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  • October 8, 2008 09:32 AM EDT by Elizabeth MacDonald

    Is the Panic Overblown?

    Every headline feels like an explosion. But is the root cause of this mess--the housing crisis--really that bad? Is the U.S. overreacting?

    Read on for some illuminating statistics from the Federal Reserve that shed fresh new light on the number of borrowers and homes that are really in jeopardy in the housing crisis.

    As banks sit staring morosely at a moldering dustheap of damaged mortgage bonds, two experts who have examined housing data now say a better bailout would be to rescue borrowers directly, which would put a floor under these Kryptonite securities.

    First the Headlines

    *Central banks around the world have ordered interest-rate reductions in a synchronized move to fight the global credit crisis contagion, with the Federal Reserve slashing the federal funds rate to 1.5%. The rate cut comes after the Fed, for the first time, said it would lend directly to nonbanks by providing unsecured lending in the commercial paper market, as the commercial paper market has contracted to $1.6 tn from $2.2 tn a year ago. Companies use the commercial paper market to fund their day-to-day operations.

    *Three weeks ago, two money funds broke the buck, having lost up to 3% of their investors' money on supposedly high-grade bond investments in financial institutions like Lehman Brothers and Washington Mutual.

    *Panicked investors yanked $200 bn out of the $3.3 tn money funds market, fleeing to government-backed Treasurys. The Treasury Department then announced a temporary guarantee of some existing money market investments, though not enough to stop investors bolting.

    *The government enacted a $700 bn bailout bill to buy Kryptonite, mortgage-related securities from damaged banks, but capital is slow in coming to these companies as the Treasury must now take time hiring portfolio managers and setting up its auctions to buy hundreds of billions of dollars in murky securities.

    *Thirteen federally insured banks and savings and loans--including two major thrifts--have failed this year, and more collapses are expected, reports note. The deposit insurance fund is now at $45.2 bn--below the minimum target level set by Congress and the lowest it has been since 2003, reports indicate.

    *If a major bank went down, the Federal Deposit Insurance Corp. could be forced to borrow money from the Treasury. The FDIC approved a proposed increase in premiums that will more than double the average paid by U.S. banks and thrifts next year to replenish that fund.

    *Meanwhile, news that would have grabbed headlines around the country has flown under the radar screen due to the chaos. U.S. auto makers got a sweet $25 bn loan bailout--in return, they are supposed to use the loans to make more fuel-efficient cars, leading taxpayers to wonder, "aren't they supposed to be doing this on their own anyway?"

    More Borrowers Under Water

    The Wall Street Journal reports that about one in six U.S. homeowners are "underwater" on their mortgages, meaning they owe more on their loans than their homes are worth--raising the possibility of a rise in defaults and more pressure on an already hurting economy.

    The WSJ reports that about 75.5 mn U.S. households own the homes they live in. After a housing slump that has drove values down 30% in some areas, roughly 12 mn households, or 16%, owe more than their homes are worth, according to Moody's Economy.com. The comparable figures were roughly 4% under water in 2006 and 6% last year.

    A Better Bailout

    Republican presidential candidate, Senator John McCain, has proposed that the government buy bad mortgages and rework their terms to keep people in their homes, an idea that is already in the government's $700 bn bailout bill, under section 110 of the new law.

    That section says that the government will buy "troubled" assets, including mortgages, and then modify their terms to "minimize foreclosures."

    In an earlier blog, I noted a similar idea from R. Glenn Hubbard, former chairman of the President's Council on Economic Advisers under President George W. Bush, and Chris Mayer, an economics professor at Columbia Business School. Their plan aims to directly put a floor under housing--and in turn, distressed mortgage securities at the white-hot core of the crisis--by bailing out borrowers (see "Forget the Bailout: Here's a Better Way").

    Specifically, they propose that the government let all borrowers refinance their loans 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.

    The direct cost of this plan would be modest for the 85% of mortgages where the homeowner owes less on the house than it is worth, the two say, adding that lower interest rates will mean higher overall house prices.

    Under this plan, homeowners would have to forfeit their right to refinance their mortgage if rates fall, although homeowners could pay off their mortgage by selling their home.

    Similarly, economist Edward Yardeni suggests the government use the $700bn "in a way that is most likely to end the credit crisis immediately. Let's buy up all the subprime and alt-A mortgages that were delinquent or in foreclosure as of August 2008. That's all we have to do. We should have done this six months ago. I don't think it is too late to do it now."

    The Plan is Doable

    Yardeni dug into the Fed's Web site and found "a gold mine of information on these nonprime mortgages" gathered by the mortgage market research firm FirstAmerican CoreLogic.

    Here are the housing stats he found, and the math behind his plan. The numbers are revealing:

    *The number of housing units in the U.S. is 115.9 mn.
    *The number of subprime and alt-A mortgage loans was 2.92 mn and 2.26 mn in August.
    *The average mortgage balance of subprime and alt-A loans was $183,917 and $321,572, respectively.
    *The number of interest-only subprime and alt-A loans were 335,035 and 627,022.
    *The percentage of subprime and alt-A loans with adjustable rates were 62.9% and 53.1% respectively.
    *The average current interest rate on adjustable subprime and alt-A loans was 8.81% and 6.55%.
    *The percentage of ARMs resetting in the next 12 months was 30.5% for subprime loans and 4.9% for alt-A.
    *The percentage of all subprime mortgages that were "troubled"--delinquent by 60+ days or in foreclosure--was 25.7%. The comparable percentage for alt-A was 11.9%.

    What's Really at Stake

    Based on the above data, Yardeni figures that:

    *The values of subprime, alt-A, and all nonprime mortgage loans was $537 bn + $726.8 bn = $1,263.8 bn.
    *The "troubled" nonprime loans totaled $138 bn + $86.5 bn = $224.5 bn.
    *Over the next 12 months, resetting subprime and alt-A mortgages will be $163.8 bn + $35.6 bn = $199.4 bn. Some of these must already be included as "troubled," while others will undoubtedly become troubled when they reset, especially if they are tied to Libor, which has soared.

    Yardeni notes: "Can you believe that we are going through all this turmoil over a measly $224.5 bn in nonprime mortgage loans that were noncurrent in August! Such a small amount of toxin has poisoned so many securities."

    So Yardeni suggests: "Let's surgically remove the toxic assets from the mortgage-backed securities" by having the government "purchase as many of these mortgages as possible."

    He adds: "In exchange for their toxic nonperforming nonprime mortgages, portfolios will get cash from" the government.

    "That should increase the marketability and the market value of such portfolios even if it is difficult to root out all the toxic assets," Yardeni adds, noting that the government "would have plenty of money left over to purchase other distressed assets, like leverage corporate loans, if necessary."

    The government's implementation issues with this idea "should be easily and rapidly surmountable given the urgency of stopping what is increasingly turning into a global financial and economic collapse," Yardeni says, but notes that the new bailout bill gives Henry Paulson, Secretary of the Treasury, sweeping new powers that could get this idea enacted rapidly.

Ralph Harrison

How do you know 5.25% is the right rate. My first home mortgage in 1978 was 9%. The market must find its own level. Manipulation of interest rates is the problem not the solution.

October 8, 2008 at 11:29 am

Jeremy Goodridge

Are you aware, by the way, that there is a popular editor used by programmers all over the world called "Emacs"?

October 8, 2008 at 11:26 am

Jeremy Goodridge

This is exactly the idea proposed by McCain in yesterday's debate! He got a lot of flack that he was breaking the budget with another 300 billion. But it may be that he's MORE tuned into economic realities than Obama. Jeremy

October 8, 2008 at 11:25 am

Robert Witting

Elizabeth, Understanding the facts(truth) about the "toxic assets" allows one to realize that the "Bailout" will not accomplish what the American people have been led to believe the bailout was intended to do. In all the hype and threats that have been spread by our government, your ability to shed light in all this darkness, as always, is excellent. There is other information that I could provide, but what you have pointed out, with great clarity, is only the tip of the iceberg. Panic is never a solution and McCain/Obama worked diligently to harm the United States, by voting for and working to pass the bailout. I am a Republican, but I will not cast(waste) my vote on either of these two men, but will be voting 3rd party, Mr. Barr and company. I will also be voting out those in both houses of Congress who voted for this plan. To create socialism, as our? government is working toward, is very sad indeed and on principle I must stand. Freedom and Liberty, a Republic form of government promised by our founding fathers, our Constitution and the Declaration of Independence are all VERY dear to me!! Perhaps we can stop the loss of our representative form of government and retrieve it from the abyss of darkness??? Lord bless, Bob W.

October 8, 2008 at 11:18 am

m abbott

Why bailout the homeowners and banks who entered into a irresponsible relationship? Why doesn't the government reward the taxpayers who are paying their mortgages, car payments, and credit card balances? These are the people keeping this sad economy afloat. Why shouldn't we have an opportunity to shore up our personal balance sheet with the government bailout funds? Why can't the government reduce all mortgages and forgive us our debt as we forgive those who trespass against us. Spread the wealth among all and not just the few irresponsible people who are pulling the masses down! Get your heads out of the sand!

October 8, 2008 at 11:13 am

TimBarton

Thanks for another good perspective. The idea of buying the mortgages at the source makes a lot more sense than buying all of the convoluted paper out there. Buying the actual mortgage with the home as collateral assures we are getting the real deal at the source. The government has collection abilities like no other so someone will have to pay off the mortgages eventually. Where as paying for the paper!? Does anyone think that those in right places and are less than scrupulous will not add more unverifiable paper to the government’s purchase?

October 8, 2008 at 11:02 am

mark

i was thinking the same thing, this is really the root of the whole mess and the numbers show that it is really not that large at its foundation. the reason it gets so "large" is that all of the derivitives that resulted that the "financial companies" are struggling with is the fact that these guys have to value them at a mark to market value which is very distorted and does not relate to the root cause, so it is effectively multiplied a lot making the problem look much larger than it really is. the real value of all of the derivitives will ultimately be known over time as the real number of forclosures is actually known and the work out known... meaning if a mortgage is for 100,000 and the bank has to sell for 80,000, the real loss is 20,000 not the full 100,000 and this proposal adresses this. too simple for our financial wizards in washington???

October 8, 2008 at 10:41 am

Alexander Avallon Jr

This is what John McCain proposed last night. According to Carly Fiorina, John McCain proposed this back in March of this year, but it went unnoticed. It seems the most obvious solution. No one knows the value of these mortgages. By doing this plan, we will know. Also, if the mortgage holders can start paying their loans back, the banks will have cash coming in. By giving the $700 bil to the banks, there is no guarantee that the mortgages will get paid back. Alex Avallon Hatboro, PA

October 8, 2008 at 10:36 am

Jeff

Nice thought, but what about those of us that have done it the right way, we are entitled to have our mortgages "reset," arn't we? If we are an nation of equality what those undisciplined, irresponsible people get we that have been responsible and disciplined should get it to...right? Anyway I can still make my payment...can they? No! Even if you reset there mortgages, they still can't make the payment...then what? Another round of foreclosure. We need to just let it go...and take our lumps. Anyway, they signed the paper, but didn't read the print!

October 8, 2008 at 10:36 am

PassthePork

Seems over-simplified and probably somewhat dated now. From day one I have supported helping the homeowner/taxpayer and not providing funds directly to the lenders, who at this point cannot be trusted to do the right thing. Why should taxpayers provide their repayment guarantee on funding provided to the lenders. There is no direct benefit. That seems to be what everyone is upset about. The governments approach is back-sswards.

October 8, 2008 at 10:26 am

Ken

Yes we should panic! Not at the market, at our GOVERNMENT that is out of control and has been that way for a long time.

October 8, 2008 at 9:54 am

about this blog

  • Elizabeth MacDonald is the stocks editor for Fox Business Network. She is recognized as one of the top prize-winning business journalists in the country, and has received 14 awards, including the top prize in business journalism, the Gerald Loeb Award for Distinguished Business Journalism, and the Newswomen's Club of New York Front Page Award for Excellence in Investigative Journalism.

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