October 8, 2008 9:32AM
Is the Panic Overblown?
By Elizabeth MacDonald
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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.
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What would happen if that $700B dollars was used directly to pay mortgages and credit cards off instead of giving the money to the lending companies? Look at all the money that would be available to boost the economy!
Dear Walter Olson, I’ve always been too ignorant to understand the stock market, and I’m probably too ignorant to understand your Elliott Wave folks in George; but I did look up the web site and am not to ignorant to understand everyone is patting themselves on the back about how right they’ve been all along. I don’t see any compassion. I don’t see anyone helping. I’m a disabled person on Social Security, barely making it. My husband lost his job a year ago and has yet to find another one. I’ve been in a panic for a year, worried about so many things, and now all this is happening. I’m very, very frightened. There was one solution offered on the website: to buy — buy Robert Prechter’s book, subscribe to the newsletter (not free, probably not for dummies). It’s probably too late, and I don’t have the money anyway.
Elizabeth,
My view is that you are hopelessly naive about the enormous economic situation right in front of us. I would respectfully suggest that you familiarize yourself with the writings of Robert Prechter and the Elliott Wave folks in Georgia. We are about to be caught in a wave based on something very deep in all of us including you.
Please turn off the TV and the laptop and start trying to understand the situation.
Thank you.
Walter Olson
Wethersfield, CT
October 9, 2008, 3:10 pm EDT
Friends
Excuse me — just buying the toxic loans leaves people like me who only bought what we could afford with no equity (the equity represented by the downpayment) in a unfair situation. The folks who walked away will now be able to get a mortgage and buy one of the foreclosed houses at the new depressed price, with a 5.25% loan, while I am stuck with the old price, a higher loan rate, and stuck paying the taxes to pay for these foreclosed buyers new 5.25% loans.
Is the “panic” overblown? Probably; to some extent all panics at some point become overblown and that’s usually where new bull markets begin.
President Bush needs to fly to Berlin and give a speech that says , Mr. Putin PUT THAT WALL BACK UP !!!
The subprime problems themselves would have resulted in a housing bubble burst, and possibly a small recession.
However, subprime EXPOSED greater systemic probems with the world’s financial institutions due to derivatives. The counterparty risk under the subprime pressures acted like proverbial bad Christmas tree lights. One light goes out, and they all go out.
Securitized debt is the culprit - not subprime.
Right the “fuse” of the crisis is only a few hundred billion in mortgages.
The bomb of the crisis is the face value of credit default swap insurance that was oversold on those mortgages, 12 trillion in mortgages, 62 trillion in credit default swaps. That added to over leveraged finance companies, banks, hedge funds, and GSEs which had little or negative stockholder equity after subtracting the goodwill, the intangibles, the Level 2 and 3 assets, future tax benefits, and opaquely valued derivative positions. Watch out for the Internation Bank of Settlements value at risk exception days reset of the value at risk model multiplier now that Q3 has ended.
Goverment,
press,
and politicans aret the ones are out of control. Question is this: whose perpuating the fear in the global marketplace?
But the root cause of all this needs to be examined closely. But now new history is revealing that the present mortgage problem had its back in the ’90s. Even Rep Barney Frank blocked legislation which President Bill Clinton wanted to introduce to curb Freddie and Frannie Mae. Use the past to learn the lesson and take that lesson to solve the problem.
The panic and the resulting stampede to a bail-out was and is ridiculous.
One of the things we have learned is that the design of our banking system operations and monetary policies no longer serve us. Since the 1970s we have allowed our currency to float with no underlying assets supporting the value of our currency. Those chickens have come home to roost. Don’t get me wrong, I’m not for a return to the “gold standard” as it is just as inherently inflationary as the current fiat policy.
Indeed, are we to be asked to suspend our disbelief that the sub-prime crisis, housing market crisis, capital market exchange crisis, entitlement funding crisis and every other financial woe that is impacting the world are somehow coincidences?
Only a true fool would believe it.
The fact is the banking and monetary policies of our nation have created an economy with very little of what people would call “economic justice”. The Lords of Wall Street put billions of bonuses in their pockets and then line their pockets some more with a phony stampede over less than 3% of the total assets in our economy and the government cracked the whip the whole way.
Are we ready for something new?
Are we ready for a monetary policy that is supported by equities - real assets? If we made this simple change in our monetary policy, we would enjoy a doubling effect as each time new money is created, it is backed up with real equity securities (of a special kind that are bankruptcy proof because we are talking about the boneheads in government here, right?). The capitalization of the government would change. The total capitalization owing to liabilities would decrease (on a percentage basis) each time the new monetary policy was used. The dollar would no longer face the drubbing in the foreign exchange markets.
But it doesn’t end there.
Imagine an economy where everyone has equal opportunity (not equality of outcome, but equal opportunity) to rise to the top based on hard work and not their birthright or relative education.
Imagine a fully funded health care system where a $500,000 policy costs the taxpayer only $25 per month, per capita.
Imagine a fully funded Social Security program that eliminates all of its deficits within 12 years.
Imagine a capital market exchange that won’t leave you holding worthless securities overnight.
Imagine being able to write-off your entire housing payment each year.
It’s all out there. It’s waiting for us. A new kind of exchange. A new kind of business investment paradigm. It’s not socialism. It’s not communism. It’s the capitalism we were promised in our school years but have never been able to quite put our finger on it. I’m a structured finance consultant so I know a little about this and about what can be done.
Imagine that.
Clinton Lovell
Houston
Government policy got us into this mess, we elected them so I guess we will be paying for the election mistakes we all made in the past. My concern now is that we are on the verge of making another huge collective election mistake that we will be paying an even steeper price for.