Blown Mortgage

We’ve all heard the general guidance about what to do that mythical day when we suddenly find ourselves ankle-deep in quicksand (and climbing quickly): relax, don’t panic, don’t make frantic movements, and work slowly and methodically to get out of the quagmire - or risk drowning. Technically speaking, there is little more to the advice of surviving quicksand and metaphorically speaking little more to surviving the housing market implosion. Unfortunately, our government is eschewing methodical work in favor of frantic movements - the results to date have been disastrous.

Look, I understand the need for politicians and elected officials to do something. We all know what happens when they do nothing. Even if that something is the wrong thing; action beats inaction at the polls 10 times out of 10. There’s always a constituency that appreciates the effort. But these gyrations are, without a doubt, making the mortgage and housing markets less and less certain everyday; and this uncertainty is killing any chance of near-term recovery (no matter how far out that idealized near-term could be).

We’re in the classic Catch-22; but with some thoughtful non-action we could be through the woods in a much faster and in-the end, less destructive way. Let’s look at some of the recent government decisions to see how we’re sinking deeper and deeper in to the quicksand with each panicked move. Before we do that though let’s reset the basic truth of the mortgage and housing market:

The housing and mortgage markets were both at ridiculous, unsustainable levels - levels supported by poor decision-making, complicity and massive, systemic fraud.

The above statement is not an opinion - it is fact. As long as we keep this fact clear in our heads the answers and solutions to extracting ourselves become much clearer than they currently appear now. It is the politicians, policy makers and other interested parties unwillingness to come to grips with this fact that is causing the pain we are facing right now. The desire to take a step back doesn’t mesh with the market realities. We can’t take just one step back; because we came so far down a path of fraud and criminal malfeasance that we need to go back up the path. That is where we’ll find the answers.

W’s FHASecure Program

While Bernanke was still touting the banking system’s stability and the containment theory; George W. rolled out the FHASecure program to “help” subprime borrowers who were getting hammered by adjustable rate mortgages. While the FHASecure program had limited scope (helping maybe 125,000 mortgage holders) it caused immediate damage in the mortgage industry. The FHA loan flood gates opened. Ambiguously qualified borrowers, directed by uninformed loan officers and hamstrung by uneducated and understaffed FHA underwriting “departments” (if you can call the one underwriter who used to do FHA a department) caused a logjam in bank pipelines. These people watched as months slipped by, hoping erroneously that they qualified for this magic FHASecure bullet.

FHASecure cost people millions in home equity and opportunity as the market continued to implode around them as they waited in line for a hand out that would never come. Who knows how many homes could have been saved with clearer direction, a better public outreach and education about the program AND an honest assessment of the actual effectiveness and reach of the program? Had loan officers not rushed to cram every loan in to the FHA pipeline - and instead taken advantage of expanded Fannie and Freddie approvals, portfolio lenders, and niche high-LTV programs could homes have been saved? Were people that waited for the FHASecure train aced out of other financing as home values dropped and programs evaporated?

Barney Frank’s Mortgage Reform Legislation

While W’s effort was more of a publicity stunt, the first major knee-jerk in response to the housing meltdown was Barney Frank’s mortgage reform legislation. The legislation in its original form hoped to outlaw stated income loans and yield spread premiums from common lending practices. It also attempted to place liability on assignees - holding Wall Street’s feet to the fire for the securitization of predatory loans. The legislation got through the house with less teeth, notably the assignee liability was eliminated, but it is in the Senate right now and should become law in one form or the other in the near future.

This law was the shot across the bow of Wall Street, investors and banks everywhere. With loans going sour at an ever-quickening pace; the specter of assignee liability was too much to handle. Investors who were bleeding cash left and right, wanted to make no further bets in an uncertain legal environment. This move effectively locked up the secondary market - as if it needed any more locking up - and put investors on notice that future bets may be laden with risks far beyond that of simple dollars and cents.

This lack of investor confidence was further exacerbated by the ne’er-do-well judges who started throwing banks and trustees out of court citing a lack of proper documentation as the interested parties in a foreclosure. This added further to the legal uncertainty for investors and ensured that the secondary market remained iced-over as investors flocked for the hills. As PJ at Housing Wire wrote - the judges’ decisions were less important than the media hyped them to be; but they were enough for an already shell-shocked investment market to keep any early money on the sidelines.

Rating Agency Fraudsters Escape

The ratings agencies were finally exposed as the paid frauds they truly are; taking money for ratings in one of the biggest scams this side of the monopolies of the early 1900’s. They took crap, turned it in to pure gold and helped their paying customers make a fortune. Unfortunately, as things quickly unraveled the ratings agencies reacted much too slowly. Fearing legal and business ramifications they have been slow to recategorize assets and lower ratings on myriad debt issuances. This has continued to haunt the institutions that holds the debt - playing more in to uncertainty than anything else. This isn’t an orderly mark down; this is covering your ass by leaking out downgrades. It has done more than any other single factor to keep uncertainty in the market place. When no one knows what the junk they hold is worth (compared to everyone else’s junk) the market can’t put a price on the outstanding debt.

The government and regulatory bodies have done little to address the ratings debacle and continue to let the ratings agencies set their own rules with little accountability. Until these agencies are compelled to act there will be little in the way of transparency on the value of debt issuances.

Super SIVs and Other Shell Games

The Fed has been unable to ease the credit crunch by lowering interest rates because banks still are uncertain where the true risk lies in the mortgage and housing market. This unknown keeps inter-bank interest rates high because no one wants to be left holding the bag. No one knows who is likely to be with out a chair when the music stops; so they horde the cash to themselves to make sure it isn’t them with out the seat. Paulson, in all his brilliance exacerbated this hording by trying to jimmy a super conduit together from banks that were willing to pony up cash to keep their SIVs and other off-balance sheet liabilities off the balance sheet.

Paulson’s thinking was that this SIV would keep banks from recognizing massive losses on their balance sheets which may have made some banks insolvent. What it did instead was to keep things in the dark. Investors, the market and shareholders couldn’t turn the lights on. If banks brought these items back on to the balance sheet the lights would be turned on. Week banks would get crushed, strong ones would survive, and inter-bank interest rates would come down for the remaining players.

State and Local Governments

State and local governments have added to this miasma by doing what they do best - pandering to their constituencies. First we have the judges of Ohio whom we’ve already touched on; then we have the Governator himself working out rate freeze agreements with major lenders and politicking for loan limit increases in the Golden State. We also have the fine folks of Minnesota outlawing stated income loans and most recently Colorado enacted emergency legislation to limit prepayment penalties.

I get it - these elected hometown officials have to do something; and so they go pell-mell down whatever rabbit hole seems to be the most promising in their own backyard. There is no incentive to think of the big picture - because the big picture doesn’t matter to Jim Brown of Highlands Colorado - Jim Brown is all that matters.

These state-based gyrations (which are loudest in the most “questionable” areas - CA, FL, CO, OH, MI, etc.) continue to keep investors on the sidelines - and add massive amounts of the real culprit in our current fiasco - uncertainty.

The Rub

So here’s the rub - all of these “do gooders” are making the situation exponentially worse. Their rash actions are actually making it HARDER to get financing. Witness the spreads in jumbo vs. conforming loan amounts. Witness the restriction of loan programs. Witness the increase in underwriting stipulations. Witness the interbank rates compared to the Fed. The fact is that all of these bail out programs (which they all are in one form or another) have added MORE uncertainty to the system. They have not improved the psyche of the people with the money. And those are the people that count right now. If the people who hold the cash don’t want to lend it because their return is unclear we’ll never see the calming of the mortgage market.

The idea is not to make Fannie and Freddie buy everything in sight; the idea is to make the mortgage market a transparent and friendly investing environment so that cash returns to the secondary markets (and debt markets in general). Will that take time to work out? Absolutely. Are any of these rash knee-jerk reactions improving the situation? Not at all. We shouldn’t be worrying about how to bail out responsible people. We should be looking at how to fix the credit and debt markets to provide transparency for investors. Transparency builds credibility. Credibility builds confidence. Confidence drives investment. Investment drives down costs of borrowing, increases program expansion and makes markets healthy.

Until we start fixing what is really wrong we’ll continue to struggle in quicksand.

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