Bailouts and False Hopes (redux)
In April of 2008, I wrote a post about the psychology behind the various government programs designed to help banks kick the can until conditions got better. In the five years that transpired since, their efforts went from frantic, to desperate, to sublimely ridiculous. Each step along the way, the sheeple were strung along and enticed to make a few more mortgage payments in what will prove an ultimately futile effort to benefit from occupying a property they can’t afford.
Over the years, others picked up on the nonsense.
This in 2011 from US Congressional Representative Patrick McHenry: How Homeowners Are Hoodwinked.
Most of the stories written about this phenomenon were written by people on the political left who were lamenting the lack of progress in keeping loanowners in their debt prisons. Based on what many of these people wrote, they were actually convinced these programs were designed to help homeowners. They weren’t. They were always designed to bailout the banks. If a few homeowners benefited in some way, that was a bonus. The real reason these programs existed at all was to save the banks.
One of the more interesting phenomenon observed during the bubble was the perpetuation of denial with rumors of homeowner bailouts. Many homeowners held out hope that if they could just keep current on their mortgage long enough, the government would come to their rescue in the form of a mandated bailout program. Part of this fantasy was not just that people could keep their homes, but that they could keep living their lifestyle as they did during the bubble. What few seemed to realize was any government bailout program would be designed to benefit the lenders by keeping borrowers in a perpetual state of indentured servitude. With all their money going toward debt service payments, little was going to be left over to live a life.
All of these plans had benefits and drawbacks. One of the first problems was to clearly define who should be “bailed out.” The thought of bailing out speculators was not palatable to anyone except perhaps the speculators themselves, but with regular families behaving like speculators, separating the wheat from the chaff was not an easy task. If a family exaggerated their income to obtain more house than they could afford in hopes of capturing appreciation, did they deserve a bailout? The credit crisis that popped the Great Housing Bubble was one of solvency, and there was no way to effectively restructure payments when a borrower could not afford to pay the interest on the debt, and this was a very common circumstance. None of the bailout programs did much for those with stated-income (liar) loans, negative amortization loans, and others who are unable to make the payments, and since this was a significant portion of the housing inventory, none of these plans had any real hope of stopping the fall of prices in the housing market.
The main problem with all of the plans is the moral hazard they created because those who did not participate in the bubble and behaved in a prudent manner would be penalized at the expense of those who were careless with risk. In one form or another either through free market impacts or direct subsidies from the government paid by tax dollars, these bailout plans all asked the cautious to support the reckless. The moral hazard involved and the moral outrage from those being asked to pay the bills prevented any of these plans from being implemented.
Many of the bailout plans called for changing the terms of the mortgage note. This might have been easy in the days when banks held mortgages in their own portfolios, but it was nearly impossible once these mortgages were bundled together in collateralized debt obligations and sold to parties all over the world. Even if it would have been possible to easily change the terms, the resulting turmoil in the secondary mortgage market would have caused higher mortgage interest rates. When an investor faces the risk of the government changing the terms of their contract, and these changes would not be in their favor, the investor would demand higher returns. Higher investor returns means higher mortgage interest rates which would raise the cost of borrowing. This was the opposite of what the government bail plans were trying to accomplish.
The first of the numerous bailout programs was “Hope Now” introduced in October of 2007. As the name suggests, Hope Now was sold to the general public as a reason for them to hang on and continue making crushing payments for as long as possible. It was a false hope, but even false hope gave homedebtors a little emotional relief, and it provided a few more payments to the lenders. According to their website, “HOPE NOW is a cooperative effort between counselors, investors, and lenders to maximize outreach efforts to homeowners in distress.” The plan was to streamline the process of negotiating workouts between lenders and borrowers to keep borrowers making payments and ostensibly to stop them from losing their homes. The emphasis was on making payments and maximizing investor value in collateralized debt obligations. Very few people benefited from the program, despite government claims to the contrary, and no rights or benefits were conferred to borrowers that they did not already contractually have. There was much fanfare when it was first announced, but the program did far too little to have any impact on the housing market.
The next bailout was aimed directly at the lenders with the Super SIV program introduced in November of 2007. An SIV is a special investment vehicle is an off-balance-sheet investment designed to hold investments a company (usually a lender) does not want to show on their own balance sheets. It is a smoke-and-mirrors device used primarily to get around regulations intended to stop lenders from taking excessive risk. The Super SIV program was intended to purchase assets from the troubled SIVs and provide liquidity for lenders who desperately needed it. The problem with the Super SIV was simple: nobody wanted these assets. Moving bad mortgage paper around was akin to rearranging the deck chairs on the Titanic. Few in the general public knew what this program was for, and even fewer cared. Most wanted to know their government was doing something to solve the problem, and the Super SIV announcement provided them with much wanted denial.
In December of 2007, the government offered a more direct homeowner bailout plan. The proposal was to freeze the interest rates on certain loans for certain borrowers for five years. This was greeted as a panacea by all parties, and the beast of homeowner denial was fed once again. As with the Hope Now program, few people qualified, and it did nothing to hold back the tide of increasing defaults and foreclosures. The denial was short lived, and this unnamed bailout plan quickly fell from the headlines.
In the Savings and Loan disaster of the late 1980s, the government was liable to investors for their losses through the Federal Savings and Loan Insurance Corporation (FSLIC.) The government had no choice by to compel taxpayers to cover the costs of the industry bailout. The Great Housing Bubble had no such government liability. However, in February of 2008 Congress and the President signed the Economic Stimulus Act of 2008 temporarily increasing the conforming loan limit for Fannie Mae and Freddie Mac, the government sponsored entities (GSEs) that maintain the secondary mortgage market. This had the ominous prospect of putting the government in a position where they may step in with taxpayer money to bail out the GSEs, even though the GSEs are explicitly not backed by the assurance of government assistance. The GSEs provide insurance to mortgage backed securities, and by raising the conforming limit, the GSEs were able to insure large, so called “jumbo” loans. This enabled the holders of jumbo loans who were unable to sell these mortgages access to capital in the secondary market. The secondary mortgage market behaves as if the GSEs are government backed, and if they were to fail due to losses from the insurance they provide, the government may have had to step in to back them. All of this was seen as another reason for homeowners in severely inflated bubble markets to hope the government was going to rescue the housing market.
Forgiveness of Debt
Perhaps the most outrageous suggestion put forth was the suggestion by the FED Chairman Ben Bernanke when he proposed lenders forgive mortgage debt in early 2008. The moral hazards were obvious. Would people stop making their payments to make sure they qualified? Would more people buy homes they could not afford then appeal for debt relief? Rational people became frightened when they heard the head banker in the United States propose massive debt forgiveness as they realized this meant the entire banking system was in peril. The implications of this proposal were lost on the typical homedebtor who only saw how they might benefit from it. Debt forgiveness was the ultimate fantasy of every homedebtor. They could be relieved of their financial burdens and get to keep their houses and their lifestyles. It did not matter to the financially troubled that the proposal made no sense and had no possibility of happening, the thought of it would motivate them to hang on a little longer to see if maybe they could hit the jackpot.
It is difficult not to become cynical about all the various bailout programs, and the proposals outlined were not the only ones discussed in the public forum. There was a steady drumbeat of public plans and announcements that were never substantial, and their only purpose seemed to be to foster denial among those who needed it.
At the time of this writing, no substantive bailout program has been implemented, and that is a good thing. There is no possible bailout program without the commensurate moral hazards and unfair benefits they would contain. The best course of action would be to ease the transition of people from overextended homeowner to renter and not to attempt to manipulate the financial markets for the benefit of a few. There is nothing that can be done to prevent of the collapse of a financial bubble. The solution lies in easing the pain of their deflation and in preventing them from inflating in the future.
We have added history to the perspective above, but nothing really has changed. The list of bailout programs grew significantly, and each one was as big a failure as the last. In 2012, the banks finally achieved their threshold of success as the false hope bailout programs finally got enough borrowers into loan modification programs to dry up the foreclosures and MLS inventory. A 50% reduction in inventory caused prices to bottom and move up dramatically in certain markets.
In the end, there are still millions of people clinging to properties they can’t afford. Perhaps some will survive through a loan modification and remain current on their mortgages through to an equity sale at a time of their own choosing. Those people will be the exceptions rather than the rule. Most will sell in a distressed or semi-distressed condition caused by the burden of their monthly housing costs.
[idx-listing mlsnumber=”OC13092946″ showpricehistory=”true”]
$450,000 …….. Asking Price
$500,000 ………. Purchase Price
10/6/2008 ………. Purchase Date
($50,000) ………. Gross Gain (Loss)
($36,000) ………… Commissions and Costs at 8%
($86,000) ………. Net Gain (Loss)
-10.0% ………. Gross Percent Change
-17.2% ………. Net Percent Change
-2.3% ………… Annual Appreciation
Cost of Home Ownership
$450,000 …….. Asking Price
$15,750 ………… 3.5% Down FHA Financing
3.77% …………. Mortgage Interest Rate
30 ……………… Number of Years
$434,250 …….. Mortgage
$115,676 ………. Income Requirement
$2,016 ………… Monthly Mortgage Payment
$390 ………… Property Tax at 1.04%
$0 ………… Mello Roos & Special Taxes
$94 ………… Homeowners Insurance at 0.25%
$489 ………… Private Mortgage Insurance
$0 ………… Homeowners Association Fees
$2,988 ………. Monthly Cash Outlays
($456) ………. Tax Savings
($652) ………. Principal Amortization
$20 ………….. Opportunity Cost of Down Payment
$133 ………….. Maintenance and Replacement Reserves
$2,033 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,000 ………… Furnishing and Move-In Costs at 1% + $1,500
$6,000 ………… Closing Costs at 1% + $1,500
$4,343 ………… Interest Points at 1%
$15,750 ………… Down Payment
$32,093 ………. Total Cash Costs
$31,100 ………. Emergency Cash Reserves
$63,193 ………. Total Savings Needed