By Martin Hutchinson
This column has since 2000 been calling for the Federal Reserve to institute a policy of much tighter money. In a sense, events since August have justified it; old-fashioned consumer price inflation hasn't reappeared, but the beginnings of a gigantic global asset price deflation are appearing. At this point, sudden adoption of the Bear's Lair monetary policy, which would involve a Federal Funds rate in the 8-10% range, would cause a collapse in confidence and very likely a repeat of the United States' unhappy economic performance in 1931-33. So, given that the Fed is now starting from a place it should never have got to, what is the least painful trajectory from here?
There are two contrary tendencies to be fought. On the one hand, the housing market continues to melt down - house prices nationwide dropped 1.5% in the past month alone. That suggests that lower interest rates are needed to increase the affordability of housing for the marginal buyers and slow the decline in prices. On the other hand, the stock markets have continued strong, and commodity and energy prices have shot up further, producing the specter of US$100 oil. That suggests that lower interest rates may actually be making the economic problem worse, transferring all our wealth to unpleasant oil producing regimes.
The ongoing collapse in the subprime mortgage market indicates that the central rationale for interest rate policy has changed since August. If house prices continue to decline as they have in the last year - and there seems currently no reason whatever that they should not continue doing so - then more and more borrowers will find themselves with a larger mortgage liability than the value of their house asset. In itself this does not matter; if employment continues robust and the non-housing sectors of the economy continue to expand, then most of those borrowers will be able to continue making their mortgage payments. Eventually house prices will recover, or their outstanding mortgage balance will decline, and they will once more find themselves in a net asset position.
This would indicate that easy money was appropriate, but there are three problems with this. First, the decline in net worth among homeowners is likely to produce a negative "wealth effect" which will cut consumption and push the US economy into recession. Second, in reducing short term interest rates, the Fed may be "pushing on a string" and find itself unable to reduce the mortgage rates it is attempting to affect. Third, it risks reigniting inflation and it makes further rises in commodity and energy prices almost certain.
The opposite policy, of raising interest rates, would clearly now be damaging if carried out to extremes. Liquidity is disappearing from the US money market as structured investment vehicles are wound down and taken back onto bank balance sheets. The reduction of $400 billion in asset backed commercial paper outstanding since August is only one example of this. A sharp rise in interest rates runs the risk of a deflationary spiral of collapsing money supply such as occurred in the US in 1931-33, as bank after bank failed.
Fed chairman Ben Bernanke and the Federal Open Market Committee on December 11 seem likely to pursue their recent policy of a mild easing of money, lowering the Federal Funds rate by 0.25% or so. This will have little effect on house prices or on the availability of home mortgages. Both need to stabilize at much lower levels before the market clears. It will not lower rates in money markets as a whole; the London Interbank Offered Rate is currently trading at a thumping premium to the Federal Funds rate and will continue to do so.
It will also not lower US fixed rates; the 10-year Treasury bond is currently trading at a yield around of 4%, close to its historic lows and far below equilibrium real levels given the Fed's prolonged inability to reduce inflation below the 3-5%-4% range. It will however inject yet more liquidity into the world economy, which will force up the price of equities and other non-housing assets, as well as commodity prices and inflation in general.
This is undoubtedly what Wall Street wants; it is also likely to be largely satisfactory to Bernanke. Only one Fed chairman has lost his job through keeping interest rates too low - the unlucky G William Miller in 1979. However, in Miller's time inflation had already established a firm grip. Bernanke may reasonably feel that inflation remains sufficiently subdued that the problem can be ignored at least until after the 2008 election, now only 11 months away.
The dangers of a sharp rise in the Federal Funds rate do not apply to the modified policy of a mild rise in the rate, maybe to 6% in three steps between now and March. While this would make little difference to the housing market or to long term interest rates, it would deflate world stock markets and begin to mop up the excess liquidity that has distorted the world economy over the last decade. The private equity market would remain quiescent, hedge funds would find themselves generally loss-making, and the major US banks that have excessive exposure to subprime mortgages and other "Level 3" assets would be forced to come to terms with reality and start cleaning up their balance sheets.
More important, commodity and energy prices would start to deflate. If asked which would be most damaging to the US economy: an oil price of $120 combined with a Federal Funds rate of 3% or an oil price of $60 combined with a Federal Funds rate of 6%, almost all economists, even those wholly uncommitted to the Bear's Lair worldview, would confirm that the former combination is likely to be much more damaging.
The US payments deficit would be exacerbated, increasing the probability of a catastrophic decline in the dollar, while huge amounts of US consumer wealth would be diverted into the pockets of oil producing countries. These would either like Venezuela, Russia and Iran spend it on enhancing their dreams of world conquest or like Saudi Arabia, most of the Gulf States, Norway and Canada, save much of the increase, investing it in foreign exchange reserves and "rainy day funds" in general.
As John Maynard Keynes would have triumphantly pointed out (even a blind pig finds a truffle occasionally) the compulsive savers are much more damaging to the world economy than the megalomaniacs, provided the maniacs don't succeed. History has proven time and again that madmen with dreams of world conquest are thoroughly stimulative to economic activity, provided they are not permitted to achieve their goals. On the other hand a further increase in the world's savings rate, producing an additional "glut" of savings in sovereign wealth funds while impoverishing US, European and Japanese consumers, is likely to produce world recession in fairly short order, however stimulating it would be to asset prices and deal flow in the meantime.
But this choice between cheap money and even higher oil and commodity prices or moderately expensive money and oil and commodity prices deflated towards their normal levels is surely what we are faced with. A decline in the Federal Funds rate from 5.25% to 4.5% has produced a surge in the world oil price from about $70 in August to over $90. A further decline in the Federal Funds rate would cause a surge in world liquidity and a weakening of confidence in the dollar, which together would cause oil prices to soar.
Extrapolating from the trend since August, a 3% Federal Funds rate, perhaps in spring 2008, would be likely to lead to an oil price around $120 per barrel. Other commodity prices would likewise surge, gold would soar well over $1,000 and the euro would rise strongly against the dollar to above $1.60. I doubt very much whether Treasury bond yields would decline significantly, so the housing market would be largely unaffected and US house prices would continue to decline, with further consumers forced into mortgage difficulties by the rise in their costs of gasoline and heating oil.
Such an economy would be even more distorted than the current one. Essentially Bernanke would have provided yet more inflation for the world economic bubble, achieving little if any progress towards his goals of US economic recovery and house price stabilization, but ensuring a most unpleasant long term denouement. Chinese and US stocks would have risen further, more major companies would have been sold to sovereign wealth funds and more of America’s wealth would have been diverted from Main Street to Wall Street and through Wall Street to the Middle East.
Conversely, a reversal of policy, raising the Federal Funds rate back to 5% on Tuesday and announcing a goal, absent clear signs of a major downturn, of raising it further to 6% within the next few months would have the opposite effect. The monetary tightening would be far too small to affect the ongoing downturn in housing - in any case long term bond rates would be little affected. However oil prices would begin subsiding to their long term equilibrium level, probably now in the $50-$60 range. That would reduce US consumers' energy bills, giving them additional purchasing power to remain current on their mortgage payments.
This tighter money policy would strengthen the dollar, reducing the economic imbalances that a weak dollar has produced and increasing the willingness of central banks and other foreign investors to hold dollars. It would begin the messy process of deflation in the US, Chinese and other stock markets, bringing on the necessary price correction, but limiting the amount of innocent money that would be lost in a major crash.
It would reduce the resources available to Russia, Venezuela and Iran, immeasurably improving the world political environment and stabilizing wobbly "domino" political situations such as Ukraine, Colombia and Iraq. In the long run, it would produce a smaller and less painful US and global downturn, and would increase long term US wealth, as well as beginning the necessary rebalancing of wealth distribution between the overstuffed of Wall Street and the under-rewarded blue collar class.
The chance of Bernanke pursing this superior alternative? Approximately zero!
Martin Hutchinson is the author of Great Conservatives (Academica Press, 2005) - details can be found at www.greatconservatives.com.
Wednesday, December 12, 2007
Hope Now: Sorry, wrong number
By Julian Delasantellis
There's an old saying along the lines of "you never forget how to ride a bicycle". Perhaps that is true, but for the US government the aphorism requires some amendment.
After caring, coddling and cosseting the interests of America's richest and most powerful classes for decades, it is apparently true that the government has forgotten how to look after the interests of average middle-class and lower middle-class folks.
The evidence of this? Amid much fanfare, President George W Bush last week introduced the "Hope Now" initiative to help subprime mortgage borrowers threatened with impending foreclosure save their homes. Part of the initiative included a toll free phone number that imperiled homeowners could call, at any time of the day or night, to receive information that could help them begin the process of their salvation.
Bush gave out the number. The president's spinmeisters and media handlers probably planned this to make Bush seem more caring and considerate, more cognizant of, as the pollsters pose the question, the interests of "people like you". It might have worked - had the president not given out the wrong number.
On the surface of it, the program is almost redolent of a good government video in a secondary school civics class. A problem arises, and the government moves in the people's interest to solve it. In reality, when you actually go beyond the surface superficiality of the headlines, you find another principle of modern government these days. In the modern, media age, it's a lot more important to look like you're solving a problem than to actually solve it.
It sure seemed easy a couple of years ago. The essence of banking is to act as the financial intermediator for, and to make a profit from, bringing together people who have money to lend with people who want to borrow. Repeated Federal Reserve interest rate cuts, along with innovative financial "engineering" by Wall Street firms employing the best and brightest from America's business schools, had left the financial system drenched in funds seeking a high rate of return. Along with that you had millions of prospective home buyers seeking the ownership deed that they believed was the entry ticket to the American dream.
The only minor obstacles in the way of their shining dream were the minor factors that many could afford neither the price of the houses they wanted to buy nor the monthly payments of the mortgages they needed to finance them.
Subprime borrowing was the solution. Sure you can afford that house, the mortgage finance industry told the borrowers - 20% down payment for a house? That's an old fogey relic, like a lapel pin for a zoot suit or something. And if the interest payments on the mortgage are too high, well, we'll just sort of forget about the interest payments for the first couple of years or so. The initial rate for the first couple of years would be in the 5% or 6% zone, barely above the bank's cost of capital, then would rise, be "reset", to much higher rates, sometimes well over 10% for the final 28 years of the 30-year mortgage.
It was all rather like the US cable television or telephone companies that lure customers into buying their services with insanely low initial "teaser" charges, such as those that offer to send a swimsuit model to your house to do the dishes "for the first three months". As a result, Wall Street's surfeit of lendable capital put millions of people in homes that they were not destined to keep.
Everything would have been OK had home prices kept rising; had that continued, the buyers could have refinanced into more conventional, fixed-rate mortgages, with the increase in the home's value essentially acting as a downpayment. To update the old introductory economics slogan of "if wishes were horses beggars would ride free", add "and if home prices had kept on rising the subprime crisis would not be".
The media is chock full of stories indicating just how far and fast US house prices are falling. Depending on your metric, home price values have not fallen this fast since the late 90s, the early 90s or the early 70s; one real estate type, displaying that singular talent for hyperbole that signifies a truly gifted salesman, says that this is the worst US real estate market since the Great Depression of the 1930s.
One wonders if, as the subprime infection spreads to the British Isles' equally overheated real estate markets, whether we will see stories in the British press about how the real estate market there is at its worst since the Black Plague.
US home prices have stopped rising, so the subprime borrowers are now defenseless against the full punishing impact of the mortgage rate resets. A quarter of a million US homeowners are losing their homes every month through foreclosure, and, as subprime borrowers were taking out low "teaser" rates until early this year, without any outside intervention this phenomenon should continue to at least 2009.
After dismissing and belittling the crisis for most of the year, the Bush administration has attempted to get in front of the crisis, or at least to give the public impression of getting in front of the crisis, through the Hope Now initiative. Much like a medic in the trenches of World War I, Hope Now uses relentless triage logic to separate the subprime borrowers into three distinct classes.
Hope Now applies only to variable-rate mortgages taken out between the beginning of 2005 and the middle of this year. For most of that period, particularly on America's east and west coasts, the market's froth boiled up and over the cups of reason and logic like an overstirred latte, as irrational markets always do.
There are those who can't make the mortgage payments at the low, teaser rates. These unfortunates will not be assisted by Hope Now; they will return to their original destinies as lifelong renters. If you can make the payments now, and some god in the sky determines that you can handle the resets OK, you won't be helped by Hope Now either. Maybe you'll be able to refinance without government assistance; maybe you won't - you're on your own.
It's the third group, the ones who can handle the teaser rates but won't be able to do so with the higher rates, that Hope Now says it will help. The help to be proffered involves a freeze of up to five years on the higher interest rate reset. It is hoped that by then the subprime borrower will have accrued at least some measure of equity in his house, or have maybe saved or prepared in some way for the higher payments. Treasury Secretary Hank Paulson described the need for policy action in this way:
I want to help as many able homeowners as possible. To do that requires continuous learning. We must deepen our understanding of how many borrowers can be helped and the most effective mortgage solutions for them. As I have said before, this housing and mortgage market decline is still unfolding. Resetting ARM [adustable-rate mortgage] rates are one factor which will play out over the next 18 months. Declining home values will also significantly affect default rates going forward. We've also learned that default rates are far higher on mortgages made in 2006 and 2007, due to lax underwriting standards. We have work to do to understand how many of these borrowers are able to afford their homes.
As usual, the devil here resides in his familiar comfy abode, the details. The obvious point of contention is the question as to who will live and who will die, who will receive the Hope Now salvation, and who will be left exposed to the market's punishing gales.
For all the credit the popular press has bestowed onto Bush, Paulson and the administration over Hope Now, in reality, the government's role in the initiative is fairly limited.
What the government has done, in essence, is to provide the meeting room for what is called the "Hope Now Alliance", described by Paulson as "an alliance between counselors, servicers, investors, and other mortgage market participants. This alliance will maximize outreach efforts to homeowners in distress to help them stay in their homes and will create a unified, coordinated plan to reach and support as many homeowners as possible. The members of this alliance recognize that by working together, they will be more effective than by working independently."
What the Hope Now Alliance will do, according to Paulson, is to develop "methods, criteria and metrics that any industry participant can use to systematically evaluate borrowers' ability to pay resetting adjustable rate mortgages. For example, borrowers who are current on payments at the lower rate might be candidates for fast tracking into a refinance or a loan modification."
Basically speaking, the alliance hopes to examine each variable rate borrower, their income, their resources, their payment histories, and, most importantly, the most critical indicator of Godliness in modern-day America, their credit score, to determine if they will be granted the absolution of a reset freeze. Above 660, it's thought that you can handle the reset without assistance. Below, you supplicant yourself to the alliance and beg for relief.
Some of the problems here are obvious. If your credit score is too high but you still don't want to be subject to a reset, well, raising a credit score may be problematic, but lowering one is not. Like a Hollywood star told to gain weight for a part, all the star, or the borrower, has to do is to pig out, the star on sweets and treats, the borrower on spending and credit. This is the classic "moral hazard" problem in economics, where one economic actor in a system sees an incentive through acting in such a way that threatens the system as a whole.
Perhaps more central is the issue of the logistics of this process. It is thought that over 2 million US homeowners are going to be facing foreclosure over the next year; the early months of 2008 will see a particularly heavy storm of resets, as the teaser loans taken out in early 2006 come due.
Will the Hope Now Alliance be able to individually examine all the coming due mortgages in the relatively brief duration before the bankruptcy judge's gavel falls? It is said that the alliance is writing special software to be able to assess the worthiness of borrowers quickly en masse; one would hope that this software code is not being written by the same guys who wrote the software that greenlighted the subprime borrowers in the first place.
It is for this reason that many observers, including Paul Krugman of the New York Times, are advocating the eschewing of the mortgage triage framework to just reset everybody's rates.
This is not bleeding heart liberalism here. The argument is that the determination as to who will and who will not receive assistance will be so inherently slow and plodding that the foreclosure damage will have occurred before the help can arrive.
But the wholesale reset argument flies right in the face of the individualistic Protestant work ethic (or, in other words, plain old stinginess) of the US general public. Polling data indicate strong opposition to just about any initiative to aid the subprime borrowers.
"I pay my mortgage, why shouldn't they?" comes the argument from out of Middle America. The answer to that proud rhetorical inquiry is that if half the houses on his block get foreclosed, abandoned and boarded up, down the drain will go the value of Mr Independent's house as well. Since it can't be told in the 15 seconds or so that local American nightly news devotes to the financial matters, the rejoinder remains unspoken.
But there is another flaw in Hope Now, one that goes to the core of the process of housing finance in this country.
When first I wrote of the subprime crisis for ATol in early March, I noted that the housing finance industry in America had traveled a long way from that portrayed in the 1946 Frank Capra movie It's a Wonderful Life. There, old-fashioned mortgage banker George Bailey (Jimmy Stewart) could honestly plead to panicked depositors in his bank that "Your money's in Joe's house right next to yours. And in the Kennedy house, and Mrs Macklin's house, and a hundred others. Why, you're lending them the money to build, and then they're going to pay it back to you."
Not any more. These days mortgages are like more sausages, chopped up and remixed, seasoned and processed, bundled and tied up to become mortgage-backed securities, bond-like investments that investors use to earn higher interest rates than those available on Treasury securities.
If your mortgage is among the $2 trillion of those that have been thus "securitized" in the past decade, the monthly mortgage check you write to your bank does not stay with your bank, unless your bank has kept some of the mortgage paper for itself. Instead, it passes through the financial system, eventually arriving in the wallets of whoever bought your mortgage, now bundled with perhaps hundreds of others. In essence, you have borrowed your mortgage money from the owner of your mortgage paper, be he a private investor in Texas, a hedge fund in Connecticut, a public pension fund in California, or a sovereign wealth fund in the Middle East. The bank that you write your check to, called the mortgage servicer, is, in reality, just a middleman.
Looking down the roster of the Hope Now Alliance, you see a lot of mortgage servicers - Citigroup, Washington Mutual, Bank of America and others. It is hoped that the alliance will, after finding out who's been naughty with credit (they'll get help ) and who's been nice (they won't), alter the specified loan terms of the mortgages so that the rates won't be set higher.
Can they do that? Is it legal to do that? After all, the mortgage is, in reality, just an IOU between the borrower, the homeowner and the mortgage paper owner. The servicer occupies a middleman role much like a stockbroker; when you buy 100 shares of a stock, the broker is just performing a service for you, much like the servicer.
The American Securitization Forum, the trade group for the securitization industry, and a key component of the Hope Now Alliance, says it can unilaterally alter mortgage terms without lender consent.
"The ASF believes that this framework is consistent with the authority granted to a servicer to modify subprime mortgage loans in typical PSAs [pooling and servicing agreements].The ASF expects that the procedures in this framework will constitute standard and customary servicing procedures for subprime loans."
What if the owner of one of the mortgages whose interest rates are being frozen objects to the terms of his mortgage bond, his loan agreement with the borrower, being altered without his consent? The Hope Now program defenders say this won't happen, that the owners of the mortgages will agree to temporarily sacrifice a little so as to avoid the costs of the foreclosure process, typically, up to 30% of the original loan.
Maybe that's true. But, as most of the teaser rates were written to be barely profitable, or even non-profitable, now so that they could be insanely profitable following the reset, maybe someone will object. It will only take one cantankerous miserly old bugger to go into the US courts and get the reset freezes stayed, and the entire Hope Now infrastructure collapses and is disposed of into the courthouse paper recycling bins.
Interestingly, the ASF legal interpretation that servicers can act in the interests of lenders without their express consent has been recently been rejected by the US courts - in reverse.
It was in October that US Sixth District Court Judge Christopher Boyco, ruling from the bench in Cleveland, Ohio, stopped a mortgage servicer, Deutsche Bank, from foreclosing on 14 properties, saying that, as the mortgage servicer could not show an actual title to the homes being foreclosed, it had no standing to foreclose on them. In mid-November, another Federal judge, Thomas Rose, of Dayton, Ohio, did the same with 26 foreclosure motions submitted to him by mortgage servicers Citigroup, HSBC and others.
Have, in Tom Wolfe's famous moniker from The Bonfire of the Vanities, mortgage finance's Masters of the Universe been tripped up in their decades-long quest to transfer the wealth of America from the working to the capital-owning classes by something so mundane and pedestrian as to having to follow the law?
In the meantime, I feel sorriest for the subprime borrowers, once again led to believe the lies of the mortgage finance industry, once again betrayed. When they returned home from their second or third job last Thursday night, desperately trying to earn the money to keep their houses, they might have turned on the news, thought that there actually was hope, maybe even hope now.
But what they thought was hope turns out to be a fantasy, their American dream now a chimera slipping like illusionary sand through their grasp. In much the say way that Bush's "Mission Accomplished" speech on the USS Abraham Lincoln ushered in the worst fighting of the Iraq War, his Hope Now initiative, intended, designed and delivered to be nothing more than the Mission Accomplished moment of the subprime crisis, may very well usher in the worst of the foreclosures in 2008.
Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.
(Copyright 2007 Asia Times Online Ltd. All rights reserved.)
There's an old saying along the lines of "you never forget how to ride a bicycle". Perhaps that is true, but for the US government the aphorism requires some amendment.
After caring, coddling and cosseting the interests of America's richest and most powerful classes for decades, it is apparently true that the government has forgotten how to look after the interests of average middle-class and lower middle-class folks.
The evidence of this? Amid much fanfare, President George W Bush last week introduced the "Hope Now" initiative to help subprime mortgage borrowers threatened with impending foreclosure save their homes. Part of the initiative included a toll free phone number that imperiled homeowners could call, at any time of the day or night, to receive information that could help them begin the process of their salvation.
Bush gave out the number. The president's spinmeisters and media handlers probably planned this to make Bush seem more caring and considerate, more cognizant of, as the pollsters pose the question, the interests of "people like you". It might have worked - had the president not given out the wrong number.
On the surface of it, the program is almost redolent of a good government video in a secondary school civics class. A problem arises, and the government moves in the people's interest to solve it. In reality, when you actually go beyond the surface superficiality of the headlines, you find another principle of modern government these days. In the modern, media age, it's a lot more important to look like you're solving a problem than to actually solve it.
It sure seemed easy a couple of years ago. The essence of banking is to act as the financial intermediator for, and to make a profit from, bringing together people who have money to lend with people who want to borrow. Repeated Federal Reserve interest rate cuts, along with innovative financial "engineering" by Wall Street firms employing the best and brightest from America's business schools, had left the financial system drenched in funds seeking a high rate of return. Along with that you had millions of prospective home buyers seeking the ownership deed that they believed was the entry ticket to the American dream.
The only minor obstacles in the way of their shining dream were the minor factors that many could afford neither the price of the houses they wanted to buy nor the monthly payments of the mortgages they needed to finance them.
Subprime borrowing was the solution. Sure you can afford that house, the mortgage finance industry told the borrowers - 20% down payment for a house? That's an old fogey relic, like a lapel pin for a zoot suit or something. And if the interest payments on the mortgage are too high, well, we'll just sort of forget about the interest payments for the first couple of years or so. The initial rate for the first couple of years would be in the 5% or 6% zone, barely above the bank's cost of capital, then would rise, be "reset", to much higher rates, sometimes well over 10% for the final 28 years of the 30-year mortgage.
It was all rather like the US cable television or telephone companies that lure customers into buying their services with insanely low initial "teaser" charges, such as those that offer to send a swimsuit model to your house to do the dishes "for the first three months". As a result, Wall Street's surfeit of lendable capital put millions of people in homes that they were not destined to keep.
Everything would have been OK had home prices kept rising; had that continued, the buyers could have refinanced into more conventional, fixed-rate mortgages, with the increase in the home's value essentially acting as a downpayment. To update the old introductory economics slogan of "if wishes were horses beggars would ride free", add "and if home prices had kept on rising the subprime crisis would not be".
The media is chock full of stories indicating just how far and fast US house prices are falling. Depending on your metric, home price values have not fallen this fast since the late 90s, the early 90s or the early 70s; one real estate type, displaying that singular talent for hyperbole that signifies a truly gifted salesman, says that this is the worst US real estate market since the Great Depression of the 1930s.
One wonders if, as the subprime infection spreads to the British Isles' equally overheated real estate markets, whether we will see stories in the British press about how the real estate market there is at its worst since the Black Plague.
US home prices have stopped rising, so the subprime borrowers are now defenseless against the full punishing impact of the mortgage rate resets. A quarter of a million US homeowners are losing their homes every month through foreclosure, and, as subprime borrowers were taking out low "teaser" rates until early this year, without any outside intervention this phenomenon should continue to at least 2009.
After dismissing and belittling the crisis for most of the year, the Bush administration has attempted to get in front of the crisis, or at least to give the public impression of getting in front of the crisis, through the Hope Now initiative. Much like a medic in the trenches of World War I, Hope Now uses relentless triage logic to separate the subprime borrowers into three distinct classes.
Hope Now applies only to variable-rate mortgages taken out between the beginning of 2005 and the middle of this year. For most of that period, particularly on America's east and west coasts, the market's froth boiled up and over the cups of reason and logic like an overstirred latte, as irrational markets always do.
There are those who can't make the mortgage payments at the low, teaser rates. These unfortunates will not be assisted by Hope Now; they will return to their original destinies as lifelong renters. If you can make the payments now, and some god in the sky determines that you can handle the resets OK, you won't be helped by Hope Now either. Maybe you'll be able to refinance without government assistance; maybe you won't - you're on your own.
It's the third group, the ones who can handle the teaser rates but won't be able to do so with the higher rates, that Hope Now says it will help. The help to be proffered involves a freeze of up to five years on the higher interest rate reset. It is hoped that by then the subprime borrower will have accrued at least some measure of equity in his house, or have maybe saved or prepared in some way for the higher payments. Treasury Secretary Hank Paulson described the need for policy action in this way:
I want to help as many able homeowners as possible. To do that requires continuous learning. We must deepen our understanding of how many borrowers can be helped and the most effective mortgage solutions for them. As I have said before, this housing and mortgage market decline is still unfolding. Resetting ARM [adustable-rate mortgage] rates are one factor which will play out over the next 18 months. Declining home values will also significantly affect default rates going forward. We've also learned that default rates are far higher on mortgages made in 2006 and 2007, due to lax underwriting standards. We have work to do to understand how many of these borrowers are able to afford their homes.
As usual, the devil here resides in his familiar comfy abode, the details. The obvious point of contention is the question as to who will live and who will die, who will receive the Hope Now salvation, and who will be left exposed to the market's punishing gales.
For all the credit the popular press has bestowed onto Bush, Paulson and the administration over Hope Now, in reality, the government's role in the initiative is fairly limited.
What the government has done, in essence, is to provide the meeting room for what is called the "Hope Now Alliance", described by Paulson as "an alliance between counselors, servicers, investors, and other mortgage market participants. This alliance will maximize outreach efforts to homeowners in distress to help them stay in their homes and will create a unified, coordinated plan to reach and support as many homeowners as possible. The members of this alliance recognize that by working together, they will be more effective than by working independently."
What the Hope Now Alliance will do, according to Paulson, is to develop "methods, criteria and metrics that any industry participant can use to systematically evaluate borrowers' ability to pay resetting adjustable rate mortgages. For example, borrowers who are current on payments at the lower rate might be candidates for fast tracking into a refinance or a loan modification."
Basically speaking, the alliance hopes to examine each variable rate borrower, their income, their resources, their payment histories, and, most importantly, the most critical indicator of Godliness in modern-day America, their credit score, to determine if they will be granted the absolution of a reset freeze. Above 660, it's thought that you can handle the reset without assistance. Below, you supplicant yourself to the alliance and beg for relief.
Some of the problems here are obvious. If your credit score is too high but you still don't want to be subject to a reset, well, raising a credit score may be problematic, but lowering one is not. Like a Hollywood star told to gain weight for a part, all the star, or the borrower, has to do is to pig out, the star on sweets and treats, the borrower on spending and credit. This is the classic "moral hazard" problem in economics, where one economic actor in a system sees an incentive through acting in such a way that threatens the system as a whole.
Perhaps more central is the issue of the logistics of this process. It is thought that over 2 million US homeowners are going to be facing foreclosure over the next year; the early months of 2008 will see a particularly heavy storm of resets, as the teaser loans taken out in early 2006 come due.
Will the Hope Now Alliance be able to individually examine all the coming due mortgages in the relatively brief duration before the bankruptcy judge's gavel falls? It is said that the alliance is writing special software to be able to assess the worthiness of borrowers quickly en masse; one would hope that this software code is not being written by the same guys who wrote the software that greenlighted the subprime borrowers in the first place.
It is for this reason that many observers, including Paul Krugman of the New York Times, are advocating the eschewing of the mortgage triage framework to just reset everybody's rates.
This is not bleeding heart liberalism here. The argument is that the determination as to who will and who will not receive assistance will be so inherently slow and plodding that the foreclosure damage will have occurred before the help can arrive.
But the wholesale reset argument flies right in the face of the individualistic Protestant work ethic (or, in other words, plain old stinginess) of the US general public. Polling data indicate strong opposition to just about any initiative to aid the subprime borrowers.
"I pay my mortgage, why shouldn't they?" comes the argument from out of Middle America. The answer to that proud rhetorical inquiry is that if half the houses on his block get foreclosed, abandoned and boarded up, down the drain will go the value of Mr Independent's house as well. Since it can't be told in the 15 seconds or so that local American nightly news devotes to the financial matters, the rejoinder remains unspoken.
But there is another flaw in Hope Now, one that goes to the core of the process of housing finance in this country.
When first I wrote of the subprime crisis for ATol in early March, I noted that the housing finance industry in America had traveled a long way from that portrayed in the 1946 Frank Capra movie It's a Wonderful Life. There, old-fashioned mortgage banker George Bailey (Jimmy Stewart) could honestly plead to panicked depositors in his bank that "Your money's in Joe's house right next to yours. And in the Kennedy house, and Mrs Macklin's house, and a hundred others. Why, you're lending them the money to build, and then they're going to pay it back to you."
Not any more. These days mortgages are like more sausages, chopped up and remixed, seasoned and processed, bundled and tied up to become mortgage-backed securities, bond-like investments that investors use to earn higher interest rates than those available on Treasury securities.
If your mortgage is among the $2 trillion of those that have been thus "securitized" in the past decade, the monthly mortgage check you write to your bank does not stay with your bank, unless your bank has kept some of the mortgage paper for itself. Instead, it passes through the financial system, eventually arriving in the wallets of whoever bought your mortgage, now bundled with perhaps hundreds of others. In essence, you have borrowed your mortgage money from the owner of your mortgage paper, be he a private investor in Texas, a hedge fund in Connecticut, a public pension fund in California, or a sovereign wealth fund in the Middle East. The bank that you write your check to, called the mortgage servicer, is, in reality, just a middleman.
Looking down the roster of the Hope Now Alliance, you see a lot of mortgage servicers - Citigroup, Washington Mutual, Bank of America and others. It is hoped that the alliance will, after finding out who's been naughty with credit (they'll get help ) and who's been nice (they won't), alter the specified loan terms of the mortgages so that the rates won't be set higher.
Can they do that? Is it legal to do that? After all, the mortgage is, in reality, just an IOU between the borrower, the homeowner and the mortgage paper owner. The servicer occupies a middleman role much like a stockbroker; when you buy 100 shares of a stock, the broker is just performing a service for you, much like the servicer.
The American Securitization Forum, the trade group for the securitization industry, and a key component of the Hope Now Alliance, says it can unilaterally alter mortgage terms without lender consent.
"The ASF believes that this framework is consistent with the authority granted to a servicer to modify subprime mortgage loans in typical PSAs [pooling and servicing agreements].The ASF expects that the procedures in this framework will constitute standard and customary servicing procedures for subprime loans."
What if the owner of one of the mortgages whose interest rates are being frozen objects to the terms of his mortgage bond, his loan agreement with the borrower, being altered without his consent? The Hope Now program defenders say this won't happen, that the owners of the mortgages will agree to temporarily sacrifice a little so as to avoid the costs of the foreclosure process, typically, up to 30% of the original loan.
Maybe that's true. But, as most of the teaser rates were written to be barely profitable, or even non-profitable, now so that they could be insanely profitable following the reset, maybe someone will object. It will only take one cantankerous miserly old bugger to go into the US courts and get the reset freezes stayed, and the entire Hope Now infrastructure collapses and is disposed of into the courthouse paper recycling bins.
Interestingly, the ASF legal interpretation that servicers can act in the interests of lenders without their express consent has been recently been rejected by the US courts - in reverse.
It was in October that US Sixth District Court Judge Christopher Boyco, ruling from the bench in Cleveland, Ohio, stopped a mortgage servicer, Deutsche Bank, from foreclosing on 14 properties, saying that, as the mortgage servicer could not show an actual title to the homes being foreclosed, it had no standing to foreclose on them. In mid-November, another Federal judge, Thomas Rose, of Dayton, Ohio, did the same with 26 foreclosure motions submitted to him by mortgage servicers Citigroup, HSBC and others.
Have, in Tom Wolfe's famous moniker from The Bonfire of the Vanities, mortgage finance's Masters of the Universe been tripped up in their decades-long quest to transfer the wealth of America from the working to the capital-owning classes by something so mundane and pedestrian as to having to follow the law?
In the meantime, I feel sorriest for the subprime borrowers, once again led to believe the lies of the mortgage finance industry, once again betrayed. When they returned home from their second or third job last Thursday night, desperately trying to earn the money to keep their houses, they might have turned on the news, thought that there actually was hope, maybe even hope now.
But what they thought was hope turns out to be a fantasy, their American dream now a chimera slipping like illusionary sand through their grasp. In much the say way that Bush's "Mission Accomplished" speech on the USS Abraham Lincoln ushered in the worst fighting of the Iraq War, his Hope Now initiative, intended, designed and delivered to be nothing more than the Mission Accomplished moment of the subprime crisis, may very well usher in the worst of the foreclosures in 2008.
Julian Delasantellis is a management consultant, private investor and educator in international business in the US state of Washington. He can be reached at juliandelasantellis@yahoo.com.
(Copyright 2007 Asia Times Online Ltd. All rights reserved.)
China eases markets before US meetings
BEIJING - China has underscored its intention to open up the country's financial markets by tripling the investment quota of qualified foreign institutional investors (QFII) from US$10 billion to $30 billion.
The announcement from the State Administration of Foreign Exchange (SAFE) came ahead of the 18th US-China Joint Commission on Commerce and Trade meeting on Tuesday and the third Sino-US Strategic Economic Dialogue, which opens on Wednesday. The Chinese government can expect to face further calls that it open up its markets more to overseas investors and take further action, such as letting it currency appreciate at a faster pace, to limit growth in its trade surplus. US Treasury Secretary Henry Paulson, Beijing for the talks, has argued strongly for faster appreciation of the yuan.
The QFII move also came out before the release on Tuesday of China's latest trade and inflation figures, which showed price increases accelerating to the quickest in 11 years and the trade surplus growing, adding further to domestic pressure on government to raise interest rates and let the currency appreciate faster.
Consumer prices rose 6.9% in November from a year earlier, faster then the 6.5% gain in country's main inflation measure in October, the statistics bureau said. The trade surplus climbed 14.7% to $26.3 billion in November from a year earlier, the customs bureau said today. The 11-month trade surplus with the US rose to $149.2 billion.
This was the second expansion of the QFII program, which allows foreign investors to trade in the yuan-denominated A shares while the Chinese currency remains not fully convertible. The country launched the QFII program in 2002 with a quota ceiling of $4 billion on a trial basis. The previous expansion, in 2005, was $6 billion. However, no foreign institutional investors have acquired any new quotas since February, when the then $10 billion quota was running low.
Shang Fulin, chairman of the China Securities Regulatory Commission, told reporters in October that raising the QFII quota was a common understanding reached at the second Sino-US Strategic Economic Dialogue. On the other hand, ahead of the Strategic Economic Dialogue, China has warned of "serious harm" to the bilateral economic and trade ties, if some legislative bills, now before the US Congress, are passed.
Finance Minister Xie Xuren said that it was "worrying" to see the rising trend of trade protectionism in the US. He was referring to more than 50 legislative bills concerning US economic and trade ties with China proposed by some US Congress members since the beginning of the year.
The SAFE said it would "decide the tempo" of quota issues in line with China's international payments and the development of the domestic stock market. "Eligible overseas medium- and long-term investment will be encouraged to invest in China's capital market," it said.
Reviewing the performance of QFII funds over the past five years, the SAFE said that the system had facilitated a transformation in Chinese investors' sophistication, improved risk management, strengthened the global clout of Chinese capital markets and helped optimize corporate governance. The number of QFIIs, described by the SAFE as "significant institutional investors," now totals 49. Their aggregate market capitalization was nearly 200 billion yuan (about $27.02 billion).
Industry analysts said the government had previously been reluctant to raise the QFII quota for fear of sparking currency appreciation and concern that the domestic stock markets were near bubble territory.
Separately from the SAFE announcement, Liu Mingkang, chairman of the China Banking Regulatory Commission, played down fears of the economy overheating in comments made at an annual conference sponsored by Caijing Magazine in Beijing Monday.
"The benchmark Shanghai index has more than tripled from 2003 to this November, which is still small compared with other BRIC [Brazil, Russia, India, China] nations. Russian stocks rose nearly 631%, Brazilian stocks 576% and Indian stocks 596%," he said.
To promote steady development of the financial markets, the SAFE also said that it would expand channels for local residents to invest abroad and raise the investment quota for qualified domestic institutional investors (QDII). The QDII program is designed to allow Chinese investors to trading in overseas shares as the yuan remains not fully convertible.
"We support more eligible local financial institutions being able to provide more diversified products for domestic investors, enhance their risk management and establish new advantages in global competition," said the SAFE in a statement.
As of end-September, all QDIIs - including banks, funds, insurers and securities dealers - had acquired investment quotas of $42.17 billion, with an actual outflow of $10.86 billion.
The benchmark yuan-US dollar exchange rate hit a new high of 7.3872 on November 27, for a cumulative appreciation of nearly 11% since China discontinued the peg to the greenback in July 2005.
Zhou Xiaochuan, governor of the People's Bank of China, or the central bank, said on November 18 that if necessary the nation would consider widening the yuan's floating band.
(Asia Pulse/Xinhua)
The announcement from the State Administration of Foreign Exchange (SAFE) came ahead of the 18th US-China Joint Commission on Commerce and Trade meeting on Tuesday and the third Sino-US Strategic Economic Dialogue, which opens on Wednesday. The Chinese government can expect to face further calls that it open up its markets more to overseas investors and take further action, such as letting it currency appreciate at a faster pace, to limit growth in its trade surplus. US Treasury Secretary Henry Paulson, Beijing for the talks, has argued strongly for faster appreciation of the yuan.
The QFII move also came out before the release on Tuesday of China's latest trade and inflation figures, which showed price increases accelerating to the quickest in 11 years and the trade surplus growing, adding further to domestic pressure on government to raise interest rates and let the currency appreciate faster.
Consumer prices rose 6.9% in November from a year earlier, faster then the 6.5% gain in country's main inflation measure in October, the statistics bureau said. The trade surplus climbed 14.7% to $26.3 billion in November from a year earlier, the customs bureau said today. The 11-month trade surplus with the US rose to $149.2 billion.
This was the second expansion of the QFII program, which allows foreign investors to trade in the yuan-denominated A shares while the Chinese currency remains not fully convertible. The country launched the QFII program in 2002 with a quota ceiling of $4 billion on a trial basis. The previous expansion, in 2005, was $6 billion. However, no foreign institutional investors have acquired any new quotas since February, when the then $10 billion quota was running low.
Shang Fulin, chairman of the China Securities Regulatory Commission, told reporters in October that raising the QFII quota was a common understanding reached at the second Sino-US Strategic Economic Dialogue. On the other hand, ahead of the Strategic Economic Dialogue, China has warned of "serious harm" to the bilateral economic and trade ties, if some legislative bills, now before the US Congress, are passed.
Finance Minister Xie Xuren said that it was "worrying" to see the rising trend of trade protectionism in the US. He was referring to more than 50 legislative bills concerning US economic and trade ties with China proposed by some US Congress members since the beginning of the year.
The SAFE said it would "decide the tempo" of quota issues in line with China's international payments and the development of the domestic stock market. "Eligible overseas medium- and long-term investment will be encouraged to invest in China's capital market," it said.
Reviewing the performance of QFII funds over the past five years, the SAFE said that the system had facilitated a transformation in Chinese investors' sophistication, improved risk management, strengthened the global clout of Chinese capital markets and helped optimize corporate governance. The number of QFIIs, described by the SAFE as "significant institutional investors," now totals 49. Their aggregate market capitalization was nearly 200 billion yuan (about $27.02 billion).
Industry analysts said the government had previously been reluctant to raise the QFII quota for fear of sparking currency appreciation and concern that the domestic stock markets were near bubble territory.
Separately from the SAFE announcement, Liu Mingkang, chairman of the China Banking Regulatory Commission, played down fears of the economy overheating in comments made at an annual conference sponsored by Caijing Magazine in Beijing Monday.
"The benchmark Shanghai index has more than tripled from 2003 to this November, which is still small compared with other BRIC [Brazil, Russia, India, China] nations. Russian stocks rose nearly 631%, Brazilian stocks 576% and Indian stocks 596%," he said.
To promote steady development of the financial markets, the SAFE also said that it would expand channels for local residents to invest abroad and raise the investment quota for qualified domestic institutional investors (QDII). The QDII program is designed to allow Chinese investors to trading in overseas shares as the yuan remains not fully convertible.
"We support more eligible local financial institutions being able to provide more diversified products for domestic investors, enhance their risk management and establish new advantages in global competition," said the SAFE in a statement.
As of end-September, all QDIIs - including banks, funds, insurers and securities dealers - had acquired investment quotas of $42.17 billion, with an actual outflow of $10.86 billion.
The benchmark yuan-US dollar exchange rate hit a new high of 7.3872 on November 27, for a cumulative appreciation of nearly 11% since China discontinued the peg to the greenback in July 2005.
Zhou Xiaochuan, governor of the People's Bank of China, or the central bank, said on November 18 that if necessary the nation would consider widening the yuan's floating band.
(Asia Pulse/Xinhua)
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