by Brian Brady
Commercial Real Estate Finance Expert
Structured Debt and Equity
Licensed Real Estate Broker in AL, CA, and FL
The best thing about being suspicious of politicians is that you learn how they think. I actually think this is a GOOD idea. Libertarians will hate it but I think this bill has merit.
Remember my Bailout Post, in March?
I have a little idea about how to save the American real estate market.
Let’s start with the premise that lenders are taking 20-30% hits on short sales. Then, let’s have the US Treasury loan 30% of the balance, of the aggregate debt, to homeowners whom request it, in order to pay down the first mortgage (or second mortgage). If I have $200,000, in aggregate liens against the property, the US Treasury will lend me $60,000, to pay down those aggregate liens, to $140,000. This reduces the lenders exposure.
What type of loan will the Treasury make to homeowners?
The term can be for the lesser of:
1- the remaining term of the first mortgage
2- 65 less the age of the primary borrower.
The interest rate can be the corresponding term treasury rate, plus .5% (for administrative costs). Maybe we can use some of that “yield spread” to coerce a few mortgage brokers to “originate” this government debt (okay, that was completely self-serving). For a 42 year old, with a 27 year term on his first mortgage, the term of this new government loan (in second position) would be 23 years (65-42=23). If a 23 year treasury bond yields 4.1%, than the note rate for the new loan will be 4.6%.
Well, maybe the Members of Congress are reading Bloodhound Blog; it wouldn’t be the first time that happened. Bryant Tutas reports on HR 5830, on Active Rain:
From what I’ve read, and understand, this Bill will give distressed Homeowners an opportunity to refinance with FHA at 90% of value IF their current Lender will agree to a short payment.
One of the caveats is that the FHA will own a piece of the action. When the borrower sells they will either pay, from any profits, a 3% exit fee (a percentage of the original loan amount) to the FHA or a declining percentage of any net proceeds, attributed to appreciation, (from 100% in the first year to 50% in year 4 or after) whichever is larger.
I guess this FHA participation, in the appreciation, is to prevent speculators and second homeowners from participating. This Bill is designed specifically to keep folks in their homes
I DO like this bill. The current market is crazy. People are walking away from homes because they “bought at the top”. While bubble bloggers will say, “That’s what the banks get for being stupid”, that attitude is quite dangerous. A whole generation of home buyers is breaking the moral code of paying back what you borrow and that IS scary. It’s scary because it sends a message to banks that FICO scores are not an accurate measure of “character”. If banks can’t determine the character of the borrower, they’ll default to asset-based lending and require hefty down payments, like they’re doing today.
This isn’t a bad bill. Lenders are getting clobbered through foreclosures. If we can get the borrowers to sit still, we may arrest this decline. Philosophically, it stinks. Pragmatically, it’s brilliant. Love ’em or hate ’em, we gotta live with the banks. We gotta get them to start lending.
Todd Carpenter says:
..”A whole generation of home buyers is breaking the moral code of paying back what you borrow and that IS scary.”
Please don’t mistake the actions of a VERY FEW for an entire generation. And you’re right, I hate the bill.
May 3, 2008 — 10:29 pm
Richard Dale-Mesaros says:
I echo Todd’s comments….
Generationally speaking, I’d love to see wealth-building and financial awareness brought into the latter years of high school – perhaps this is something we can aspire to. Mind you, if we’re going to do that, then we should of course include negotiating, networking, ethics and integrity and all those other things so crucial to life that rarely get a mention in school. Sure wish my chemistry classes had been replaced with stuff from Robert Kiyosaki, Guy Kawasaki and Seth Godin!!!
Yours with boundless enthusiasm,
Richard 🙂
Chief Deal Weaver
http://www.BlackWidowNetwork.com
May 4, 2008 — 7:02 am
Bob Wilson says:
>It’s scary because it sends a message to banks that FICO scores are not an accurate measure of “character”.
FICO scores measure the propensity to pay, not the ability to pay. There are lots of people with character who have suffered loss of income. I have several short sale clients with 700+ FICO scores who can’t pay and they are distraught over not paying – almost as much as they are about the untenable situation they are facing.
May 4, 2008 — 7:12 am
David Richey says:
I think it sounds like a good idea, but I still haven’t heard that we are recognizing that most of this was caused by people losing their jobs and NOT being able to pay their mortgage. And we are still in denial that the entire mess is still not being dealt with by certain politicians that keep everyone on edge by hyping the “security threat” and taking our attention off the worst president (and his parties policies) in our countrys history. We have had 7.5 years of ruinous devisive political machinations and incompetent leadership. Thats what has got us to this point. We are all suffering damage while Bush fumbles through his last days in office.
May 4, 2008 — 9:03 am
David Shafer says:
FICO scores still do a great job of predicting future behavior. The real issue is the high LTV loans that allowed borrowers to get into a home without any of their own “skin.” If you have a person who is looking at being upside down, maybe considerably upside down and they had no money into the home, then you have a conflict between the “moral code” (which was a one-sided moral code with the lenders) and rational financial thought. Bankruptcy/Foreclosure is not the end of the world and those laws are there to ensure that. Walking away from a untenable situation is in my opinion the morally and financially correct situation. Tell me what the history has been when a person gets sick or loses a job and needs a temporary break from the lenders. Where was their moral code???
May 4, 2008 — 9:10 am
Bob Wilson says:
OK, I have read the bill and a few summaries and at first glance I like this bill. It wont solve every problem, but it is the best idea I have seen yet. Neighbors may not like the fact that the guy across the street got a short refi, but every distressed sale that doesn’t hit their market reduces the collateral damage.
May 4, 2008 — 9:11 am
David Richey says:
Dave, I like your question “where was their moral code”!
In the past when someone had a legitimate mortgage problem the lenders were very unsympathetic in their actions (their PR efforts to the contrary). Now when they are trying to get out the message of don’t walk..we will work with you..no one believes them.
Now they are learning what goes around….
May 4, 2008 — 9:51 am
Sean Purcell says:
que bono
May 4, 2008 — 10:15 am
Todd Carpenter says:
“que bono”
The Federal Government. That’s why I hate it. There’s half a billion dollars worth of appropriations in that bill and it’s barely out of committee. Wait until it goes through markups in the House. Then wait until it goes to the Senate. This will be a billion dollar Farm-Bill-wanna-be in no time.
May 4, 2008 — 11:09 am
Brian Brady says:
“que bono”
ad majorem popularem
May 4, 2008 — 11:18 am
Brian Brady says:
“ad majorem popularem”
case may be incorrect
May 4, 2008 — 11:32 am
Robert Kerr says:
Brian, it seems to me that you’ve abandoned Adam Smith, libertarianism, free markets, government nonintervention and even the importance of periodic recessions and moral hazard to a healthy, sustainable economy.
Am I wrong?
May 4, 2008 — 2:19 pm
Brian Brady says:
“Am I wrong?”
I have, Robert. I’m more in line with Bernanke, now; deflation could be very dangerous to the long-term health of the economy. In my original post I wanted to allow the loans to be collateralized by future Income from SSI.
The moral hazard I fear is the willingness of home buyers to walk away from a mortgage because they don’t like the fact that prices dropped. I fear that banks will start pricing the “walk away” factor into loans, and severely pull back.
The “lessons” we’re learning is that a generation of home buyers are redefining morality for the worse- that’s scary to me
May 4, 2008 — 3:01 pm
Michael Cook says:
I think the moral argument is silly here. The reason people sign contracts and there are so many provisions in contracts is to take “moral” out of it. A loan is strictly a business deal. I pledge some equity and a home and you pledge a mortgage. If I dont pay, you get the house. That is the deal. People who walk away are not dead beats, they are just following the contract.
I have yet to see a “moral” bank forgive a loan for any reason until very recently. If walking aways makes good business sense, then homeowners should do it with a clear mind. A home is an investment after all and who here would double down on a stock that has dropped 20% with no prospects of appreciating again? Perhaps I am too young to have an old fashioned sense of morality, but I work for a bank and I know first hand its all business.
May 4, 2008 — 4:35 pm
Brian Brady says:
“If I dont pay, you get the house. That is the deal. People who walk away are not dead beats, they are just following the contract”
This is what I’m talking about. Michael, you also personally guarantee the note with your signature. The bank expects you to pay that loan back because you live there. In fact, they’re “banking” on the compunction that comes from NOT honoring a debt. Ask Lewis Ranieri how valuable that compunction is- he sold Wall Street on it.
“I have yet to see a “moral” bank forgive a loan for any reason until very recently.”
They did in the 80s and 90s.
“If walking aways makes good business sense, then homeowners should do it with a clear mind. A home is an investment after all and who here would double down on a stock that has dropped 20% with no prospects of appreciating again?”
I don’t mean to pick on you Michael but you’re making my point for me.
“Perhaps I am too young to have an old fashioned sense of morality, but I work for a bank and I know first hand its all business.”
It’s not old-fashioned, Michael, it’s uniquely American. There was something sacrosant about the roof over our head. Families would do ANYTHING to get and keep that roof and that was priced into the market. We priced these loans based upon that principle and the principle is not held by the first time home buyers of today. They don’t view home ownership as a long-term investment and that IS a problem. They lack the patience required to produce real wealth.
If the long held social stigma of foreclosure is removed, loan programs will be priced much worse than they were priced for the last three decades. I think this bill helps to dissuade this new, atypical behavior exhibited by the newer home buyers.
May 4, 2008 — 6:15 pm
Brian Brady says:
Michael,
Don’t take my comments about “uniquely American” to suggest that anyone who believes differently is somehow “un-American”; that’s not the case.
Trends in borrowing behavior evolve with social mores. This bill could very well reinforce the American tradition of pride of ownership.
May 4, 2008 — 6:27 pm
Brian Brady says:
Michael,
Have you read “Liar’s Poker”? I think you’d get a kick out of it.
May 4, 2008 — 6:30 pm
Bob Wilson says:
Banks forgive loans only when it is in their best interest. It is a business decision, pure and simple.
>you also personally guarantee the note with your signature.
The personal guarantee counts for nothing to the bank without the collateral.
This won’t be the farm bill if they plan on seeing this pass this year.
May 5, 2008 — 6:33 am
David Shafer says:
In historical terms how does the foreclosure rate for conforming loans compare? This should tell you all you need to know about the lending business. Take out sub-prime, option arms and alt-a and you still have a forclosure rate inside the historical range *(although it is threatening to break above the historical range). So what has the lending community done? Well sub-prime is dead, alt-a is severely curtailed, and option arms are even more costly. 100% loans are nearly impossible to find, leaving FHA 97% the best deal for those with little down payment. Of course FHA has gone into the red for the first time in its existence. If people put money into the deal say 10% they are much less likely to walk-a-way, doesn’t the data say this????
And who should pay the price for the underwriting decisions that allowed folks to buy houses with no or little money down, no reserves, and marginal at best credit scores?
May 5, 2008 — 7:20 am
David Richey says:
Right on Dave! And while we are at it ..who benifitted from the huge number of homes sold that enabled the sellers to buy up and created a great deal of wealth for a lot of people. We wanted bragging rights for having the most people involved in home ownership in history. Everything has its price … we made a decision to go for it (historic highs in home ownership) and now because of high job losses and enduring unemployment we now have record foreclosures.
We could have had a much easier time recovering from these problems had we not followed the wrong headed economic policies we followed over the last 7.5 years.
Instead of tax cuts for the wealthy (that did not create jobs) we could have stimulated the savings interest rate and gradually required larger downpayments. But this would have required an intelligent plan from politicians who had long term vision and a sense of how to make this country continue to grow. Instead we got a cynical combination of no gun control and an attempt to break down separation of church and state. Now we pay for our collective stupidity!
May 5, 2008 — 7:49 am
Sean Purcell says:
Can’t decide which is more inane: Brian’s abandonment of the free market for some type of “moral compass” which does not exist in a laisez faire economy or David Richey’s attempts to lay all problems at the feet of an administration he does not like.
Brian: morality is not a component of a free market, nor should it be. I ask you: whose morality shall we follow? What religious ethos shall dictate the direction of our pluralist nation? Morals are individual, ethics are national. There is no ethical reason not to give back the collateral for an investment you no longer find tenable. Michael Cook’s comments were right on here. The only thing I see the banks doing is pricing a down payment back into the process. Investors (if not banks) work on a very black and white ledger. If the majority of foreclosures are because people are upside down then that is what they will stop allowing. (David Shafer was dead on here.)
David Richey: come on. You will have to do better than this on BHB. Tax cuts that benefit the wealthy and gun control? Tax cuts are simply a return of money confiscated by a bankrupt system and money returned to “the wealthy” impacts the economy stunningly, as evidenced by the growth every time it has happened. (And gun control means I hit what I aim at…)
ad majorem popularem?
Brian, this sounds a lot like “the good of the many outweigh the good of the one”. That does not sound like the libertarian, free economist I have come to know and love. Are you becoming an old liberal or a shill for the banking industry?
May 5, 2008 — 10:11 am
David Richey says:
Sean, We have a laisez faire economy when the government steps in to bail out the stockholders of Bear Stearns? I bet they are really glad it didn’t apply to them. I think I see a bankrupt company and its owners “stunningly” recouping their massive losses (due to their own gross malfeasance). Talk about an unpatriotic move..rob the taxpayers to bail out Bear Stearns. Or did that money come from some other planet?
Yes, the tax cut really created a lot of jobs – NOT!
Yes Sean, impacted stunningly sure applies.
May 5, 2008 — 1:21 pm
Sean Purcell says:
David,
You are making my point for me. I no more support the bail out of Bear Stearns than I do Brian’s bail out of the banks. The point of laissez faire is to get government’s hands out of the pockets of people and business. Legislators are no match for the law of unintended consequences.
Tax cuts stimulate the economy. That has been shown time and time again. Liberals do not like it because people are allowed to spend their money on what they want instead of what big government thinks is best. That is a philosophical issue for another time.
May 5, 2008 — 2:21 pm
Brian Brady says:
“ad majorem popularem? Brian, this sounds a lot like “the good of the many outweigh the good of the one”.”
Screw up. I was trying to say for the betterment of all of the people. Summum bonum would have been the right phrase.
May 5, 2008 — 4:42 pm
Brian Brady says:
How’s the physiocrats’ meeting going here?
This bill has three voluntary components to it:
1- Banks would voluntarily take a 10% hit to principal.
2- Borrowers voluntarily offer up a 3% fee and a hefty pre-payment penalty (half to most of the property’s profit in the first few years)
3- HUD willingly insures the refinanced loan (under more strict underwriting guidelines).
People screamed when “program trading limits” were instituted after the crash of ’87 but it gave a volatile market time to think. When information flows freely, volatility follows because rumor, fear, and exuberance reign. In short, market participants aren’t ready to properly act upon the free flow of information.
This happened in the real estate market this decade. The information revolution finally reached residential real estate. This bill pauses things and gets people to think clearly about what they’re doing.
Forget morality. Call this an amoral observation. Borrower behavior is changing against the banks and it leaves us with two incentives:
1- Get borrowers to realize that there are economic cycles and walking away from debt has negative consequences.
2- Accept the change in borrower behavior and price it into the new loans.
I prefer the former because I’ve seen the latter
May 5, 2008 — 5:04 pm
Todd Carpenter says:
What’s the Latin for “socializing the mortgage industry”?
May 5, 2008 — 5:04 pm
Brian Brady says:
“socializing the mortgage industry”?
Would you rather have Wall Street run scared? Fellas, we really don’t need to go backwards. Securitizing home loans led to affordable residential real estate financing. We reduced a borrower’s costs by half, in 15 years.
Come on, let’s be pragmatic here. It’s easy to be an 18th century French philosopher on the internet but borrowers have real problems today…real problems. Banks have major problems; we need to get these two to trust one another
I want to be part of the solution
May 5, 2008 — 5:09 pm
Greg Swann says:
> What’s the Latin for “socializing the mortgage industry”?
The Romans called it proscription.
May 5, 2008 — 5:13 pm
Brian Brady says:
I’m not following, Greg. Are you suggesting that the banks are plutocrats and need to be condemned as enemies of the state?
May 5, 2008 — 5:42 pm
Greg Swann says:
The power to tax is a function of the power to murder while calling theft and murder justice. Marcus Antonius was more honest than modern statesmen.
May 5, 2008 — 6:04 pm
David Shafer says:
Brian, why not let the market absorb all these homes instead of rewriting contracts and forcing outcomes?
Don’t you think the light will appear again? I mean we are already seeing Alt-A loans come back into the market (although with lower LTV requirements). Won’t it only be a matter of time before the pendulum swings back again??
May 5, 2008 — 6:10 pm
Brian Brady says:
“Marcus Antonius was more honest than modern statesmen”
He might not have fled to Greece had he the opportunity to restructure his debts. Antony was not a sober man; a chance to do the right thing may have straightened him out.
“Brian, why not let the market absorb all these homes instead of rewriting contracts and forcing outcomes?”
You’re all confusing my intent. Read my comment to Greg (above here) about Antony. This market allows for moral relativism with respect to debts; it is now “fashionable” to walk away from a debt under the banner of free market economics.
I want Wall Street to retain their high regard for the American homeowner rather than thinking him as one who lacks compunction. The consequences are worsened loan terms for all.
Michael Cook may be right; I might just be getting old.
May 5, 2008 — 7:09 pm
Sean Purcell says:
Brian,
You are correct, of course. We should maintain our integrity and our principles as much as possible. But when times become worse than they have ever been, we should compromise for the greater good. Viva la situacion etica.
Yesterday I met a man who was more hungry than he has ever been, so he stole some bread. Today I know a man who is more broke than he has ever been. He is going to lie to his client. Tomorrow, who knows? Maybe I shall meet a man who is more horny than he has ever been.
God bless the slippery slope.
May 5, 2008 — 7:39 pm
Sean Purcell says:
PS
I had to look up the word physiocrat. Very nice…
Not very apropos though. The concept of laissez faire has come a long way from the wealth of the state being derived by agriculture and labor to the Chicago School of market freedom causing the most good by definition.
May 5, 2008 — 7:47 pm
Brian Brady says:
“The concept of laissez faire has come a long way”
Agreed but it’s being practiced selectively, here. We suckled at the teat of the gov’t sponsored loan programs for years, now we cry “foul!” when they want to protect their investment.
I’m a pragmatist, a mercantilist, a plutocrat. Bubble bloggers will say I’m part of the REIC. Maybe I suffer from TB (true believer) disease. Now, it appears that I’m morally corrupt.
Call me what you will but this system worked for decades. The explosion of inexpensive capital provided for financial security for tens of millions of families who never would have had that chance. That “broken” system is in peril because of the selective practice of laissez-faire economics.
Fellas, I’m being honest here. If you were so darned pure, you never would have originated a conforming, HUD, or VA loan.
Which of you is without sin? Stones accepted.
May 5, 2008 — 8:06 pm
Smithers says:
Nothwithstanding the “more horny than he has ever been” comment, I have to agree with Sean on this thread. And certainly with Michael Cook (whom I wish would post more often).
Dave Shafer: “tax cuts” being bad presumes that the level of taxes being cut were appropriate to begin with. Even with these “cuts”, more than half of what I make goes to the government (fed, state, local). Why is that not enough for you? A rhetorical quesiton, I suppose, but should I encourage my children to f-off instead of working hard? Should they be mediocre and spend their lives complaining about those who work hard instead of swilling beer watching tv shows? Would that make you happy or make your life better?
Brian: Yes, yes, yes. But, this never-ending call to prop-up housing prices is killing us. In the long run, we would all be so much better off if the government stopped screwing with markets, including the “borrowing market”. That includes the sacred mortage interest deduction, and extends to bail outs of lenders and borrowers alike. So what if lenders will only lend based on asset value? Sounds perfect to me. Asset values will then (appropriately) fall back to where everyday folks [including all those people you say would “never have a chance”] can afford housing in the first place, without artifical props from the government. All the mortage brokers and realtors(R) will still do just fine, maybe better since people will leave you alone to go about your business.
(p.s., thanks for the post – and comments. Good stuff to get out there)
May 5, 2008 — 9:14 pm
Brian Brady says:
Smithers,
I’m down with the physiocrat philosophy but read the last paragraph. I’m not trying to prop up the markets, I’m trying to save the ideal that American homeowners aren’t willing deadbeats
May 5, 2008 — 9:57 pm
Greg Swann says:
> I’m trying to save the ideal that American homeowners aren’t willing deadbeats
An epistemological inversion. Good behavior doesn’t engender morality, morality engenders good behavior. If your complaint with American borrowers is moral, you’re getting to them decades too late. Plastering them with the veneer of compliance will not have caused them to have chosen though time consistently to have complied. Repealing the laws against theft will not make honorable men of thieves.
One of the long-term effects of true laissez nous faire Capitalism is the inculcation of the entrepreneurial morality. Government undermines that process in three ways: By making commerce unprofitable for marginal players by taxation. By forbidding many marginal commercial activities — not only do you need a useless license to sell real estate, but you have to pass a literacy test to braid hair. And by limiting what you can do with your money, should you somehow manage to make any. Higher on the food chain, we might “tsk, tsk,” but what seems to us to be morally obvious looks more like a sucker bet to marginal producers.
Why can’t you legislate people into a state of grace? Because legislation is always at war with free human will, the only possible source of grace.
As long as the answer to the disasters ensuing from past government manipulation of the economy is still more government manipulation of the economy, the manipulations will be more extreme and more frequent and the disasters more cataclysmic. They will always result in less, not more, individual morality, but you’re not so likely to notice this. In the long run, the capricious behavior of the governors and their armed minions will come to command most of your attention.
We have lived through all of this before, many, many times. With the ethanol famine upon us, this seems like a very good year to learn to do better.
May 5, 2008 — 10:22 pm
Robert D. Ashby says:
Ok, I will admit that I have not gone deep into the bill, but history shows that government intervention prolongs the pain and does little to truly assist in solving the dilemma. This bill, from my basic knowledge encourages stupidity, rather than solving the problem.
I know these days are strange in that people are just walking away, but can you blame them? There are no “real” penalties for doing so. In fact, many can make money by walking away and the government is not doing anything to prevent it. Instead they feel compelled to use bills to keep people in their homes (even if undeserved), failing to learn from their mistakes, all to justify their “everyone deserves to own a home” failed philosophy.
Obviously, I do not like the bill as it takes away the punishment for costly mistakes made by lenders and homeowners. Sometimes a good “spanking” is needed to correct the problem!!! If the government feels the need to step in, make it harder for homeowners to walk away.
May 6, 2008 — 11:12 am
Brian Brady says:
I’ve been thinking through this issue long and hard. I may need to pay attention to Bob Ashby’s comments. Perhaps, stiffer loan guidelines will be necessary. Foreclosures, defaults and BKs happen for various reasons and underwriters analyze them.
Lenders are risk pricing loans now so we may see this addressed in the near future. BofA flat refuses to lend to anyone with a BK, foreclosure, or default.
My biggest concern is that the actions of the (growing) few don’t blow the deal for the rest of us. I once said that failure is a costly by cogent instructor. I might rethink this issue. Excellent comments and discussion in here.
May 6, 2008 — 6:52 pm