Sunday, December 02, 2007

Multiple Choice Question

EXCLUSIVE: Paulson 'Optimistic' on Subprime Plan:

Paulson said the plan will not be a government-run bailout of subprime borrowers, and the banks that loaned them money. Instead, Paulson said, the government is just providing an industry-sponsored solution to borrowers who can afford to own a home but would have trouble making their mortgage payments after a reset.

'This is not a government subsidy that we're talking about here,' said Paulson.

'This is something that the industry will do where it makes sense.'

The plan would establish guidelines for lenders to freeze payments for homeowners who qualify for the program. Paulson said the program would be completely voluntary, and only some borrowers would qualify.

He said homeowners who can handle an increase in payments and those who don't 'have the financial capability to own a home' will not be offered an interest-rate 'freeze. [emphasis mine]
Once upon a time their were three families who both bought a home June of 2006. The families were identical in every way. They had the same credit rating, the same amount of debt, the same income, the same number of kids. For all practical purposes they were mirror images of each other, except for one thing...

The first family decided to buy a 3 bedroom, 2 bathroom starter house in a decent neighborhood using a fixed rate interest loan which they were able to get because they had been saving up for a down payment for several years. They made sure to take out a loan that they could afford and because they already had some built in equity, they weren't to worried about the housing market.

The second family decided to buy a 4 bedroom, 3 bathroom executive home in a great neighborhood. They did take out an adjustable rate loan, but they weren't to worried since they made sure that the house wasn't so expensive that they couldn't afford the reset if for some reason they were unable to refinance in a couple of years. It would be tight, but they figured they would be ok, especially since their payments were exactly the same as the first family and they had a bigger and better house.

The third family decided to buy a 5 bedroom, 3 bathroom McMansion instead. They knew they wouldn't be able to afford to the reset, but figured what the hell, they would always be able to refinance, because after all "housing prices always go up." They can afford their current payment, but it is tight.

Multiple Choice Question: Which family will soon get a helping hand?

The first family is living within their means, they made good decisions, and are financially sound... they won't be getting anything from the government.

The second family is still OK. They might be overstretched, but at least they were smart enough to make sure they could afford the reset. The government doesn't give a crap about them either.

The third family is living it up, living far and above their means. Yes... this family will be getting a helping hand from President Bush and the rest of the crooks that run the predatory mortgage companies.

Can you say Moral Hazard?

Moral Hazard is the prospect that a party insulated from risk may behave differently, for example, that an insured party's behavior will be more risky than it would without the insurance. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.

13 comments:

rightwingprof said...

I don't have to tell you what I think about that, now, do I?

Alan G. said...

Once upon a time there were two Treasury Secretaries facing a crisis brought on by poor undewriting practices by banks who gave out mortgages to people who couldn't afford them because the banks knew they'd securitize the loans and sell them to investors.

One Treasury Secretary said: "The buck stops with the people who are going to lose their houses and the investors who bought higly rated securitized mortgages that are now worth 27 cents on the dollar. We don't want to create moral hazzards, and we're willing to have a nice big recession that will hurt the entire economy for the next three years."

Another Treasury Scretary said: "The moral hazzard was created when banks made, securitized and sold the subprime mortgages. Not stepping in to deal with the mess has little to do with that moral hazzard since the banks that securitized those loans have long since booked their profits. If banks can profit by selling products that harm the economy, they will. They'll make loans to Leona Helmsley's dog if there's a dollar in it for them."

What's wrong with wanting a modest house, even with a subprime mortgage, rather than no house at all? If MER and C can't forecast that they'll get burned by subprime, how do you expect a high school grad who depended on working overtime during a hot economy to make the mortgage payments to figure it out?

Parentalcation said...

"What's wrong with wanting a modest house, even with a subprime mortgage, rather than no house at all?"

False dilema. There is nothing wrong with wanting to buy a modest house with a subprime mortgage, as long as you can afford it. It isn't a choice between owning and living on the street, its a choice between owning and renting.

What happened to the good old days when families saved up money for a down payment, paid off their mortgage early, and didn't consider their homes equity ATM's?

Alan G. said...

If banks are allowed to sell financial heroin, don't be surprised that there are financial heroin users out there. Let's remember that owning can be cheaper than renting due to the tax break for mortgage interest. If you want the good old days, you can legislate or regulate easy credit out of existence, and get rid of real estate over-investment by cutting the tax break. As a middle of the road person, I think that's probably a huge mistake if the result is "hard credit." And it is not going to happen - not because the subprime borrowers have political clout, but because the Wall Street securitizers have the clout.

I agree - the choice is between owning and renting - between being lower class and middle class. But who wouldn't reach for the bottom rung on the ladder rather than sit in the mudpit? That's a moral hazzard?

It is your examples that are a false dilemma - most of the people in trouble bought a bottom rung house and got in trouble by trying to move up to the middle class, not by going for luxury when they should have stuck with middle.

Let's just be clear about the source of the moral hazzard: what's changed from the "good old days" is the sudden availability of easy credit, with lenders lending to a market where a significant percentage were in over their heads on day 1 or as soon as the rate reset. Don't just blame the victims when the tragedy is foreseeable. Stock brokers can't sell unsuitable speculative investments to retirement plans. Mortgage brokers?

Moral hazzards are for people who could afford better morals but prefer the quick (financial or political) buck. Banks may have lent because they expected Alan G or Ben B to save them, investors may have bought BBB tranches because they expected rate cuts if the market crashed, but no subprime borrower agreed to a 10% mortgage because they thought Bush was going to save them. Let's get real.

Bush Is Set to Unveil
Relief Plan for Homeowners
By DAMIAN PALETTA
December 5, 2007 3:19 p.m.

WASHINGTON -- President Bush is expected to unveil a broad plan Thursday afternoon aimed at helping homeowners struggling with their mortgages, two people familiar with the matter said Wednesday.

. . . .

The plan has multiple parts, including a proposal to freeze interest rates on certain subprime loans for five years, fast track other borrowers toward refinanced loans and allow state and local governments to use more tax-exempt bond programs to fund refinancings.

The Bush administration has been working with consumer groups, lenders and investors to find a way to stave off foreclosures, with interest rates on 1.5 million mortgages expected to reset higher next year.

NYC Educator said...

I get your point and I don't disagree at all. I'd just add a few things:

1. The fault is shared by the banks who made these short-sighted loans. It's really their job to know better.

2. It's not just people buying McMansions who hit this situation. Where I live, even starter homes are beyond the reach of average working people. Here in the suburbs, you're talking 400K for a starter. In Queens it's at least 600K. I'd like to keep the equity in my home, but I wouldn't be too upset if prices tumbled a bit either.

Right now they're simply ridiculous. But with the tumbling dollar, people from other countries can come in and grab them up as bargains, keeping the price up for Americans who can't afford them. All in all, not good for us or our kids.

Parentalcation said...

I agree - the choice is between owning and renting - between being lower class and middle class. But who wouldn't reach for the bottom rung on the ladder rather than sit in the mudpit? That's a moral hazzard?

Absolutely false... perpetuating the myth that you need to own to be middle class is absolutely false. The concept tricks people who shouldn't buy into attempting to buy.

It is your examples that are a false dilemma - most of the people in trouble bought a bottom rung house and got in trouble by trying to move up to the middle class, not by going for luxury when they should have stuck with middle.

Owning a home will not make someone middle class... having a middle class income will. In Los Angeles, it was more affordable to rent in a middle class neighborhood than it was to buy in a low income neighborhood. People bought because they thought it was a road to riches... the fell for the ponzi scheme.

Let's just be clear about the source of the moral hazzard: what's changed from the "good old days" is the sudden availability of easy credit, with lenders lending to a market where a significant percentage were in over their heads on day 1 or as soon as the rate reset. Don't just blame the victims when the tragedy is foreseeable. Stock brokers can't sell unsuitable speculative investments to retirement plans. Mortgage brokers?

Recipients of easy toxic mortgages and credit weren't victims, they were co-conspirators.

no subprime borrower agreed to a 10% mortgage because they thought Bush was going to save them.

No they bought a home because they believed housing prices always go up, they could always refinance, and that "it's different here".

Buyer beware... getting foreclosed on doesn't mean going homeless, it means that they learned a lesson. It means they have to rent for a while, and it means that a family that can (really) afford to buy gets a home.

rightwingprof said...

I don't want to seem cold, but it seems like we're talking about saving idiots from their own stupidity here. If you don't know what "adjustable" means and (surprise!) your interest rate (and therefore payments) go up, well, I just don't have a lot of sympathy. And "borrowers who can afford to own a home but would have trouble making their mortgage payments" seems to me like an oxymoron. Being able to afford a home *is* being able to pay your mortgage. (We got a fixed-rate loan, by the way.)

It's a bail out, even if it only applies to this mysterious group of people who can afford a home, but can't pay their mortgages. Is anybody here old enough to remember Nixon's price freezes?

Not good memories.

NYC Educator said...

Most people with decent credit and income have been getting fixed rate loans for years. I know I did.

This program appears to reward those who made the very worst decisions--an article in the NY Post yesterday suggested that those with 5% equity in their homes would not qualify. So those who put zero down would.

It also mentioned a woman who made 34,000 a year with a 4,300 per month payment. It did say that many of these people were victims of bait and switch schemes by these companies. I still don't see how people with that sort of income buy half-million dollar homes.

I was amazed, though, at how many people with less than half my income were settling into homes that I could not remotely afford.

Alan G(reenspan) said...

"Recipients of easy toxic mortgages and credit weren't victims, they were co-conspirators."

More like the mark in the con game. Sure the mark wants to get rich, but without the con artist there's no scheme. The scheme is the banks pushing unaffordable ARMs, and hiding the fact that their models predict the buyer can't afford the loan and will default. And Alan G himself was pushing ARMs at some point, but I don't remember exactly when.

"People bought because they thought it was a road to riches... the fell for the ponzi scheme."

Right on! But usually, the only person who gets indicted is Mr. Ponzi of Parma, not the investors in "lots in the blue sky".

"Where I live, even starter homes are beyond the reach of average working people. Here in the suburbs, you're talking 400K for a starter. In Queens it's at least 600K."

Hey NYC Educator - Can you guess where I am? My not-luxurious hacienda was north of 600K according to the tax bill - but it is only 15 1/2 ft wide. Yes I am in Queens! Aren't there trailers wider than that? I know we all have our reasons for staying in Metropolis, but wouldn't it make sense to sell now at close to the top of the market? As far as I can tell NYC prices haven't really fallen. I would if I had a trade I could practice somewhere out there where land is cheap and getting cheaper. Why do any teachers stay in NYC when their quality of life would be better in NC?

"perpetuating the myth that you need to own to be middle class is absolutely false."

We're in different markets Parentalcation. Unfortunately, I have friends who never jumped on the bandwagon, and are now leaving NYC with nothing to show for years of paying rent. Middle class people have to turn their pockets inside out to buy something in my market, so your assumption that we're only talking about the working poor doesn't apply everywhere. Though, you're right - NYC is not where the foreclosures are. But if you don't own, you're throwing money away, getting killed on taxes, and never build any equity. So you didn't buy Google at 85. Does that make it crazy to buy at 500? I bought at 500 in August, and made a few bucks.

Nice talking to you! Never been to Alaska, but with global warming, it may be the place to be!

Parentalcation said...

http://www.therealdeal.net/issues/December_2007/1196817075.php

It's a simple real estate equation: Sales go down, inventory piles up and prices start dropping.

That's what's been going on in Manhattan's residential real estate market, and more of the same is on the way as deals made in the wake of the credit crisis come to a close.


http://www.nypost.com/seven/11292007/news/regionalnews/bklyn__qns__foreclosures_soar_412880.htm

November 29, 2007 -- As the nationwide mortgage crisis deepens, Queens and Brooklyn are bearing the brunt in the city.

In Queens, foreclosures were up a whopping 120 percent last month compared with last year, based on figures from RealtyTrac, which follows default notices, auction-sale notices and bank repossessions around the country.

The number of houses lost in Queens spiked from 688 for the month last year to 1,514 this year.

Brooklyn fared better, but still saw an increase of 50 percent this October over last. Property foreclosures were up to 1,277 versus 815 a year ago, the data showed.


Famous last words:

"It's different here"

Alan G. said...

Famous last words:
"It's different here"

Let's remember there are over 4 million people in B'klyn and Queens - so 2000 foreclosures a month is minor relative to the Sunbelt and Midwest. Unlike other parts of the country, there is no land available to build new houses. So there isn't the overbuilding and empty houses problem. The housing stock is old, and owner occupied - there is relatively little investment property, so there isn't the investors who walk away problem. That said, NYC tracks the fortunes of Wall Street, so if prices drop in Manhattan because bonuses are down, BQ is toast too.

Not that I believe the "bailout" will actually happen or work. Just that the moral hazzard issue is more complex than your multiple choices suggested, and involves more players than just the lowly borrower.

I hear you about "greedy and foolish" but that's Wall Street every day of the week, using computer models to predict that these loans made sense. Poor debtors will always borrow if someone is willing to take the risk of lending to them. I am not all that impressed with that as a moral hazzard example. The financial gurus who modeled themselves into a crisis had the education and brainpower to do better.

Nassim Taleb wrote ("Fooled By Randomness")that unusual events are more common than financial models ever predict - using the Long-Term Capital blowup in 1998 as an example. That said, if bailing out Wall Street means avoiding a recession, with all the misery that brings, you have to at least weigh the costs and benefits.

Did Greenspan do wrong by lowering rates after the internet bubble burst? I'm inclined to say no - I did benefit from the low rates I locked in - but I admit that the popping of this second bubble is the test. If I recall, bubbles always have an echo bubble, where there is a second round of speculation frenzy.

NYC Educator said...

Prices are indeed unbelievable in Queens, as Alan says, but from what I read, the NYC market has not tumbled, and may in fact even be rising even as prices in the rest of the country go down.

If you could stand to live in the burbs, you could sell your house and buy a much bigger one outright in Nassau. But then your tax bill would quadruple.

When we bought, we couldn't afford anything we liked in Queens. In retrospect, we could've bought something we didn't like, sold it, and bought a nicer house than the one we live in with no mortgage.

But ya never know. If only we could get tomorrow's sport page delivered today...

Alan G said...

So I was debating selling the humble shack in Queens and banking the quarter mil equity ( and waiting for Manhatan prices to tumble, and moving there in say 2 years (or somewhere else where I can get a house for $250,000 and still find a job). But with Manhattan, it is hard to predict where prices will go - see excerpt below. If all the I-banks have good short positions in place, Wall Street may even have a good year. Of course with Goldman et al all forecasting recession, I imagine Wall Street is going long even as Main Street panics.

Apartment Prices in Manhattan Defy National Real Estate Slide

January 3, 2008

As the housing market across the country continued to stagnate in the fourth quarter of last year, the market in Manhattan set a record, according to reports to be released on Thursday by four of the city’s major real estate brokerage firms.

Sales at 15 Central Park West, top, and at the Plaza Hotel have driven up prices.

The average price for an apartment reached $1.4 million in the last quarter of 2007, up 17.6 percent from the fourth quarter of 2006, according to data tracked by the brokerage firm Prudential Douglas Elliman.

The reports noted, however, that average prices were being pushed to record levels because of the increasing number of apartments selling at the top end of the market, above $10 million.

Many other indicators also showed that the Manhattan sales market remained strong: the number of apartment sales jumped by 3.2 percent, compared with the same time period the year before; apartments sold an average of 18 days faster than they did a year ago; and the inventory of apartments for sale shrunk by 13.5 percent.

“Every single indicator that we tracked showed a gain,” said Jonathan Miller, the executive vice president and director of research of Radar Logic, who prepared the data for Prudential Douglas Elliman.