Saturday, May 31, 2008

Housing Policy Incoherence Part III: Why Help?

Part I of this series discussed a framework to determine which borrowers should be helped with their mortgage problems. Part II outlined which parties might be help these borrowers, and this part will outline possible motivations as to why we might want to help these borrowers.

Reasons to help borrowers fall into several categories:

Altruistic Reasons. At the most basic level, some people believe we should help borrowers just because they're in trouble. Usually the desire to help for this reason is tied to a perception the borrowers are victims, are suffering, etc. This concern is outlined in Robert Shiller's New York Times piece, The Scars of Losing a Home, and derided by Yves Smith in a Naked Capitalism post. Since resources are limited, proposals to help borrowers for these reasons need to sort out worthy borrowers from unworthy borrowers (e.g., borrowers who committed fraud or who don't need help).

Collective Local Good. Foreclosures have an adverse effect on neighborhoods both by depressing values and creating blighted vacant homes (discussed in more detail in a previous post). Some proposals focus on minimizing this effect by helping borrowers. Often these proposals encounter arguments that they unfairly benefit borrowers who don't deserve help; a speculator's foreclosed house is just as big a drag on a neighborhood as a deserving homeowner's foreclosed house, but does that mean we should bail out the speculator?

Collective General Good. There is a theory declining home values and foreclosures will have a general negative economic impact, and we will all benefit from proposals which will help minimize foreclosures. A variation on this theme is that proposals to help these borrowers will help financial institutions also under stress from the mortgage crisis. These proposals also run into arguments that they unjustly benefit bad actors.

Obviously, these motivations are not mutually exclusive; a plan may be driven (and often is) by all three motives. Still, the motive for the help is important to consider because many of the specific objections to a plan are not relevant depending on the the plan's goal. For example, if you think avoiding foreclosures is necessary for the general economic good, you might be just as willing to help a borrower who committed fraud to get his loan as you would be to help someone who was duped by a loan broker.

Housing Policy Incoherence Part II: Who Should Help?

Part I of this series laid out some potential criteria for determining which borrowers should be helped with their mortgage problems. This part develops a framework identifying who might help them.

Lenders. The obvious counterparty to assist borrowers are their lenders. This is not so simple, because although there are some conventional borrower lender loans out there, in most cases the situation is much more complicated. Here are the lender players:

  • Loan Broker. The loan broker is the face of the lending process to the borrower. The brokers sell the programs to the borrowers, assist in completing applications, and shepherd the process to funding. The broker gets paid when the loan closes and doesn't have a continuing role in the loan. Lender. The lender typically underwrites the loan broker's application package, prepares the loan documents, and funds the loan. Sometimes the lender retains the loan, but often the loans were placed into pools, securitized and sold to investors. Here is a link to a more detailed discussion of the securitization process.
  • Investors. The investors are the buyers of the mortgage securities. A single pool of mortgages will have multiple securities associated with it based on the priority and timing of the cash flow allocations, so there are often multiple investor classes with an interest in the cash flow associated with each mortgage. The price the investor paid for their security was in part by the rating assigned to it by the rating agencies.
  • Servicers. After the loan is sold, the servicer collects the payments, administers the loan for the investors and is the interface with the borrower. Frequently the lender retains the servicer role.
So, when we speak of the lender helping the borrower, what we're probably talking about is the servicer modifying the loan for the borrower on behalf of the investors. The modification typically will postone or reduce interest payments for a period of time, or possibly reducing the principal amount owed. These modifications have an immediate adverse impact on the cash flow for the investors, and will typically have a disproportionate impact on the various investor classes. Although the immediate impact is negative, ideally the modification will result in a higher recovery for the investors than a foreclosure.

Statutory/Regulatory Assistance. Some proposals call for statutory or regulatory changes which will provide relief for borrowers (for example, foreclosure moratoriums or extending the foreclosure period). These proposals are in essence income transfers from lenders to borrowers in that they allow borrowers an additional period of collateral posession without making payments.

Taxpayer Funded Assistance. These proposals come in a variety of forms:

  • Direct Assistance (e.g., funding provided to municipalities to acquire foreclosed homes to recycle to worthy owners).
  • Assumption/Extension of Risk. Proposals to provide assistance by taking on additional future risk (e.g., liberalized FHA financing terms).
  • Tax Breaks. Some of these proposals include liberalized loss carryforward provisions for home builders and waiver of forgiveness of debt income arising out of foreclosures and modifications.

Part III of this series will discuss, why help?

Wednesday, May 14, 2008

Housing Policy Incoherence Part I: Which Borrowers Should Be Helped?

Every day I read multiple posts touting or panning a "solution" to the housing mess. A few weeks ago Risk and Return has a post criticizing a plan which would fund acquisition of abandoned foreclosed homes by states and localities. There are many good points made in the post, but it (and every other post on various plans I've read) does not address a fundamental question: who should be helped?

Let's start by talking about the characteristics of a borrower we're most likely to agree we should help.

This borrower (let's personalize it and call her Teresa) owns and has occupied her very modest home for 40 years. Teresa is 82, worked all her life as a maid, has limited reading and math skills, is disabled by arthritis, and supports herself on fixed social security payments. She has no living relatives except for her severely retarded 55 year old daughter, who lives with her and also receives disability payments. Over the years maintenance problems with the house accumulated because Teresa lacked the money to fix problems as they arose. An unscrupulous mortgage broker proposed a loan with a low teaser rate. Teresa used the funds to repair the house, but when the rate adjusted she could not afford the new payments. She is now in foreclosure, and when she's evicted she and her daughter will be homeless.

Now, let's meet Tom Rakewell. Tom, a recent MBA graduate, bought a luxury condo in La Jolla in 2005 using 100% financing and rented it to a college friend with the intention of flipping it in a year or two. In 2006 Tom took out a $200,000 stated income home equity loan. Tom exaggerated his income and used the money to start a brokerage business. The brokerage business failed and when the interest rates reset on his loans Tom was unable to keep the payments up and the condo is in foreclosure. Tom is living with his parents at their Santa Barbara estate.

Let's parse out Teresa's and Tom's respective situations:

Modest housing versus luxury housing. Some believe people who got in trouble buying high end housing should not be helped.

Long term owner versus recent owner. Some argue recent purchasers who bought at the top should take their lumps.

Owner occupied versus investor/speculator. Some argue investors and speculators should not be bailed out.

Limited opportunity for recovery versus good future prospects. Some argue those who are in a position to start over should not be helped.

Loan funds used for necessities/productive purposes versus loan funds used for frivolous purposes. Some argue people who bought big screen TVs and new pickups with their home equity lines do not deserve help.

Limited capacity and/or duped versus knowledgeable and/or complicit. Some argue those who knew or should have known the risks of the loan they were entering into should not be helped.

Unable to make contractual payments versus able to make contractual payments. Some argue those who are able to make their contractual payments should not receive relief.

Able to make modified payments versus unable to make modified payments. Some argue to receive a modification ability to succeed under the modification should be demonstrated.

No housing alternatives versus those with housing alternatives. Some argue those who have housing alternatives after foreclosure (e.g., move back in with Mom and Dad) should not be helped.

I don't expect there would be consensus on which criteria are most important (although I do think a program which provided funding to a municipality to buy Teresa's house at the foreclosure sale and let her continue to live there would get more support than such a program benefitting Tom).

Part II of this framework is to identify who should help the borrowers.

Wednesday, May 7, 2008

Who Cares About the Employment Birth/Death Model?

The debate over the reliability of BLS employment figures, and specifically the impact of the birth/death model, rages on. The latest posts I've seen (both very helpful) are from A Dash of Insight and Across the Curve; older posts from The Big Picture and Econbrowser demonstrate the debate has not moved forward much. My belief is the concern is overstated if you look at the employment figures in the right way (i.e., year over year change) over time.

My point is illustrated by comparing the trend in Sacramento:

with what's going on in Seattle:

Clearly, something is deeply amiss in Sacramento, while Seattle is holding it's own. If the birth/death model is understating job losses (and that's not a given, there are smart people on both sides of that issue), the Sacramento curve should be even steeper and Seattle might have started trending down. But if you're trying to use the published numbers to make investment decisions, this way of looking at the data gives you a pretty clear idea of what's going on.

This example also demonstrates the interesting stories happening in individual markets that get averaged out when you roll up to the national figures.