Sunday, September 13, 2009

End Game?

Much of this post is speculation on future events by me. Do not take my opinion/rant as facts. I only offer up a possible outcome over the near future for the housing market. As I have watched the market I have seen little more than the emergency brake have been hit by the Fed with little resolution to the fundamental problems facing the market of overleveraged borrowers getting in way over their heads. I present this as possible outcome:

I found this summary of a report Amherest Securities Group on
Housing Wire
to be interesting and could point to a final plan developing to remove the mortgages off the banks books and onto the backs of the taxpayers. Basically the report points out that short sales result in higher recovery rates than foreclosures. This makes sense for two reasons. One, the property is still owner occupied or just recently vacated meaning the home would have less deferred maintenance than your typical foreclosure. And two in a declining market the sooner you get out the more your recover. This shows why the industry needs to come up with a uniform way of first and junior liens cooperating to divvy up the proceeds of a short sale instead of the senior liens telling the junior liens "this is what we are offering" and the junior liens using the "hostage value" of their lien to try and get more.

The other part of this report points out that a new Hope for Homeowners (H4H) is in the works. With this option Amherst believes the loss would be the same as the short sale, the owner still keeps the home and the bank no longer has a bad loan on its books. Any default from that point forward comes out of the FHA insurance fund and, if that fails, the taxpayers. I believe this to be the end game for the administration. The Fed can tremendously influence rates, however temporarily, they can bring down rates to even lower levels so the qualification for H4H is easier and the banks can put as many loans in H4H in as little time as possible. While there may be a hit to capital to the banks they magically turn a non-performing loan into a performing loan which carries zero risk and they wouldn't have to withhold any capital or increase loan loss reserves against it.

Moral Hazard? Yes, not an issue to the Fed. Price Discovery? No, exactly what the banks and government want. Overleveraged borrowers get to keep "their" home? Yes. Saving the too big to fail banks? Yes, it may require an additional capital injection depending on the initial H4H losses. Keeping the housing market stagnated and inflated? Yes.

I think it is as good as the administration can expect given their goals of keeping the housing market inflated and as many borrowers in homes as possible. Needless to say I see a taxpayer funded bailout for FHA coming a few years down the road but they get to kick the can and politicians will always do that over making the tough decisions.

The only losers are the fiscally responsible and those who pay the majority of taxes. Truely this is an ownership society and homeowners are a protected class of people. I am sure we will hear more about a new much more lenient H4H probably by early next year.

From the April 28, 2009 MHA press release:
"Support for Legislation to Strengthen Hope for Homeowners: In order to ensure that many more borrowers are able to participate in Hope for Homeowners, we are working to improve the program and actively pursuing legislation so that the FHA may reduce fees paid by borrowers, increase flexibility for lenders to refinance troubled loans, permit borrowers with higher debt loads to qualify, and make further improvements to strengthen Hope for Homeowners so that it can function effectively as an integral part of the Making Home Affordable Program. "

"Treasury Purchase of Special Ginnie Mae Pools to Provide Liquidity for Hope for Homeowners Loans: Under HERA authority, Treasury or the GSEs would purchase special Hope for Homeowners Ginnie Mae IIs wrapped by the GSEs. These purchases will increase secondary market liquidity for new Hope for Homeowners loans, supporting additional assistance to homeowners. "


Effective Demand said...

Note: This is the renter apocalyptic version. Everything is highly dependent on the underwriting details of the H4H loans.

JohnF said...

I have to say, I agree with your analysis. The Feds can do the math just like you and I can, and they realize there is no way they can let the market be engulfed by all of these homes coming on to the market.

Now that the federal government controls close to 90% of the mortgage market through Fannie, Freddie and FHA, it will start writing down principal balances on its loan portfolio and have the taxpayers pay the difference. The amounts will be staggering, likely in the trillions of dollars. But if they do it their way at least several million voters get to "stay in their homes" and get a do-over. The Fed will print whatever is necessary to fund it.

The stupid people like me who didn't buy in the last 5 years during the mania will be left fighting over the few decent homes that will be available over the next decade.

I have been telling people this for months - that we are heading into a situation with extremely low inventory for the foreseeable future - due to the scenario you laid out in your post. There will be no more significant price declines because you need actual foreclosure sales (not just NOD's and NTS's) and transaction volume to drive prices down.

We will have neither for many years in my opinion.

ronald said...

interesting post and comments. Couple quick thoughts.
A rather complex financial scheme the FED is weaving but these financial models work best in studio conditions. Real time economic forces generate actual risk which the FED can only estimate or hope they don't occur either way the fall out from this credit expansion is still in the early stages.