This the final logical step of the housing bubble and the bailouts that followed. The banking losses have slowly been transferred to the taxpayers, then from them to the Federal Reserve. It’s been a long process and below is brief explanation the slow of transfer of losses to private banks all the way to the Federal Reserve with assistance the Federal Government over the course of five years. We need to review a little bit to see how exactly did we reach this point and why the Federal Reserve bailout(s) will occur.
A long crazy road
When the housing bubble first started to burst, the first entities to feel it were local banks or mortgage bankers like Downey Saving banks. They were stuck with bad loans they originated, but could not package into a Mortgage Backed Security (MBS). So, these banks were the first ones to feel losses. Just a little of ahead of the banks to feel the losses was the FDIC. The FDIC (tax payer) started to pay larger insurance claims on deposits at banks that failed. Well, the FDIC starting to merge troubled small banks with other small banks that were performing well and to slow down insurance payoffs. Well failures stared to hit larger and larger banks and the FDIC didn’t have resources bailout to these big banks. Remember the bank run at Indy Mac?
The big banks have larger resources, but only to delay to bankruptcy not stop bankruptcy. So, the Treasury Department stared merging big banks together, a strong bank with a weak bank. WaMu was purchased by JPMorgan Chase, BofA purchased Country-wide (still paying for it), and Well Fargo purchased Wachovia. To help sweeten the deal the Federal government created the TARP program that loaned money to these merged banks. It was the first real direct big government bailout of the banks since 1930′s and the S&L of the 1980′s. These loans were given to many banks and it made huge news in the day. What was less know is the change in the mark to market accounting that allow banks bypass the fair market value accounting and keep the book value of mortgage, even it was in default or underwater. Now banks could delay their loss reporting more importantly carry a bad asset on the books without reporting a loss. However, it wasn’t the biggest bailout, but it was the one that made most news.
As more of these home loans failed, there were two government sponsored enterprises called Freddie Mac and Fannie Mae that started also having losses. These agencies package loans called mortgage backed securities (MBS) from banks and sold them on the secondary market with federal guarantee on the MBS in case of major defaults. So many loans were defaulting and losses increasing, the federal government did a outright multi-hundred billion dollar take over of Fannie Mae and Freddie Mac. It purchased 79.9% in each agency and also did a cash infusion. This event slowly transferred losses from banks and mortgage banks to directly to taxpayers. In fact, their assets and liabilities should be booked on the US balances sheets because taxpayers are on the hook for losses . The federal government now owns the secondary mortgage market. The private mortgage industry never recovered as 90% of the mortgages passed through and guaranteed by these agencies. However, it’s not fair to just to single out the banks.
There have several Federal Acts gave a tax credit to push home sales or acts for tax forgiveness on the discharge of debt to individual tax payers. In 2010, if you purchased a home, the buyer was given tax credit as failed attempt to stop the housing bust. Once the tax credit expired, sales dropped off and it was only temporary up swing in home sales. In fact, if you purchased with a FHA loan the tax credit probably covered the downpayment for the loan. But the key handout was the The Mortgage Debt Relief Act of 2007 generally allows taxpayers to exclude income from the discharge of debt on their principal residence or debt reduced through mortgage restructuring, as well as mortgage debt forgiven in connection with a foreclosure This allowed homeowners to walk away from the loan without the forgiven debt taxed as income. However, the main the focus of the bailouts still occur in the mortgage market.
As the secondary market consolidated in Fannie Mae and Freddie it allows even more far reaching programs in conjunction with the Federal Reserve. The Federal Reserve set the cost of borrowing to zero percent interest rate. This sent mortgage rates down along with Certificate of Deposits rates. Fannie and Freddie then used this opportunity start a loan modification program and principal reduction program called HAMP and HARP respectively. The goal to is modify existing loans in fixed lower rates or even principal reductions some cases. These programs failed to get number of homeowners to into permanent modifications. There is one federal government that has been successful in generating new lending and up to 30% of the market share in new loans.
FHA was a program to assist first to time home buyers to purchase lower income homes. However, the scope of it’s business expanded to include middle to high middle income homes. In addition, buyers could be eligible for another FHA loan after 5 years of ownership in your current house. FHA was greatly expanded and it assumed the subprime mortgage role no longer present in the private mortgage industry. This new subprime role caused delinquencies to increase to 17% of all FHA loans. As of this writing will be an FHA bailout and further insurance premium increases in 2013.
But it was the Federal Reserve QE program that tied it altogether. The Fed prints money and then uses to purchase loans on the secondary market by Fannie, Freddie, and Ginnie Mae (FHA). The Fed has comes in with so much cash that it has pushed down the mortgage rates, which also encourages underwater borrowers (and borrowers with equity) to refinance in the HARP and HAMP programs. What has resulted is the Fed is now the investor 95% of new loans and the now the investor in refinanced loans, many of which are underwater. The Fed has taken over whole mortgage industry. Loans are originated by banks (using overnight loans with the Federal reserve); then they are package by Fannie, Freddie, and Ginnie all with federal guarantees; and then purchase in vast quantities in MBs by the Federal Reserve. These MBS are no longer owned by mutual funds, banks, insurance pools, or pension systems; its being transfer the Federal Reserve and it wants to own $4 trillion mortgages by end of 2013. Banks mortgage functions are now down to originate loans and then service the debt.
And now principal reduction
Now that a greater number of loan are owned by the Federal Reserve the easier the principal process since private banks won’t be included. The loans are owned by the Federal Reserve. The money that used to purchase loans was printed out of thin air. The loans were packaged by Fannie, Freddie, and Ginnie and have federal guarantees. There will be no tax money involved just the phoney fed money. This I think this will be order of events that will start the Federal Reserve bailout.
The federal government will push for principal reductions via the new FHFA head through a third round of the HAMP and HARP programs. When loanowner defaults on their loan or loan modification, the GSEs and FHA will cross check to see who is the investor of the loan. If it’s the Federal Reserve you will get a principal reduction. There wouldn’t be a payout of the guarantee fee, somehow it will be waved, then again why pay guarantee fee when investor is basically yourself. Word will get out, maybe even promoted by FHFA, and every loanowner that has negative equity will default on their loan to get a principal reduction. Too far fetch…President Obama wanted to use FHA to modify non Freddie and Fannie loans that were underwater. That would put almost negative equity loans under the federal guarantee. This is the just the short term affects, the long term affect are much worse.
The long term affects is that it kills the idea of personal responsibility and opens the Pandora box of moral hazard to the nth degree. You have huge swing in home prices in every business cycle and homeowners defaulting every time there is drop in home values. This type of mortgage industry will require constant federal bailouts, loan modifications, and all the other associated programs. You fact, you can’t have private mortgage industry that operates like a consumer debt industry without having consumer debt interest rates. The purpose of the all this intervention is too keep rates low and home values high to bailout the banks. This will ensure for foreseeable future there won’t be a private mortgage industry.
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Something that pop on the news yesterday about principal reductions.
RBS: Housing policy shift to reinforce refinancings
Posted by kpanchuk on 12/14/12 at 8:28am
Investors looking into the 2013 market are likely to see housing policy shift to a focus on bolstering refinancing activity and “a tailored principal forgiveness program,” said Sarah Hu, an analyst with the Royal Bank of Scotland.
This shift will greatly impact the prepayment landscape in some cases, with Hu estimating that Ed DeMarco’s days at the Federal Housing Finance Agency (FHFA) are likely to be numbered.
She added, “mortgage rates will likely be dependent on the duration of QE3, which in turn will have a profound impact on prepayments.”
Hu sees the the housing market in a recovery phase, but not in a boom phase.
“While rising home values will be a welcome relief to our economy, many borrowers will remain underwater on their mortgages,” Hu pointed out. “Nonetheless, involuntary prepayments could decline with an improving housing market. Moreover, rising g-fees and wider primary-secondary spreads will continue to increase borrowing costs, hindering refinance ability.”
Hu added that higher coupons will face more potential headwinds from changing housing policies, while loan balance paper is less sensitive to HARP adjustments. To be sure, the Mortgage Bankers Association warned in October it expects to see $1.3 trillion in mortgage originations during 2013. This is down more than 25% from its revised estimation of $1.7 trillion in 2012.
Refinances are expected to fall to $785 billion in 2013, down from a revised estimate of $1.2 trillion in 2012.
“The prepayments of streamlined FHA loans resemble that of VA loans for pre-June 2009 originations. Both will likely prepay fast in 2013. By comparison, 2010 and 2011 GNMA production provides solid prepayment protection due to their higher insurance premium hurdle,” Hu explained.
kpanchuk@housingwire.com
Mozilo Unbowed Says Countrywide Was ‘World-Class Company’
Countrywide Financial Corp. co- founder Angelo Mozilo said under oath last year that he had “no regrets” about how he ran the mortgage firm and that he only agreed to a record $67.5 million regulatory settlement in 2010 to protect his children.
Mozilo, who led the lender blamed by lawmakers and regulators for contributing to the housing collapse, spoke in a June 2011 deposition as part of a lawsuit between his firm, which was bought by Bank of America Corp. (BAC), and MBIA Inc. (MBI), according to documents filed this week in New York. MBIA, once the biggest bond insurer, claims Countrywide committed fraud by securitizing loans that were riskier than promised.
The crisis was “not caused by an act of Countrywide,” said Mozilo, 73, according to a transcript of the deposition. “This is all about an unprecedented, cataclysmic situation, unprecedented in the history of this country. Values in this country dropped by 50 percent.”
Bank of America, the second-biggest U.S. bank by assets, has spent more than $40 billion to clean up mortgages inherited from the 2008 Countrywide purchase. Congressional investigators released e-mails from Mozilo, the Countrywide chief executive officer, showing that as early as 2004 he was concerned about the decline in quality of mortgages the lender was originating.
Mozilo was responding to questions from an MBIA attorney who asked if he regretted how Calabasas, California-based Countrywide was run after “all the foreclosures and ruined lives and lawsuits.” Mozilo called the lawyer’s question “nonsensical and insulting.”
Bankrate’s forecast for Mortgage Rates
Forecast for mortgage rates
By Judy Martel · Bankrate.com Thursday, December 13, 2012
The Federal Reserve’s announcement Wednesday that it would continue buying mortgage-backed securities and long-term Treasury bonds is aimed at lowering the national unemployment rate to boost the economy. But homebuyers and those looking to refinance into a lower mortgage rate will feel the effects as well.
“Once the Fed’s new stimulus, dubbed QE4 (which stands for the fourth round of quantitative easing), gets started after the first of the year, it should help marginally reduce long-term interest rates and, more specifically, fixed mortgage rates,” says Greg McBride, CFA, Bankrate’s senior financial analyst. But the Fed’s action is “small potatoes compared to the ‘fiscal cliff,’” he adds. “If the economy slows due to going over the cliff early next year, then the slower economy and not QE4 will be the main catalyst for lower rates.”
A sustained mortgage rate below 3.5 percent will facilitate another round of serial refinancing for borrowers who had previously refinanced just above the 4 percent level, McBride says.
The mortgage rate forecast for next year will depend on what Congress does this year to prevent a possible economic slowdown. “If the fiscal cliff is averted and the economy continues to grow, we’re likely to see mortgage rates trend higher in 2013″ says McBride. “But mortgage rates will in no way be an impediment to a well-qualified borrower. Even if today’s 3.5 percent rates became 4 percent sometime next year, those rates are still low enough to enhance affordability.”
The ultimate result of all this monetizing of debt, both public and private, is just to inflate it away. That’s what’s always happened, since the time of Constantine.
The price of houses will not fall, or at least not fall precipitously. Debts, both public and private, will not prove onerous. But the prices of things other than houses and T-bills will rise steeply, and wages will not keep up. The net results will be that savings are destroyed — essentially looted to pay off debts, both your own and those of others — and the standard of living of most people declines. You won’t be underwater on your $650,000 house any more, and your salary will have risen to a handsome $100,000 — but milk and gasoline will be $18 a gallon, a decent shirt $300, and a quick meal at McDonald’s $25, so you’ll feel (and actually be) less well off than you were. That’s how the debt will be paid.
And arguably it’s fair in the crudest sense. Essentially, we just pile all our debt in a big honking steaming mess, and then each of us is forced to choke down a roughly equal share of it. Obviously this sucks if you’ve been a careful saver, but if you have been you’re in the minority, and the thing about a democracy is the choices it makes usually benefit the majority, whether or not that makes moral or practical sense.
This is why the underappreciated genius of the Founders is not that they figured out how to set up a democracy — how to do that has been obvious since ancient Greece — but that they figured out a way to set up a democracy with profound restrictions on the power of the majority, so that individual entrepreneurship and brilliance, always a rare flower, could not be prematurely plucked by a greedy and ignorant majority.
It worked for a very long time. But for most Americans these days, a visceral fear of the majority and its clumsy whims or ignorant prejudices is no longer a daily occurrence. We have succeeded at the “melting pot” too well — we no longer fear our neighbor’s essential craziness. Instead of mutually agreeing with him to mind our own businesses, we attempt to build common cause with him (to screw over and steal the goodies of the neighbor down the block, or one street over).
We need more mutual distrust. We need to forget how to work together, and start working individually, and start wanting to be left the hell alone while we do.
Amen. Thank you Carl. Every successful “win-win” deal I have seen with respect to our debt problems inevitably requires a third party (usually a saver) to unwittingly take one for the team. Win-win in real life is very difficult and requires work and some level of healthy mutual distrust to achieve. It is a breath of fresh air to hear someone else express this.
There are really three economies. The jobs held by folks who will get paid no matter what else happens because what they do is essential for life. Then there’s the jobs that we do for each other just because we can, and more often than not the world would be better off if they never got done since we want so much that is actually bad for us. And then there’s the jobs that are created by ‘the brilliant’ who think that because they can use huge sums of credit and fiat to control whole sectors of the economy that they are the masters of the universe. They invariably destroy everything they touch because they really don’t know how to do anything but borrow.
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