Wednesday, December 05, 2007

Greenspan should have thawed of this before he strong-ARMed the mortgage market

The moral hazard side of the debate on the Paulson Big Freeze plan is picking up, with even average joes chiming in on the issue (see, e.g., Subprime Bailout Backlash).

Guambat wonders how much of this Big Freeze business would have been necessary if Greenspan's low interest, get an ARM mortgage, policies had been headed off at the pass, and with that thought looked back to what exactly did he say that perhaps contributed.

Some of what he said at the time, back in February 2004, was:

"Rising debt service ratios are a concern if they reflect household financial stress and presage a drop in consumption or a rise in losses by lenders.

Financial institutions might be able to help some households in this regard by looking for ways that households--both renters and homeowners--can shield themselves from unexpected payment shocks.

many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade [especially the last half of that decade when the Fed was running a too low for too long rate policy], though this would not have been the case, of course, had interest rates trended sharply upward [which was not likely with his hand so heavily on the low interest rate lever].

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage.

To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."
MSM hailed the Chief ARM twister. For instance, USA Today breathlessly reported,
Federal Reserve Chairman Alan Greenspan said Monday that Americans' preference for long-term, fixed-rate mortgages means many are paying more than necessary for their homes and suggested consumers would benefit if lenders offered more alternatives.

In a standing-room-only speech to the Credit Union National Association meeting here, Greenspan also said U.S. household finances appeared generally sound, despite rising debt levels and bankruptcy filings. Low interest rates and surging home prices have given consumers flexibility to manage debt, he said.

While borrowers can refinance fixed-rate mortgages, Greenspan said homeowners were paying as much as 0.5 to 1.2 percentage points for that right and the protection against a potential rate rise, which could increase annual after-tax payments by several thousand dollars.

Joseph McKenzie, deputy chief economist at the Federal Housing Finance Board, says buyers like the stability of fixed-rate mortgages, but there is increasing flexibility in products. "There are lots of innovative programs, especially targeting low-income and first-time buyers," he says.

The Mortgage Bankers Association said the average rate for a 30-year fixed mortgage in the week ended Feb. 13 was 5.46%, compared with 3.27% for a one-year ARM.
If you doubt this speech has influenced the mortgage industry, check out this online advertisement that, today, says, "Greenspan said homeowners "might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade"

Daniel Gross, and others, immediately dumped on Greenspan's mortgage advice, Gross calling Greenspan "ARMed and Dangerous". Gross observed,
Buying an ARM when long-term interest rates are in long-term decline makes sense. But if you buy one in a period when the general trend of interest rates is higher, then you could be just another American Sucker. And that's why Greenspan's comments seem oddly timed.

If ever there were a moment when an ARM didn't seem to a good buy, surely it is now. Interest rates are at historic lows. Can rates drift a little lower? Sure. Can they go significantly lower? Most likely not.
Fast forward from Greenspan's speech, and Gross' objections, for 2 years to early in 2006 when others, like Barry Ritholtz, begin pounding the drums, blowing the conch or whatever other analogy is applicable to warning the markets about the tsunami sent out by Greenspan's quake:
You may have missed this over the weekend: The Saturday WSJ reports that "More than $2 trillion of U.S. mortgage debt, or about a quarter of all mortgage loans outstanding, comes up for interest-rate resets in 2006 and 2007, estimates Moody's Economy.com, a research firm in West Chester, Pa."

Let's repeat that number: Over the next 20 months, more than two trillion dollars worth of adjustable rate mortgages will reset at higher interest rates.

Now, I don't want to be accused of being a perma-bear or anything like that, but I am having a hard time trying to figure out exactly how anyone can spin this into a positive: Dark matter? Credit Surplus? Real Estate Boom?

I'm at a loss for words spin.

how awful can it be? Well, the worst case scenario is a wave of defaults, foreclosures, and forced sales, forcing home prices appreciably (depreciably?) lower.

Hopefully, many of the defaults will refi and avoid foreclosure. (Gee, I hope Carmella's Spec house wasn't variable mortgaged). But the macro impact will clearly be on consumer spending; Not only will this group of non-saving, free spending consumers have their budget's crimped by their increased mortgage costs, but their ready source of equity to borrow against goes buh-bye. This does not end well . . .

One title insurer ran the numbers, and they project that of the adjustable rate mortgages written over the past 2 years, as many as 1 in 8 (12.5%) will end up in default:

"Most borrowers will be able to cope with the coming wave of resets, in some cases by refinancing with new loans, lenders and mortgage industry analysts say. But some borrowers will have trouble meeting the higher payments and may be forced to sell their homes or could lose their homes to foreclosures. A recent study by First American Real Estate Solutions, a unit of title insurer First American Corp., projects that about one in eight households with adjustable-rate mortgages that originated in 2004 and 2005 will default on those loans."

Its hard to imagine how without a significant uptick in economic activity, (by definition) a recession is unavoidable no later than the end of 2007. We believe that when looking back in hindsight from 2008, there's a very real possibility that the recession will be marked as beginning towards the end of 2006.

If and when this happens, there are two classes of goats for the lynch mobs to single out: Those clowns who insisted that the U.S. savings rate is not actually negative (thanks to home appreciation!), and those members of the sunshine crowd who insist that this imbalanced structurally unstable, economically disparite economy was just fine.
(Apologies to Barry for "extracting" almost the entire post, but it is, first of all, an old one anyway, and second, so damned spot on, Guambat couldn't resist.)

The point here is that this mortgage default debacle was carefully orchestrated, cheerfully effected, and its effects known wide and large way, way, way in advance, yet, the planners and instigators of this result, who first counseled calm and containment, are now crying crisis and covering asses faster than ... I don't know; something.

But what gets Guambat is why was the carefully spoken Greenspan encouraging this refinancing in the first place and suggesting in that speech that home owners change to "alternatives to the traditional fixed-rate mortgage"?
"the surge in mortgage refinancings likely improved rather than worsened the financial condition of the average homeowner.

Indeed, the refinancing phenomenon has very likely been a supportive factor for the general economy.

we know that increases in home values and the borrowing against home equity likely helped cushion the effects of a declining stock market during 2001 and 2002."
Was this all only about propping up the stock market in the first place?

And if so, wouldn't it only be just if the fall-out from the mortgage mess that he helped create, to salvage the savages on Wall Street, fell on those savages now rather than the average joes on Main Street?

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