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Michael Gracie

First, Let’s Stabilize Home Prices

You lost me at hello

R. Glenn Hubbard and Chris Mayer, via WSJ (emphasis mine):

We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac.

What a novel approach (notwithstanding the fact that Fannie and Freddie were recently nationalized because they were spiraling down the rabbit hole).

(h/t Calculated Risk)

Comments

John Preston says:

The Plan to Repair Housing in America…..Q & A with John Preston

Q1. Simply speaking, what is The Plan to Repair Housing in America?

The “Plan” is a program designed to address the current situation in the general economy by specifically targeting the housing market and mortgage payment issues. The “Plan” assumes that the “burden of the debt”, and, secondarily, the “cost of the debt”, are the problem in housing today. At this time, the plan does not consider the impact of the “amount of debt”. By burden, I mean monthly payment rates. By cost, I am referring to the interest rate. Payment rates and interest rates are somewhat related, but there are differences. Based on my real world experience, the homeowners who are having trouble with their mortgage payments have seen their monthly income drop by 20-40%, or more. We need to reduce mortgage payments in a dramatic fashion, without dramatically discounting the value of the mortgage asset. My plan does this.

The plan allows for a “fair” rate of interest, but, since it incorporates a discounted payment schedule, the monthly burden is dramatically reduced in the early years, and scheduled payment increases are spread out over time to allow homeowner’s the opportunity to grow their income. Essentially, the plan restores affordability to the general household monthly budget, and buys time for the economy to heal.

Below, you will find a table designed to illustrate the initial benefit of my plan.

My Plan/35 yr GPM Generic 30 Year Mtg Hubbard Plan
Loan Balance $200,000 $200,000 $200,000/$190,000
Interest Rate 6.5% 6.5% 5.25%
Principle and Interest Payment $928.11 1,264.14 1,104.41/1,049.19
Effective Payment Rate 3.767 6.5% 5.25%

The purpose of the plan is to stabilize home prices and neighborhoods, and to allow the economy to begin to perform in a more normal manner. As home prices stabilize, and perhaps even grow, there will be a positive effect on the various balance sheets of the many affected financial institutions.

It is my opinion that, at the current crisis level, it is impossible to value any of the real estate, the mortgage assets and balance sheets effectively. We need my plan to be able to make quality decisions based on reliable and clear data.

Q2. Why do we need a plan which essentially is helping out homeowners who made mistakes or who experienced bad luck?

This is complicated, because there are several levels on which this question needs to be addressed.

First, there are studies which correlate housing optimism and consumer spending. If these studies are accurate, and housing health and the economy are linked, then the economy will continue to suffer as long as housing suffers. I often cite a study by Robert Shiller, called COMPARING WEALTH EFFECTS: THE STOCK MARKET VERSUS THE HOUSING MARKET, which supports this assumption.

Second, if the homeowners misread the market, and made mistakes in calculation or judgment, what about the lenders, regulators and the Wall Street financiers…did they miss it too? The housing problems did not begin in 2001 or 2003…the foundation for all of the problems today were laid in the 1990’s. The real problems started at the top of the system. A great deal of money and manpower has been focused on the top…thus far to no avail. I believe the solution must start at the bottom, and that we need to redirect money and manpower into Main Street. My plan does just that.

Third, by addressing the situation in the manner outlined in my plan, all homeowners with mortgage debt, up to a yet-to-be-determined amount, are included. By broadening the scope of the plan, all levels of the economic and social structure are affected in a positive manner. It just seems fair to help more people so that they can in turn help the economy.

Lastly, let’s remember that all levels of the economy, both public and private, benefited during the housing boom. Jobs were created, incomes went up, businesses started…government tax revenues went up…a lot of benefit was handed out to everyone. And, for those who did not purchase during this time, their rents remained low.

It’s not like the gain on equity from a home sale, or money that was extracted in a refinance, was buried in someone’s back yard…the money got spent back into the economy for goods and services.

Q3. Still, shouldn’t people have known better?

Sure, many should have known better. A lot of really smart folks missed it. Currently there are states and municipalities experiencing budgetary shortfalls, and they have professionals whose job it is to forecast revenues and to manage the budget efficiently…and they couldn’t do it. The FDIC, the agency who manages and insures the banking system, in a 2005 study, did not see this crisis coming. They predicted stagnation in the housing market. And, they have a really good staff of economists and number crunchers.

Congress has oversight with the mortgage industry through OFHEO, and thereby, Fannie Mae and Freddie Mac, and they sure missed it.

Wall Street…boy did they miss it…and they created much of it.

So, are we going to really hold the 8-5 worker on Main Street to a more accountable standard?

Q4. You mention Congress…but isn’t the problem really about deregulation and greed?

The root of the problem goes back to 1992. Ironically, out of the S & L crisis of the late ‘80’s and early ‘90’s, came our current crisis.

There are good and bad regulation efforts…and there are good and bad deregulation efforts.

During the early to mid 1990’s, there were regulatory efforts to correct the abuses of the 1980’s. Some of this was probably good. However, during this time, an effort was begun to transform the mortgage industry into a social welfare program…with the belief that expanding housing opportunities was good for America. This was a noble intention, gone sadly wrong.

It was bad legislation…combined with flawed and veiled miss-regulation, stirred by a lack of adequate oversight from those charged with the responsibility of protecting and managing the process, which has necessitated the sort of dramatic response now required to correct the sins of the past.

Everyone in authority should have known better, because we have been here before. As Yogi Berra once said, “It’s like deja vu all over again”.

Q5. So, you’re saying Yogi Berra could have helped???

I’m not sure if he could have helped…but he was right about the déjà vu part…we have been here before.

Let me address the dynamics of the lending abuses in the 1980’s which led to THAT crisis…the S & L debacle, as it is called. Setting aside fraud, which I am not attempting to account for in the model of my proposed solution, the real issue was credit manipulation by lenders, allowed by regulators, and financed by investors on Wall Street. Does this sound familiar?

I met my first subprime lender in 1980. I assisted in the development of what we now call the option ARM, in 1983-84. The first “no doc”, “stated income” programs that I saw were visible in the marketplace in 1984. None of these programs or concepts are really new…and their performance history should be a matter of fact. Many, both in government and in the media, believe that these ideas were spawned after 9/11. Wrong.

The point I am making is that lending in the 1980’s, not counting the fraud issues for now, allowed for increasingly flexible credit underwriting, which artificially expanded the demand side of the market, thereby distorting market values in real estate. This began around 1983, and continued until around 1989-1990. At this point, after lenders realized that approximately 90% of the borrowers who took out the “no doc”, “stated income” loans….had lied, they withdrew the programs and, in effect, collapsed the housing market. Does this sound familiar, too?

With the development of the Fannie/Freddie AUS (automated underwriting system) systems in the mid-to-late 1990’s, credit underwriting began to expand…only no one could really see it…because it was veiled by the curtain which was the DO/LPAUS process…like the little man behind the curtain in The Wizard of OZ, Fannie and Freddie could now move the market as they saw fit, or as directed.

Credit underwriting, as was the process in the 1980’s, became an accordion-like process…expanding and contracting to the beat of the regulatory direction they received.

My point is that none of this is new…those at the top of the system ignored the history, and they repeated the sins of the past. Or, they knew the history, and didn’t care. Or, they were greedy.

Bad regulatory legislation…abuse of the credit underwriting process…lack of regulatory oversight…and Wall Street greed and financing…sound familiar?

Q6. How would you select the homeowners to be included in your plan?

All homeowners with mortgage debt would be eligible. Whether they are current with their payments, behind or in foreclosure, everyone who wants into the plan is allowed to participate. No investor owned properties, and no second homes are allowed…only primary residences.

I would also require that lenders, on any properties held unsold in their REO inventory, offer this process to the previous homeowner who was foreclosed on, on a right-of-refusal-basis.

Q7. Why would you include foreclosure homes and the previous owners?

First, to stabilized home prices and the economy, we must get these home off of the market. Lender owned homes create a false market and there for by removing as many as possible, the market is allowed to return to some level of normalcy.

Most of these disadvantaged homeowners should perform adequately with the discounted payment plan I am proposing.

Q8. How would those want relief be qualified?

Because there are serious time constraints at this time, all of those wishing to participate would be automatically approved for the loan modification. Remember, these borrowers already qualified in some fashion in the past for their current. Many have suffered recently and now have diminished credit scores and income. With time, and good payment histories, their scores will rise again.

Consider this, how many of our financial institutions currently have good credit…and we are granting them relief, without which they would fail. We need the same thought process for the homeowners as well.

To reprocess credit, income, appraisals, etc, would just take too long and become too daunting. This process need to be quick, clean and simple.

All homeowners in trouble, now or in the recent past (completed foreclosures), together with any other concerned or worried homeowners who want help, are allowed into the process. All they have to do is to raise their hand and ask for help.

Q9. You advocate a “one size fits all” approach. Could you explain what you mean?

We do not have time to discuss mortgage options with each homeowner looking for help, and we do not have time to go through risk assessment and make various offers with various terms…there is not time.

All of those seeking help and relief would get the same loan, at the same interest rate…with the same general structure. Many homeowners will see their interest rate and payments be reduced. Some homeowners may see their interest rate go up and their payments go down.

When complete, all of the distressed homeowners and their mortgages, together with those who are worried and concerned, will have the same mortgage. They will all be in one basket. It will be easier to monitor, to manage and to value.

Q10. Who would process the paperwork, and what would it cost?

All lenders and servicers currently have huge loss mitigation staffs. All of these staffs are set up to do one thing…process current payoff information and process paperwork.

There is more than adequate staff available at this time, and they are set up to process paperwork. We just have to give these workers new instructions and direction.

There would be no lender fees allowed to be charged. All pending fees, attorney fees, foreclosure title fees, etc, would be the responsibility of the lenders.

The homeowner would be responsible for closing fees…escrow/attorney and title, recording, etc., back taxes, if any, and insurance.

Subordinate debt obligations would be required to re-subordinate or be wiped out.

Q11. How long would the process take?

I believe that the process could be completed in 4-6 months, and be divided into two phases: the Opportunity Phase; and the Modification Phase.

The Opportunity Phase : My plan would require that a period of time…30-45 days, for instance, would be allowed for those homeowners seeking relief to enter the program. This would be a hard window, and once closed, it’s closed.

The Modification Phase: All lenders would then process the new modification paperwork with the intent to close the process in 3-4 months.

Q12. What happens to the participating homeowners scheduled payments during the modification phase?

During the processing period, there would be no required payments from the participating homeowners, as these payments would be financed into the modification payment.

Q13. What about the value of the real estate? Many homeowners have negative equity. Can you comment on how you would deal with this issue?

While it is possible to appraise a home at this time, it is not practical, other than of academic purposes. First, there is the time issue…we need to move quickly. Second, it is unsound to attempt to set values while in the midst of a crisis. Admittedly, values are lower today that say they were in 2005. However, just as many consider that 2005 values to have been artificially high, there are many that think that values today are artificially low. We need to return the value question, and the negative equity question, once the crisis has softened and we have returned to a more normal market.

It is simply not the right time to address this issue. Homeowners who have concerns about their equity position can walk away. In a manner of speaking, this is a simple game of Deal, or No Deal.

Once the market has stabilized, and calm data is available to quantify the problem, then we can address this issue.

Q14. In your plan, you ask for all foreclosures to be halted by the court system. Why?

If housing is to be stabilized, and if my plan were to be implemented, there is no reason to proceed with the foreclosure process until the plan has been fully realized. We are trying to calm the market, restore confidence in the general public, stabilize the financial system and grow the economy. I would like all lenders and servicers to voluntarily cease the foreclosure process, but, if they will not, then I would ask the US Supreme Court to do so.

Q15. How does your plan work with the legislation passed last summer, or the recently passed Housing and Economic Recovery Act of 2008?

As for last summer’s bill, much of the money which was to be paid out to organizations such as Hope Now can be saved, as can a lot of cost that would have been incurred by lenders as they attempt to restructure mortgages. It was complicated legislation, and not well targeted to resolve the core issues.

The current Act will provide the standby funds needed to either collateralize or purchase the modified mortgage packages created by the participating lenders. My plan would require that the lender participate in the Plan’s modification process to have access to any of the financial benefit of the Act.

Q16. Why shouldn’t homeowners use the current crisis to cram down the lenders and lower their debt, through whatever means they can?

First of all, a deal is a deal. One of the public criticisms or the bailout is that individuals and institutions should be accountable for their decisions. The problem has so pervaded the economy that action must be taken for the greater good, or risk greater evils. Still, I am willing to let a deal be a deal, at this time.

By that I mean, I am not going to put that option, the opportunity to cram down the mortgage amounts, in play today, given that fact that we are still in the crisis. I feeling is that if more work is need to balance the process, then we will have to deal with that later. I find it exceedingly difficult to determine stabile value at this time.

One of our problems in housing has been the rather cavalier nature in which value has been wiped from the books…by accounting practices…by mortgage servicers in their deal making and foreclosure process…some of this is borderline criminal behavior.

Q17. There was a proposal outline in the Wall Street Journal recently which sounds a lot like your program. Would you care to comment on it?
The article, by Glenn Hubbard and Chris Mayer, of Columbia University, was the first dialogue I have seen on this topic which I feel is heading the right direction…towards a real, workable solution.

Entitled, First, Let’s Stabilize Home Prices, it differs in several key areas. First, it focuses in the interest rate and the amount of debt. They propose lowering the rate to 5.25%. On this subject, my payment rates are lower.

They envision re-qualifying the borrower and the property, and I differ there. There is simply not enough time to complete all of the work and the analysis, and it would be too costly.

They would also have the private sector profit from this process, and I differ there as well. The lenders have already invested in their loss mitigation staffs, and we can use them to process the paperwork.

The real difference, though, is in the monthly payments. The payments on my plan will be 10-15% lower initially, at a time when both the homeowners and the economy needs the most help. My plan does not address that amount of debt at this time, as I would wait to see where housing values are when the market calms down and returns to somewhat of a normal range.

My plan should be less costly to implement, will produce a more dramatic effect and should serve to restore health to the economy more rapidly.

Q18. You said that this boom-bust process happened before in housing, why won’t it happen again? I believe that the American public wants reassurances for their $700 billion dollars and related sacrifices.

In the beginning of the interview, I made the case that this is really the second time in my 30 year career that this credit binge-purge process has occurred, and this has to be the last. The credit process cannot be allowed to be treated in an accordion-like manner…expanding for fun and profit, and contracting in panic and profit.

I contend that the binge-purge is not a market function, but a function of greed and ignorance. Income, credit rating and interest rates are the key variables in underwriting.

In part 2 of my plan, I address the future of mortgage credit and underwriting. I believe that credit underwriting guidelines need be so structured as to have minimum levels required of all lenders, which would satisfy those who wish to see housing opportunity expanded. Then maximum tolerances would be defined. What you would have is a well articulated lending landscape, in which the market participants would define themselves. Lending needs to have a clearly defined playing field, and there is simply no abuse or alteration to be allowed. It would be fair, clear, inflexible and ruthlessly enforceable.

Q19. Do you have any final comments?

I have contended now, for well over a year, that we need to address the housing and mortgage issue with a simplified, one-size-fits-all, solution. There is too much confusion, congestion and inconsistency in the current loss mitigation process and it is leading us nowhere.

I have also contended that the problem is monthly payments…and that we need to create a discounted payment program to deal with the current crisis. We do not need to discount the interest rate…that’s the function of the market place, nor do we need to discount mortgage balances at this time, given the non-market driven, depressed nature of housing values, influenced by non-market forces.

My Plan to Repair Housing in America was constructed to address the key issues: getting payments down to a manageable level for those households in trouble or worried, thereby affording homeowners some much needed room in their current household income; controlling interest rates and removing the “ARM reset” headlines from the media; removing excess housing from the real estate market; and calming the economy.

The loan program I am advocating is the ONLY one which can accomplish the task at hand, for the good of America.

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