Moral Hazard! No Kidding

[don]

Moral Hazard? From these folks! Oh, moral hazard for the sheeple. Check.



The second shoe drops- the toxic mortgages to be piped directly, without pretense, straight down the public's gullet. Will balloon pricing hold?

Fannie, Freddie Backstop May Foreshadow Mortgage Forgiveness


By Jody Shenn
Dec. 28 (Bloomberg) -- The U.S. Treasury Department’s expansion of its capital backstops for Fannie Mae and Freddie Mac may foreshadow a shift in the government’s mortgage- modification tactics, Keefe, Bruyette & Woods analysts said.

The Treasury announced Dec. 24 that the two mortgage- finance companies, which were seized by the U.S. almost 16 months ago, could tap an unlimited amount of capital for three years, up from as much as $200 billion each. The companies’ needs would be unlikely to exceed the prior limits “even in a stress case scenario,” Bose George and Jade Rahmani, the New York-based analysts, wrote in a report today.

“Given this outlook, we believe that the main driver of this significant change is the flexibility it gives the government to take more aggressive action to support the housing market, including potentially going down the road of allowing some form of principal writedown,” the analysts wrote.

Under the Obama administration’s Home Affordable modification program, loan servicers reduce borrowers’ payments to 31 percent of their pretax incomes through means starting with interest-rate cuts. The program, which is meant to curb soaring foreclosures, doesn’t reduce the size of homeowners’ debt, even with more than one-fifth owing more than the value of their properties, according to Seattle-based Zillow.com.

Shifting to principal forgiveness to cure so-called negative equity that makes borrowers more likely to abandon loans whose payments they can afford may prove more costly for Washington-based Fannie Mae and Freddie Mac of McLean, Virginia, by sparking “another wave of delinquencies as people look at it as a rational choice” to default to seek the aid, George said in a telephone interview. (as a rational choice is a moral hazard when practiced by the sheeple)

The larger backstop would be available to protect against the “moral hazard issue,” he said. (See above)

Second Mortgages

A change in tactics in the U.S. modification program is needed as the “current version has been a failure,” in part because of trouble in getting the necessary documents from homeowners, George said. (Homeowners! Fabricated altered loan docs aren't with the homeowner, they're with the lenders' posse.)

Dealing with second mortgages, which aren’t owned by Fannie Mae and Freddie Mac, would be “essential” to any move to principal forgiveness, though “I don’t know what the solution to that will be,” he said. (Hey, betcha we can guess)

Through November, servicers had permanently modified 31,382 mortgages under the Home Affordable program, which was announced in February as targeting 3 million to 4 million loans, the Treasury said Dec. 10. A total of 728,000 of the modifications were under way.

Fannie Mae has tapped $60 billion of its lifeline so far and Freddie Mac has been provided with $51 billion.

http://www.bloomberg.com/apps/news?p...lYN2HgY&pos=6#

[bw]

Re: Moral Hazard! No Kidding

Fabricated altered loan docs aren't with the homeowner, they're with the lenders' posse.

Perhaps they were looking for actual proof of income.

[ASH]

Re: Moral Hazard! No Kidding

“Given this outlook, we believe that the main driver of this significant change is the flexibility it gives the government to take more aggressive action to support the housing market, including potentially going down the road of allowing some form of principal writedown,” the analysts wrote.

Maybe somebody in Washington is paying attention after all. Stimulus spending is hand-to-mouth, and loose monetary policy is fairly ineffectual, so long as the consumer has a cash-flow problem. The only way to get a self-sustaining economic recovery on the old model of credit-driven consumption is to discharge enough of the overhang of private debt to free up more cash flow. This could happen by default, but bankruptcy is an impediment to a recovery driven by credit expansion because (a) it eats into bank reserves, and (b) it temporarily disqualifies potential consumers from taking out more credit. This could happen if the debtors tightened their belts, down-sized, and paid off their debt... but that runs counter to the objective of getting people to support employment by consumption in the near term, exacerbates the economic downturn, and undermines asset prices; this route may eventually be followed through wage inflation, but that's not immediately in the cards. So, actual debt forgiveness is the logical policy response, if your goal is to get the old model of the economy working again. I believe this is even what some at iTulip have advocated, when contemplating the problem posed by an economy overburdened by consumer debt. The debt is the basic problem, and it has to be dealt with -- otherwise we're a nation of zombies.

The practical problem, of course, is that they're talking about transferring debt rather than actually cancelling it. To repeat an oft-used phrase, the solution to debt is not more debt. In my opinion, it would be better for the Fed to monetize the mortgages and forgive some of the principal than for the Fannie Mae to forgive some of the principal and have the Treasury make good their losses. Either way is 'bad', but this whole conversation is about which version of 'bad' one tolerates.

The ethical problem is significant. Moral hazard indeed! The healthier thing in the long term would be for asset prices to fall, people to down-size to a lifestyle commensurate to their productivity, and operation of a production/consumption economy with much less use of credit. But that route involves people losing their savings, their jobs, and their standard of living. No politician is going to chart that route, so the game plan is going to remain restoring things to the way they were... and relieving the consumer of some debt burden is probably a necessary part of that attempt.

[vinoveri]

Re: Moral Hazard! No Kidding

...
So, actual debt forgiveness is the logical policy response, if your goal is to get the old model of the economy working again. I believe this is even what some at iTulip have advocated, when contemplating the problem posed by an economy overburdened by consumer debt. The debt is the basic problem, and it has to be dealt with -- otherwise we're a nation of zombies.

The practical problem, of course, is that they're talking about transferring debt rather than actually cancelling it. To repeat an oft-used phrase, the solution to debt is not more debt. In my opinion, it would be better for the Fed to monetize the mortgages and forgive some of the principal than for the Fannie Mae to forgive some of the principal and have the Treasury make good their losses. Either way is 'bad', but this whole conversation is about which version of 'bad' one tolerates.

The ethical problem is significant. Moral hazard indeed! The healthier thing in the long term would be for asset prices to fall, people to down-size to a lifestyle commensurate to their productivity, and operation of a production/consumption economy with much less use of credit. But that route involves people losing their savings, their jobs, and their standard of living. No politician is going to chart that route, so the game plan is going to remain restoring things to the way they were... and relieving the consumer of some debt burden is probably a necessary part of that attempt.

I fear you are right.
So in the very best tradition of moral hazard, let us ask ourselves, if this is coming, "how can we benefit"? How can we profit indiviudally while leaving our fair citizens to hold the bag when our bets go awry. Borrow, spend and gamble, and default, that is how .... Ethics? What say ye? Are ya mad man, everyone is doing it ... and if you don't get yours now soon there will be no more, it's just business anyway, right?

Either the debt forgiveness by Fannie and backed by the Treas OR the debt monetization scenario by the Fed maybe a practical short term solution to getting the credit cycle going again, but would be a monumental mistake in the long term. Either 'solution' rewards misguided risk-taking and irresponsibility and directly punishes the opposite virtues of frugality, carefullness, and savings (through liability transfer and/or inflation), and although the banks already got bailled out and are the poster child for moral hazard, extending it to those of the populace at large who are underwater or who simply want out of their mortgage would be jumping off the chasm IMO.

Yes, Moral Hazard indeed. With all the stories of those who bought at the top and now have negative equity, I don't hear any talking about all those millions of folks who benefitted on the way up, from folks smart enough to sell at the top, flippers, RE brokers, mortgate brokers, etc., all those who exploited the opportunities at hand. Again, as with the banks we have "privatize the profits and socialize the losses" but now extended to a much larger segment of the citizenry.

The message to anyone paying attention is borrow as much, and consume or invest, it's your duty to support the economy. The problem now it that the duty to make good on your debts has now been made a laughing stock. Withouth both duties, this can only go on for so long ....

[c1ue]

Re: Moral Hazard! No Kidding

ASH,

Principal forgiveness won't fix the problem unless actual equity is given to the borrower.

What the article fails to talk about is that even if someone who is $50,000 negative equity is brought to $0 via 'forgiveness', even if a $25,000 2nd mortgage is bought up and 'forgiven' by Fannie/Freddie, that the borrower STILL has no skin in the game.

The borrower is still stuck in the sense that:

a) they can't move without coming up with the 7%+ of sale price in cash needed to sell the home. This is still a boat anchor from a labor flexibility issue.
b) the home represents zero investment on their part - what's the motivation to maintain?
c) the forgiveness doesn't cover their other debts: credit cards, auto, etc
d) the share of the consumption engine represented by their home (i.e. home improvement, real estate, construction demand via home sales volume, etc) is still dead

The only game I see is the 2nd mortgages will now be bought up by Fannie/Freddie, the caps on loans that can be made will be increased, the requirements slackened, and losses due to defaults from loans alread held as well as future ones will increase.

Those reading more into this Fannie/Freddie cap limit raising are simply engaged in wishful thinking.

[ViC78]

Re: Moral Hazard! No Kidding

I posted this in another thread.
Dean Baker has a very plausible explanation for this. It seems that this is yet another vehicle to bail out the banks by overpaying for the MBS which the GSEs have been buying from them since Sep 2008.



Fannie Mae and Freddie Mac: Just a Four-Letter Word?


That word would be "TARP" of course. The night before Christmas, the Treasury announced that these two bankrupt mortgage giants would get an unlimited draw on the taxpayers' dollars. This looks a lot like TARP.
Just to remind everyone, the original TARP program was about buying up bad assets from banks. It had the appearance of the mother of all bailouts, as it seemed likely that the government would overpay for these assets, handing public money to bankrupt banks. The TARP changed course, with the government providing hundreds of billions of dollars of loan money to banks at a time when the private sector had no confidence in the banking system.
The TARP, along with the much larger lending programs from the Federal Reserve Board and the FDIC, succeeded in preventing the financial system from collapsing. The banks are now back on their feet, with near record profits and near record bonuses for the executives who are so skilled in getting public money. The largest banks have now repaid their TARP money, with many smaller banks anxious to follow suit in order to avoid troubling questions about how they have used their taxpayer dollars.
The major exception to the happy picture in the financial sector is the plight of Fannie Mae and Freddie Mac. Officially, the Treasury reports that together the two companies have drawn just over $100 billion on their $400 billion line of credit from the government. But this story is very hard to reconcile with the decision to enlarge this line of credit without limit. The Treasury claims this was done to assure the financial markets that the government would stand behind the debt of the two mortgage giants.
Since Fannie and Freddie went into conservatorship in September of 2008, it has been explicit policy that the government would back up their debt. Originally, $200 billion was committed for this purpose. That amount was subsequently doubled to $400 billion (almost half of the ten-year cost of the health care bill). If the bad debts to date have only forced Fannie and Freddie to draw just $100 billion, isn't a commitment equal to four times prior losses sufficient to maintain the confidence of financial markets?
The arithmetic on this is very hard to understand. While Fannie and Freddie did get into subprime near the peak of the bubble in 2005, the vast majority of their assets were still tied to prime mortgages. These are mortgages in which people had to put 20 percent down or buy mortgage insurance.
The combined portfolios and guarantees of the two companies were $5.5 trillion at the time of their takeover. Suppose that 10 percent of their mortgages went bad (an extremely high rate for prime mortgages). This would put $550 billion at risk. If the loss rate on these mortgages was 25 percent (a very high loss rate for prime mortgages), then Fannie's and Freddie's combined losses would be just $163 billion, not even half of the line of credit.
Furthermore, Fannie and Freddie had combined reserves of more than $50 billion going into this disaster, and make money on ongoing operations. On the face of it, it is very difficult to see how Fannie and Freddie could go more than $400 billion in the hole, based on their September 2008 assets. In fact, this possibility seems so far out, it is hard to imagine that the financial markets need any further evidence of the government's commitment to these mortgage giants.
This raises the possibility that Fannie and Freddie are incurring losses on assets purchased after September of 2008. This would mean that they were paying too much for mortgages and mortgage-backed securities bought from banks after the financial meltdown was already in full swing. This was the original purpose of the TARP program. Of course, TARP came with at least some restrictions and disclosure requirements. If Fannie and Freddie are overpaying for mortgages, then there are no conditions whatsoever put on the banks that get the money.
It is possible that there is some other more innocent explanation for the sudden need to raise Fannie's and Freddie's credit limits. If so, then the Obama administration should make its case to the public and explain how losses could conceivably run above $400 billion (credit markets don't need reassurance against inconceivable events).
While they are it, the Obama administration might also want to explain why the CEOs of these bankrupt companies now stand to pocket $6 million a year, a fact released in another Christmas Eve announcement. Surely, there are people who can run bankrupt companies at a much lower pay rate. This looks like yet another case where Santa is being very generous to the financial industry boys, while leaving the rest of us with a lump of coal.
Christmas Eve announcements were a favorite trick of the Bush administration. It is disappointing to see this practice continue under President Obama

[vinoveri]

Re: Moral Hazard! No Kidding

ASH,

Principal forgiveness won't fix the problem unless actual equity is given to the borrower.

What the article fails to talk about is that even if someone who is $50,000 negative equity is brought to $0 via 'forgiveness', even if a $25,000 2nd mortgage is bought up and 'forgiven' by Fannie/Freddie, that the borrower STILL has no skin in the game.

The borrower is still stuck in the sense that:

a) they can't move without coming up with the 7%+ of sale price in cash needed to sell the home. This is still a boat anchor from a labor flexibility issue.
b) the home represents zero investment on their part - what's the motivation to maintain?
c) the forgiveness doesn't cover their other debts: credit cards, auto, etc
d) the share of the consumption engine represented by their home (i.e. home improvement, real estate, construction demand via home sales volume, etc) is still dead

The only game I see is the 2nd mortgages will now be bought up by Fannie/Freddie, the caps on loans that can be made will be increased, the requirements slackened, and losses due to defaults from loans alread held as well as future ones will increase.

Those reading more into this Fannie/Freddie cap limit raising are simply engaged in wishful thinking.

c1ue, I think you are underestimating the imagination of our leaders. Keep in mind that if you're $100k under water and that principal reduction brings you to 0 equity, you still have the hope that the housing appreciation will restart and you will ultimately gain, which is exactly what the goal is here and which will IMO restart, at least within a few years. And perhaps Goldman and Co. can develop a new financial product that can be traded ... a sort of principal reduction credit if you will (they need something new since the carbon credits may be delayed awhile:rolleyes

a) they can't move without coming up with the 7%+ of sale price in cash needed to sell the home. This is still a boat anchor from a labor flexibility issue. solution: tax credit to cover the commission and/or new financing to allow financing 107% of new house (like they are doing today with 125% LTV financing)
b) the home represents zero investment on their part - what's the motivation to maintain? future appreciation - see above
c) the forgiveness doesn't cover their other debts: credit cards, auto, etc - credit card debt forgiveness is coming in masse, and it is already here in the sense that this debt is being routinely written off by the big banks; people understand there is no recourse to CC default, and the banks balance sheets will/are be made whole by the gov

[c1ue]

Re: Moral Hazard! No Kidding

VV,

Certainly anything is possible.

But note that 0% equity won't help you if one of the 2 household earners loses their job. With positive equity you have incentive to dip into savings to hold on; with 0% equity you do not.

Similarly a household which already has been bitten by falling housing prices might be considerably more cautious in throwing down cash or taking on more debt to 'improve'.

Lastly over 100% financing is equally not going to help: as I've said before, my mother has extensive experience with HUD foreclosures.

When the FHA program really got going in the post 1985 era, a lot of people bought houses with 3% down due to the availability of FHA financing (vs. 10% or 20% down conventional). A huge percentage of these foreclosed anyway despite a (slowly) rising housing price - Tehachapi, CA for example had over 5000 FHA owned foreclosed homes for nearly a decade in the '80s.

In the bubble years the FHA foreclosures disappeared as the 100%/5 years housing price increase made selling the house trivial.

What you're proposing as a possibility is to have people buy houses who are ALREADY negative equity.

The point I'm illustrating is that the financing is only one component. If the housing prices don't also start shooting up - i.e. an RE bubble reprise - then the only impact will be a short term pop in sales volume followed by a wave of foreclosures 2 to 4 years later.

Not that what you propose can't happen, but that the ultimate impact isn't going to be a good one

[don]

Re: Moral Hazard! No Kidding

After the Fannie news came out this weekend, a friend called me and his brother works for Chase Mortgage. He told me that Chase is redoing stated income loans and instead of actually appraising the home, they are going back 3 years on the homes valuation in order to get the loan processed. Then they are selling these mortgages to Fannie Mae.

Yes, that's an anecdotal claim, but if true can someone explain to me how this isn't out-and-out fraud?

http://market-ticker.denninger.net/a...ng-Fannie.html