Monday, October 11, 2010

The Dynamics of American Ingenuity


                                                                                                                                                                                                                     Take This National Mortgage Crisis Test

Here's a test.
After reading this article and its second part companion, take this test.
How would this plan affect:

home values today  _____     (Greatly improved?)
current mortgage delinquencies  _____ (Greatly reduced?)
most middle-class homeowners ______  (Greatly better off?)
existing legal status of mortgages_______  (Solved 99% ?)
the foreclosure problem _______   (Greatly reduced?)
economic stimulus________   (Greatly enhanced?)
the federal deficit_________   (Much, much  better?)
the general economy_______ (Significantly better?)
the threat of deflation_______  (Greatly reduced?)
our monetary base ________  (Would  this stop A trillion dollar loss from Fannie et al?)
                                                                                          
A certain dialogue making its way in discussions today is:
FDR’s spending and programs didn’t work. He didn’t pull us out of the economic morass. It took WW II to get our economy back on track.”

The reality is that FDR did not go far enough. Yes, the $1 trillion deficit built up from WW II ($10 trillion in today’s dollars) got our economy going. How? WW II G.I’s got their pay checks 3 meals and a “bed”, so they saved their pay. Back home, women and men hit the workforce, riveting, sewing, driving steam shovels. It was full employment with spouses working, and that $1 trillion went to the pay checks of the people. After the war, the  people spent their money, bought cars and homes, and it was a “bottoms up”  trickle effect economic rehabilitation. 
Different issues today? It was a crisis (war) that pushed us into action back then. Maybe its a different crisis, but we need to move into action again, not sit back.

We have the basis to do this, and more than just the basis. We are neck deep in the basis already. We are the (proud?) owners of Fannie Mae's and Freddie Mac's obligations to all the mortgage poolholders who own the Fannie Mae and Freddie Mac pass-through mortgage pools. We the people currently have 100% default (creditor) risk on virtually 100% of the residential mortgages in the U.S. (Sure, take out the sub-prime loans still remaining which are now minimal, and jumbos, and then its 95% of virtually all residential mortgages in the U.S.) By the way, we (you and I) by virtue of our government, also have guaranteed all principal and interest on the FHA and VA loans, none of which we own. Those are 100% sold into AAA+ mortgage pools also. We just have the obligation to make sure investors take no loss.

We need to first understand the position that we are in. We cannot solve anything unless we truly appreciate our current position as it exists right now. Currently, without doubt, we the people right now guarantee all the Fannie Mae, Freddie Mac, FHA , VA, and residential USDA (rural) home loans in the U.S.
Thats's why all these mortgage pools (all of them, delinquent or otherwise) trade currently today
as AAA+ rated securities.  The banks do not own this paper. It is not the banks who will suffer from property loss, foreclosure halts, etc. The banks are purely servicers of the loans with no ownership interest in them.  That is a common fact among bankers, Wall Street, and anybody making $100,000 or more in the financial industries. Banks basically own very, very few mortgages. They act as servicers  (collect payments for Fannie Mae, etc.) for most of the mortgages. The banks actually are making money as servicers from the foreclosures because it raises their servicing fees to manage the foreclosure process. This is a fee bonanza to the banks.


Almost all these mortgages have been sold in their entirety to a wide variety of investors who rely upon us, the United States of America, to make good on their investment. We, as a country, have guaranteed the performance on all these mortgages. 

But, we do not own them. We guarantee them so that the owners (pensions, life companies, hedge funds, etc) do not have any default risk. We have the complete 100% downside, shared by no one. We have no upside, since we get none of the interest or principal return for our guarantee.


At this moment we (you and I) have all the risk on the exisitng mortgages, but we own none of the mortgages.

If we own 100% of the risk, but NONE of the reward, then lets keep the same exact risk posture but get interest on that risk by re-financing all these mortgages. Lets' refinance and keep the ownership on all the new mortgages from the refinance. We will pay off the old current mortgages with a refinance to a new mortgage only on all existing Fannie, Freddie, FHA, VA, and Rural USDA mortgage borrowers, and only for what they currently owe (which is by virtue of our country's guarantee, what you and I are currently on the hook for) at 3.25% interest. We already have the risk on all these old mortgages, causing us (you and me) massive losses each time a foreclosed home sells for less than what is owed. You and I pay for that difference right now. When Fannie Mae and Freddie Mac need an extra $200 billion every 4 to 6 months, that's not just to make payroll. That is from paying those losses to the mortgage poolholders at each sale of a foreclosed property . Whose money is that? (Don't say "government money", unless you are somehow exempt from sales, property and income taxes, to name a few, and figure that this national debt is somebody else's debt.) Same with a loss on an FHA or VA foreclosure, if government money is  being lost, then that's your checkbook and mine that just got opened.  Each and every current foreclosure, its your financial loss and my financial loss. Don't you just kinda want to stop this financial hemorraging?
It would be our risk on the  new mortgages, so let's own the reward too. Let’s allow ourselves the capitalistic upside for the people. At, say, 3.25% interest,  we would earn $325 billion per year, with no further risk (we already have that), and by virtue of the Federal Reserve funding/ owning the new re-financed loans. The Federal Reserve pays no interest to fund these. Our risk position would actually improve dramatically by virtue of the fact that at a 3.25% fixed rate mortgage, significantly less defaults will occur. (see second article)

From history, FDR’s capital influx was not enough: it took $1 trillion back then.  $10 trillion today. In funding these new mortgages, the Federal Reserve position would pay down naturally as interest, principal and early payoffs. The average life of a mortgage is less than ten years on thirty year fixed rate loans. This one-time effort would pay out naturally in approximately ten years. Staving off deflation could be a significant boon to Americans.


Our monetary base and the threat of creating inflation is not an issue here. You say, oh yeah? Consider all of this: For FDR , his spending wasn't enough, it took a $1 trillion surge during WW II to get us out of the deflationary mess. What is that in today's dollars? Keeping from replicating Japan's last 15 years of deflation is a real challenge, not imaginary. This $10 Trillion is actually secured by arguably great collateral! Perfected new first liens on residential homes in the U.S.! (And we own that  risk currently anyway!) And, this monetary increase actually gets returned down to zero during natural payments over the next 10 years! It withdraws itself from the system as the mortgage payments and pre-payments occur! Therefore, it gives us a kick in the right direction now, and then goes away naturally.
If you keep up with Paul McCulley,  Hyman Minsky's theories, and Bernanke's past speeches about Japan in 2002, we need  a small dose of inflation.
Does this destroy our financial institutions geared toward the mortgage industry? NO. This is for refinancing only, one time only. The home purchase market for mortgages remains unaffected. The mortgage business remains intact. It just gets all those  "old" flawed mortgage documents on the existing mortgages flushed down the toilet, because as everyone refinances, hopefully it won't be on flawed robo-docs. So, actually, this helps the mortgage entities replace all of the flawed paper.

We also have a great vehicle to make this happen. Our FHA system (unlike Fannie Mae and Freddie Mac which paid hundreds of millions of bonuses to their executives over many years) paid no bonuses and yet FHA has not asked for one dime of taxpayer money in the last 40 years. FHA would always finance those not qualifying for the Fannie Mae program
 with lower credit scores or lower down payments such as FHA’s 3 ½ % down payment requirement. But, it has stayed solvent from the fees it charges without any government funding.


The real plus, plus, plus (all positive) and the simplicity of the plan is in the following article:




Part 2
Key Points of Resolving the U. S. housing crisis
through our management of the mortgage GSE’s


There is a national consensus that our government should act in a prudent manner to lower unemployment from over 9%, deal effectively with the foreclosure crisis, potentially cut taxes, and not raise our national deficit. The lemons that have been handed to our congressional leaders, in the form of the GSE’s contingent liabilities, the default levels on residential properties, and the stalled housing construction industry can effectively be turned into lemonade without much in “new” strategies.  The current programs work very effectively, but need to be expanded in ease, scale, and breadth.
Topic 1
First, let’s narrow the scope. Let’s talk about only those mortgages (generally $417,000 or less, except in high-cost areas) which are insured or guaranteed by Fannie Mae, Freddie Mac, FHA, or VA. This accounts for about 99.9% of all fixed rate mortgages in the U.S. 
This discussion leaves out sub-prime mortgages and those mortgages that are privately pooled as Wall Street securities for two reasons:
1. This program as outlined is to fix our direct U.S. government exposure
2. The enactment of this program will cause “all ships” , including sub-prime and private pool collateral to  rise in value.
All mortgages which are “Fannie Mae, Freddie Mac, FHA or VA” loans are either guaranteed or insured by Fannie Mae, Freddie Mac, FHA or VA.  This means in essence that we, the people,  have insured or guaranteed these loans. There is no upside on these loans of Fannie Mae, Freddie Mac, FHA , VA or we, the people. We do not own them and their nice interest rate returns. We only guarantee or insure the investors/owners so that they do not lose money. Therefore, Fannie Mae , Freddie Mac, FHA, VA and we the people have no upside on the mortgage pool as a whole, only the downside of guaranteeing the principal if they should default.
In short, currently we have no upside, all downside.
Topic 2
The investors in these mortgages, be it pensions, banks, life companies, hedge funds, individuals, foreign nations, etc have always known in the world of fixed income securities, that these higher yields on basically government guaranteed investments are higher yields for one major reason. That reason is pre-payment risk. These investors are always discussing pre-payment speeds and estimated length to maturity, etc because they determine their yields to maturity based on pre-payment speeds.
The art of the bargain is that any homeowner on these types of loans have no pre-payment penalty, and can so choose to refinance any time that a good refinance offer comes along.
Therefore, the give and take between homeowners and investors is that the investor gets a significantly higher yield for not much more risk, all because of the possibility that the investor could get their remaining principal back in the form of a pre-payment at any time.
Therefore, pre-paying mortgages is not a legal, ethical or moral issue.
Re-financing is expected in times of low interest rates, except that now we have the unusual major decline of value of the underlying homes stopping this process.
Topic 3
There is a mortgage program that has allowed for a quick refinance successfully for more than the last 25 years. In fact, this month alone, it will have billions of dollars of these refinances funded. It is a mainstay, every day occurrence that has been occurring every time rates go down for the last 25 years or more. This program is the FHA to FHA Streamline refinance. For decades, this program allows the current balance, plus some costs, to be refinanced to a lower rate without any money going back to the homeowner.   Amazingly, this program does not require a new appraisal even if the home is upside down in value! Also, the program does not require the current borrower to even  be working! There is no proof of income needed. Why? Because if the payment on , say, a $100,000 mortgage were being made at 6.50%, then FHA’s risk is reduced when the mortgage rate is lowered to 5.50%.
The borrower was making their payments at the higher rate. Now FHA is guaranteeing a loan where the same borrower has lower housing costs.
If it has been good enough for FHA (and VA has a decades-old identical program), then why not Fannie Mae and Freddie Mac?
Topic 4
A program to take the current loan balances on our risk exposure (Fannie Mae, Freddie Mac, FHA and VA loans) , and refinance them to a lower fixed rate should be more open and easier to use during these unusual times. Fast, efficient, and built-in factors that defy abuse.
Topic 5
The program should not cost the federal government or taxpayer one dime, but actually take the federal government and taxpayer out of the way of current default risk on the higher rate portfolios of all these mortgage agencies. This program would certainly help the vast, vast majority of homeowners, however its primary target is to cure the potential default on the mortgage portfolio.  This end result would occur by making the financing terms very desirable. Borrowers will not want to walk away from such terms.
Topic 6
Reducing the average fixed mortgage rate on these selected mortgages by means of a complete refinance from a national average of 6.25% to 3.25% will not cost the government any money. Nor will it raise the federal deficit.
But, think on this next point very hard. Reducing mortgage rates through the tried and true method of refinance by an average of 3% nationally would be the equivalent of the biggest recession fighting tax reduction in history! If families reduced their average $100,000 mortgage from 6.25% to 3.25%, that would add cash flow to that family of almost $3,000 per year, year after year after year!
That savings to almost every homeowner in America acts just like a permanent tax reduction, even though its not, and does not take away any tax revenues to the treasury. It does not raise the U.S. deficit.  “Stimulus money” without a dime being spent.
Topic 7
What happens when approximately $10 trillion of mortgages refinance to a rate that is lower by about 3% on average?
For one thing, $300 Billion of interest deductions on tax returns go away. Higher taxes are paid to the federal government, but not higher tax rates to the taxpayers. This event of decreased deductions on tax returns (higher tax revenues to the Treasury) is not a one-time event.  In political lingo, take this re-set to lower rates onto the budget charts for the next ten years and it is a $3 trillion reduction of tax deductions.
You could say that this program goes in the right direction of reducing the federal deficit  in this manner.
But, I think the greater reduction of the future deficits is that Fannie Mae and Freddie Mac would not be costing us an estimated $1 Trillion from defaulted loans it guarantees, an estimated future loss that gets bantered about on occasion.
Topic 8
Some form of mortgage guarantee fee, such as .50% per year, should be charged by
HUD on this program.
Topic 9
It sure does help resolve the issue, “What do we do about Fannie Mae and Freddie Mac?”
For the most part, if we do this, then they don’t have many loans left on their guarantees  to speak of. The Fannie Mae/Freddie Mac problem: solved.
However, to achieve this result (and solve the “What do we do with Fannie Mae and Freddie Mac?” issue), we must have some leniency without creating an iota of more risk.
 What I mean is this, if someone currently owes back taxes and defaults, those back taxes are already the absolute full exposure  to Fannie Mae or Freddie Mac. If they don’t default, then they are not the expense of Fannie Mae or Freddie Mac. At 3.25 %, they are more likely not to default. We need to roll in back taxes if they are owed, but we must now escrow  for taxes and insurance on this program for all loans.
Topic 10
This is a net zero game for the most part. $10 trillion of mortgages at 6.25% will be paid off, with the huge job of re-investing all that cash. Basically, the balloon has popped and these mortgages are re-setting to rates of today’s reality, but quicker in this program in order to make the process less painful.
At the same time , $10 trillion of new Ginnie Maes are going to come to market.
There may be a requirement that the Federal Reserve owns that paper if there are no buyers of 3% GNMA’s at par. If that is the case, then I am greatly convinced that we own less risk than when we were guaranteeing $10 trillion at the higher rate portfolio.
Topic 11
The monthly payment on these homes will be lower than any alternative of similar housing. The cash-flow analysis will convince homeowners that it is cheaper to stay with an “underwater” home/mortgage than alternative housing payments.
In essence, we would hope to stabilize the existing housing market.
Topic 12
Here’s the details from my point of view.
 Even though we typically value residential properties by the “comparative sales” approach, in reality, property is valued by the homeowners and investors by virtue of cash-flow.  (Most people would pay more for a home if the fixed payment for thirty years is very low. Its cash-flow, get it?) Low housing payments create value and desirability to own.
At a 3.25 % fixed rate, it is (for the vast, vast majority) cheaper of a house payment than renting. Even if you are under water, why would you move to a higher monthly payment?
We need an act of Congress:
1) that every residential 1-4 family mortgage insured or guaranteed by Fannie Mae, Freddie Mac, FHA, VA, or USDA shall have the immediate ability to re-finance at
their current balance plus accrued interest, plus $1,500 total costs and plus escrows, plus back taxes  rolled in. No appraisal needed, but property must be inhabited by owner or renter, but not vacant. Proof must be determined. (We are already on the hook for insuring/guaranteeing these loans, therefore let’s reduce our exposure by making it highly desirable to homeowners to maintain ownership and paying their mortgage debt.)
2) There is no qualifying required.
3)The interest rate will be 3.25% fixed for 30 years, for homes owned by or before December 31, 2011, for “no cash out” re-finances only (not available at time of purchase).
4) a federal contract bid for 1000 institutions with current FHA/VA servicing  will conduct the re-financing. It will probably be necessary to invoke a sequential order, such as borrowers with last names beginning with A thru D only for first month, etc.
5) Holders of second or third mortgages from federally-insured institutions would need to be federally required by the Federal Reserve to subordinate to the new first mortgage.  Other second mortgages must choose whether to subordinate or not. Usually they already do permit a subordination when its a "no cash out" re-finance, so that should not be any big issue.
6) It is mandatory that payoff letters on the existing current mortgages have the positive or negative escrows netted into the payoff figures, rather than providing a separate return of escrows to the borrower after re-finance in the form of a check.
7) These new mortgages will be bundled into approximate $100 million bundles of mbs securities like a typical gnma and the loan type will be 203-G with FHA insuring the loan, and GNMA guaranteeing payment flow.
8) These bundles will be sold to the Federal  Reserve at par. 
9) This last comment is redundant, however, it may be important to repeat.  This program’s main intent is to greatly reduce the risk of default and the possibility of the United States of America to take considerable loss on the loans that it either has directly (FHA and VA) or indirectly guaranteed.  All $10 trillion of the Fannie Mae, Freddie Mac, FHA , VA and USDA residential 1-4 family home loans is under major pressure from the decline in home values and the snowballing foreclosure effects. We cannot afford to sit and watch when we have an opportunity to achieve major positive results from a program such as this.  It is a tried and true method by the experience of the FHA streamline refinance program, which program  needs to be expanded and modified.
I hope that this write-up can spur some positive creative thought.

Jim

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