money to lend with people who want to borrow. Repeated Federal
Reserve interest rate cuts, along with innovative financial "engineering" by
Wall Street firms employing the best and brightest from America's business
schools, had left the financial system drenched in funds seeking a high rate of
return. Along with that you had millions of prospective home buyers seeking the
ownership deed that they believed was the entry ticket to the American dream.
The only minor obstacles in the way of their shining dream were the minor
factors that many could afford neither the price of the houses they wanted to
buy nor the monthly payments of the mortgages they needed to finance them.
Subprime borrowing was the solution. Sure you can afford that house, the
mortgage finance industry told the borrowers - 20% down payment for a house?
That's an old fogey relic, like a lapel pin for a zoot suit or something. And
if the interest payments on the mortgage are too high, well, we'll just sort of
forget about the interest payments for the first couple of years or so. The
initial rate for the first couple of years would be in the 5% or 6% zone,
barely above the bank's cost of capital, then would rise, be "reset", to much
higher rates, sometimes well over 10% for the final 28 years of the 30-year
mortgage.
It was all rather like the US cable television or telephone companies that lure
customers into buying their services with insanely low initial "teaser"
charges, such as those that offer to send a swimsuit model to your house to do
the dishes "for the first three months". As a result, Wall Street's surfeit of
lendable capital put millions of people in homes that they were not destined to
keep.
Everything would have been OK had home prices kept rising; had that continued,
the buyers could have refinanced into more conventional, fixed-rate mortgages,
with the increase in the home's value essentially acting as a downpayment. To
update the old introductory economics slogan of "if wishes were horses beggars
would ride free", add "and if home prices had kept on rising the subprime
crisis would not be".
The media is chock full of stories indicating just how far and fast US house
prices are falling. Depending on your metric, home price values have not fallen
this fast since the late 90s, the early 90s or the early 70s; one real estate
type, displaying that singular talent for hyperbole that signifies a truly
gifted salesman, says that this is the worst US real estate market since the
Great Depression of the 1930s.
One wonders if, as the subprime infection spreads to the British Isles' equally
overheated real estate markets, whether we will see stories in the British
press about how the real estate market there is at its worst since the Black
Plague.
US home prices have stopped rising, so the subprime borrowers are now
defenseless against the full punishing impact of the mortgage rate resets. A
quarter of a million US homeowners are losing their homes every month through
foreclosure, and, as subprime borrowers were taking out low "teaser" rates
until early this year, without any outside intervention this phenomenon should
continue to at least 2009.
After dismissing and belittling the crisis for most of the year, the Bush
administration has attempted to get in front of the crisis, or at least to give
the public impression of getting in front of the crisis, through the Hope Now
initiative. Much like a medic in the trenches of World War I, Hope Now uses
relentless triage logic to separate the subprime borrowers into three distinct
classes.
Hope Now applies only to variable-rate mortgages taken out between the
beginning of 2005 and the middle of this year. For most of that period,
particularly on America's east and west coasts, the market's froth boiled up
and over the cups of reason and logic like an overstirred latte, as irrational
markets always do.
There are those who can't make the mortgage payments at the low, teaser rates.
These unfortunates will not be assisted by Hope Now; they will return to their
original destinies as lifelong renters. If you can make the payments now, and
some god in the sky determines that you can handle the resets OK, you won't be
helped by Hope Now either. Maybe you'll be able to refinance without government
assistance; maybe you won't - you're on your own.
It's the third group, the ones who can handle the teaser rates but won't be
able to do so with the higher rates, that Hope Now says it will help. The help
to be proffered involves a freeze of up to five years on the higher interest
rate reset. It is hoped that by then the subprime borrower will have accrued at
least some measure of equity in his house, or have maybe saved or prepared in
some way for the higher payments. Treasury Secretary Hank Paulson described the
need for policy action in this way:
I want to help as many able
homeowners as possible. To do that requires continuous learning. We must deepen
our understanding of how many borrowers can be helped and the most effective
mortgage solutions for them. As I have said before, this housing and mortgage
market decline is still unfolding. Resetting ARM [adustable-rate mortgage]
rates are one factor which will play out over the next 18 months. Declining
home values will also significantly affect default rates going forward. We've
also learned that default rates are far higher on mortgages made in 2006 and
2007, due to lax underwriting standards. We have work to do to understand how
many of these borrowers are able to afford their homes.
As
usual, the devil here resides in his familiar comfy abode, the details. The
obvious point of contention is the question as to who will live and who will
die, who will receive the Hope Now salvation, and who will be left exposed to
the market's punishing gales.
For all the credit the popular press has bestowed onto Bush, Paulson and the
administration over Hope Now, in reality, the government's role in the
initiative is fairly limited.
What the government has done, in essence, is to provide the meeting room for
what is called the "Hope Now Alliance", described by Paulson as "an alliance
between counselors, servicers, investors, and other mortgage market
participants. This alliance will maximize outreach efforts to homeowners in
distress to help them stay in their homes and will create a unified,
coordinated plan to reach and support as many homeowners as possible. The
members of this alliance recognize that by working together, they will be more
effective than by working independently."
What the Hope Now Alliance will do, according to Paulson, is to develop
"methods, criteria and metrics that any industry participant can use to
systematically evaluate borrowers' ability to pay resetting adjustable rate
mortgages. For example, borrowers who are current on payments at the lower rate
might be candidates for fast tracking into a refinance or a loan modification."
Basically speaking, the alliance hopes to examine each variable rate borrower,
their income, their resources, their payment histories, and, most importantly,
the most critical indicator of Godliness in modern-day America, their credit
score, to determine if they will be granted the absolution of a reset freeze.
Above 660, it's thought that you can handle the reset without assistance.
Below, you supplicant yourself to the alliance and beg for relief.
Some of the problems here are obvious. If your credit score is too high but you
still don't want to be subject to a reset, well, raising a credit score may be
problematic, but lowering one is not. Like a Hollywood star told to gain weight
for a part, all the star, or the borrower, has to do is to pig out, the star on
sweets and treats, the borrower on spending and credit. This is the classic
"moral hazard" problem in economics, where one economic actor in a system sees
an incentive through acting in such a way that threatens the system as a whole.
Perhaps more central is the issue of the logistics of this process. It is
thought that over 2 million US homeowners are going to be facing foreclosure
over the next year; the early months of 2008 will see a particularly heavy
storm of resets, as the teaser loans taken out in early 2006 come due.
Will the Hope Now Alliance be able to individually examine all the coming due
mortgages in the relatively brief duration before the bankruptcy judge's gavel
falls? It is said that the alliance is writing special software to be able to
assess the worthiness of borrowers quickly en masse; one would hope that this
software code is not being written by the same guys who wrote the software that
greenlighted the subprime borrowers in the first place.
It is for this reason that many observers, including Paul Krugman of the New
York Times, are advocating the eschewing of the mortgage triage framework to
just reset everybody's rates.
This is not bleeding heart liberalism here. The argument is that the
determination as to who will and who will not receive assistance will be so
inherently slow and plodding that the foreclosure damage will have occurred
before the help can arrive.
But the wholesale reset argument flies right in the face of the individualistic
Protestant work ethic (or, in other words, plain old stinginess) of the US
general public. Polling data indicate strong opposition to just about any
initiative to aid the subprime borrowers.
"I pay my mortgage, why shouldn't they?" comes the argument from out of Middle
America. The answer to that proud rhetorical inquiry is that if half the houses
on his block get foreclosed, abandoned and boarded up, down the drain will go
the value of Mr Independent's house as well. Since it can't be told in the 15
seconds or so that local American nightly news devotes to the financial
matters, the rejoinder remains unspoken.
But there is another flaw in Hope Now, one that goes to the core of the process
of housing finance in this country.
When first I wrote of the subprime crisis for ATol in early March, I noted that
the housing finance industry in America had traveled a long way from that
portrayed in the 1946 Frank Capra movie It's a Wonderful Life. There,
old-fashioned mortgage banker George Bailey (Jimmy Stewart) could honestly
plead to panicked depositors in his bank that "Your money's in Joe's house
right next to yours. And in the Kennedy house, and Mrs Macklin's house, and a
hundred others. Why, you're lending them the money to build, and then they're
going to pay it back to you."
Not any more. These days mortgages are like more sausages, chopped up and
remixed, seasoned and processed, bundled and tied up to become mortgage-backed
securities, bond-like investments that investors use to earn higher interest
rates than those available on Treasury securities.
If your mortgage is among the $2 trillion of those that have been thus
"securitized" in the past decade, the monthly mortgage check you write to your
bank does not stay with your bank, unless your bank has kept some of the
mortgage paper for itself. Instead, it passes through the financial system,
eventually arriving in the wallets of whoever bought your mortgage, now bundled
with perhaps hundreds of others. In essence, you have borrowed your mortgage
money from the owner of your mortgage paper, be he a private investor in Texas,
a hedge fund in Connecticut, a public pension fund in California, or a
sovereign wealth fund in the Middle East. The bank that you write your check
to, called the mortgage servicer, is, in reality, just a middleman.
Looking down the roster of the Hope Now Alliance, you see a lot of mortgage
servicers - Citigroup, Washington Mutual, Bank of America and others. It is
hoped that the alliance will, after finding out who's been naughty with credit
(they'll get help ) and who's been nice (they won't), alter the specified loan
terms of the mortgages so that the rates won't be set higher.
Can they do that? Is it legal to do that? After all, the mortgage is, in
reality, just an IOU between the borrower, the homeowner and the mortgage paper
owner. The servicer occupies a middleman role much like a stockbroker; when you
buy 100 shares of a stock, the broker is just performing a service for you,
much like the servicer.
The American Securitization Forum, the trade group for the securitization
industry, and a key component of the Hope Now Alliance, says it can
unilaterally alter mortgage terms without lender consent.
"The ASF believes that this framework is consistent with the authority granted
to a servicer to modify subprime mortgage loans in typical PSAs [pooling and
servicing agreements].The ASF expects that the procedures in this framework
will constitute standard and customary servicing procedures for subprime
loans."
What if the owner of one of the mortgages whose interest rates are being frozen
objects to the terms of his mortgage bond, his loan agreement with the
borrower, being altered without his consent? The Hope Now program defenders say
this won't happen, that the owners of the mortgages will agree to temporarily
sacrifice a little so as to avoid the costs of the foreclosure process,
typically, up to 30% of the original loan.
Maybe that's true. But, as most of the teaser rates were written to be barely
profitable, or even non-profitable, now so that they could be insanely
profitable following the reset, maybe someone will object. It will only take
one cantankerous miserly old bugger to go into the US courts and get the reset
freezes stayed, and the entire Hope Now infrastructure collapses and is
disposed of into the courthouse paper recycling bins.
Interestingly, the ASF legal interpretation that servicers can act in the
interests of lenders without their express consent has been recently been
rejected by the US courts - in reverse.
It was in October that US Sixth District Court Judge Christopher Boyco, ruling
from the bench in Cleveland, Ohio, stopped a mortgage servicer, Deutsche Bank,
from foreclosing on 14 properties, saying that, as the mortgage servicer could
not show an actual title to the homes being foreclosed, it had no standing to
foreclose on them. In mid-November, another Federal judge, Thomas Rose, of
Dayton, Ohio, did the same with 26 foreclosure motions submitted to him by
mortgage servicers Citigroup, HSBC and others.
Have, in Tom Wolfe's famous moniker from The Bonfire of the Vanities,
mortgage finance's Masters of the Universe been tripped up in their
decades-long quest to transfer the wealth of America from the working to the
capital-owning classes by something so mundane and pedestrian as to having to
follow the law?
In the meantime, I feel sorriest for the subprime borrowers, once again led to
believe the lies of the mortgage finance industry, once again betrayed. When
they returned home from their second or third job last Thursday night,
desperately trying to earn the money to keep their houses, they might have
turned on the news, thought that there actually was hope, maybe even hope now.
But what they thought was hope turns out to be a fantasy, their American dream
now a chimera slipping like illusionary sand through their grasp. In much the
say way that Bush's "Mission Accomplished" speech on the USS Abraham Lincoln
ushered in the worst fighting of the Iraq War, his Hope Now initiative,
intended, designed and delivered to be nothing more than the Mission
Accomplished moment of the subprime crisis, may very well usher in the worst of
the foreclosures in 2008.
Julian Delasantellis is a management consultant, private investor and
educator in international business in the US state of Washington. He can be
reached at juliandelasantellis@yahoo.com.
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