Second Lien Roadblocks

Obama’s Making Home Affordable Plan has hit a significant speed bump for many borrowers who are depending on it to help them refinance. 

In a nutshell, many second lien holders aren’t playing nice.  They’re not readily agreeing to jump back in line behind a new first mortgage.  But why should they?

They want to get paid off.  They want to get better terms.  And they hold the trump card.

In the event of a refinance, those in second lien positions have to agree to go behind the new primary loan.  If they don’t, no bank will agree to write a new primary loan.

Second mortgages are inherently riskier than firsts.  If a house goes in foreclosure, the first lien holder calls the shots.  They’re going to auction or dispose of the property in a way that tries to get what they have in it.  They’re not too concerned about who else is in line.

What’s left gets dispersed to the second lien holder, and any one else holding a lien against the property, like a homeowners association that wasn’t getting its dues.

The greater risk, the less certainty they will get paid off in a worse case scenario, is the reason HELOCS and HELOANS typically carry higher interest rates than conventional mortgages.

And the equity loan companies have been getting hammered because people have been defaulting on them before they stop paying on their first loans. 

So they want to be taken care of, as well.

The Wall Street Journal is reporting today that this has caught the Administration by surprise.    If so, it betrays shocking incompetence in basic understanding of the mortgage business.  The bureaucrats are now scrambling to come up with a solution. 

Oops!

Obama's Foreclosure Fix

The highly anticipated news du jour, Courtesy of CNBC

Housing Fix: $275 Billion To Help 9 Million Families
"President Obama unveiled his much-anticipated plan Wednesday to fight the housing crisis, pledging up to $275 billion to help stem a wave of foreclosures sweeping the country.

A total of 8.1 million U.S. homes, or 16 percent of all households with mortgages, could fall into foreclosure by 2012, according to a report by Credit Suisse.

An Obama administration official said the total plan commits up to $275 billion for housing, including $50 billion from funds already committed in the country's financial sector bailout. It aims to help up to 9 million American families."

The Fixin might need Fixin

Chairman of the Federal Deposit Insurance Corporation, Shelia Bair has found religion.  She believes that she has found the solution to the foreclosure crisis:  loan modifications.

Qualifying homeowners in serious delinquency get a letter from the FDIC offering them a way off the foreclosure highway:  more affordable monthly payments! 

The Feds can do this through reducing the interest rates on the loans, extending the amortization and deferring principal payments.  We commented on this here.

As we mentioned in an earlier post, the FDIC has used this pilot program on more than 5000 formerly Indymac borrowers the corporation inherited when the bank collapsed. In congressional testimony over the last several weeks, Bair has been hailing the success and wants other banks to follow the FDIC’s example.

Of course, all this costs money.  Millions so far.  Which will make Barney Frank and some of his Democratic colleagues on the Hill very happy.  They want some of Paulson’s 700 billion bailout money to be used for homeowner relief instead of the many curious ways the Treasury Secretary has disbursed it so far.

But will this work?

The Wall Street Journal’s MarketWatch does not fill me with confidence.  “For the industry in general, after mortgages are modified roughly 25% go delinquent again after just one post-modification payment and more than half end up delinquent after several post-modification payments. . .”

Maybe the solution will need a solution.

On to Bailout #2 - Is the Hubbard Plan next?

Earlier this month The $700b Bailout was passed into law. Labeled the Emergency Economic Stabilization Act of 2008, it provides Paulson & Co. $700b with which to purchase any type asset from any investor it deems worthy of its favor (among other things).

Not only did it receive a considerable backlash from the general public and quite a few government representatives, but it also drew criticism from a significant number of economists around the country. One of those economists was Jeff Miron of Harvard, who suggested that the banks and investors who purchased all of these risky, non-performing assets bear the responsibility and file for bankruptcy if need be and the American taxpayer should not bail them out.

Another such economist (though not on the list linked above) is Glenn Hubbard, current dean of the Columbia University Graduate School of Business and former chair of the Council of Econimic Advisors. Mr. Hubbard has come up with his own plan which he presented in an editorial in the Wall Street Journal on October 2nd:

First, Let's Stabilize Home Prices

"We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify."

In addition to focusing on the very real problem in the housing market, the plan could be implemented immediately. As a result of the U.S. government's conservatorship of Fannie Mae and Freddie Mac, origination of new mortgages can be financed quickly. Congress would have to raise the overall borrowing limit and approve the new federal purchases of negative equity loans. But it will likely take the Treasury much longer to buy troubled assets than Fannie and Freddie, and it would have to seek the involvement of many additional private actors, as opposed to using vehicles already in place. The decline in housing prices remains the elephant in the room in the discussion of the credit market deterioration. Let's start there."

The Hubbard plan was also covered by NPR:
Bailout Critics Say It Won't Fix Underlying Problem, NPR Morning Edition 10/3

Is this a viable and/or appropriate solution for our ailing economy? Or is Hubbard just trying to score a few points on Bernanke (the guy who took his spot at the Fed)?

MONSTROSITY

monstrosity (noun) - a: an object of great and often frightening size, force, or complexity b: an excessively bad or shocking example



Once 3 pages, bailout bill now length of novel

The FED's recent open market operations - The Alternative Bailout

This morning the Federal Funds rate was 7%. Doesn't sound so bad, huh? Well, the problem is that the Fed Funds target is 2%. What does this mean? The cost of US banks lending to each other was 5% higher than it should be. If the spread between the actual and target rates persists, banks become very reluctant to lend to each other and to consumers. Draw this out over weeks and the flow of money (lending) will be hindered and the economy will slow down considerably (more than we want).

But the Fed has not been sitting idly by. In order to reduce the Fed Funds spread, the Fed pumped $20b into the money markets at 9:40am today. In fact, over the last 30 days, the Fed has injected $530b into the US financial system. And the problem isn't just with US banks. We are in the middle of a worsening global credit crunch, with one of the indicators being the TED spread (a measure of illiquidity).

The open market operations in which the Fed is engaging is the ongoing bailout, or aka The Alternative Bailout. Granted, we're not talking about a $700b blank check. But the Fed's operations are just as risky, if not more. The assets that the Fed purchases ARE returned to the owner and the loan IS repaid with interest to the Fed, but repayment in the current market is not a given. The assets that the Fed is now purchasing, thanks to temporary policy changes announced on 9/14, are not just Treasuries and MBS (allowed in 2007) but a broad range of asset types such as equities, junk bonds and subprime mortgage bonds.

Fed takes fresh steps to battle credit crisis (AP, 09/29/2008)
"Under one new step, the Fed will boost the amount of 84-day cash loans available to U.S. banks. The Fed is increasing the amount to $75 billion, up from the current $25 billion starting on Oct. 6. Banks bid on a slice of the loans at an auction. That move will triple the supply of 84-day loans to $225 billion, from $75 billion, the Fed said. Meanwhile, the Fed will continue to make $75 billion worth of shorter, 28-day loans available to banks. All told, the total amount of cash loans — 84-day and 28-day — available to banks will double to $300 billion from $150 billion, the Fed said. Moreover, the Fed will make a total of $620 billion available to other central banks, expanding ongoing currency "swap" arrangements with them where dollars are traded for their currencies. That's up from $290 billion previously in such arrangements."

The Fed's balance sheet is $800b, which leaves approx. $200b in lending ability. This is not a good debt-to-high credit limit ratio.

I don't think we have much leftover for Hedge Funds.

All Eyes on The House

HOUSE REJECTS BAILOUT FOR US FINANCIAL MARKETS

But it ain't over...

The Right Man at the Right Time

By now most know about the Fannie Mae & Freddie Mac "bailout". It's been blogged, reported & commented about for months. So if you didn't catch it on every major news channel & site this morning, you will.

While some are questioning whether the largest bailout in US history was really necessary, most (experts) say that it was and the fallout from other options (receivership or equity injection) would have been worse.

Paulson: "We had no choice"


And former Secretary of Treasury John Snow said it best on Squawk Box this morning (interviewed in front of the Rotunda at UVA), "This action was necessary in the face of the realities of the financial markets, the need to stabilize housing and the larger issues of the US economy and it's spill over affects on the rest of the world. So we are where we are, I guess now the question is can we find a good path out of this so that we get a permanent solution coming out of the next congress..."


Realty Check (CNBC) on the the housing market will react.
Questions is, "How much and how soon"
Mark Zandi of Moody's Economy, "It will help the housing market, it won't bring an end to the housing downturn immediately though."


I truly feel sorry for the thousands of employees at Fannie Mae & Freddie Mac. This is like Enron times two. "Fannie Mae’s workers had $116 million in the employee stock ownership plan at the end of 2006. Today, it’s more like $17.5 million. Ouch."