And There's That Catch

I haven't posted yet on Bush's mortgage rate freeze plan because it seemed at first glance like a pretty good idea that was, if anything, too generous to people in need. That, though, didn't sound right at all, so I figured I must be misunderstanding. And, indeed, it turns out that Bush has devised a bailout that doesn't help low-income people.

That's more typically Bushian and absurd. Bailouts are always a tricky thing, because you don't necessarily want to insulate people from the consequences of bad decision-making. On the other hand, when there's objective hardship and the ability to help out, it can make a lot of sense to step in. Excluding the worst-off people stands the moral logic of the enterprise on its head.

Comments

The not applying to people who have mortagages for more than the house is now worth pretty much makes the entire program moot.

The only people who need their variable rate mortgages locked are people who are under water. Duh, if you have positive equity you can just refinance anyway.

Posted by Eric K | December 6, 2007 3:14 PM

Eric, actually there's been some discussion in the papers about a credit crunch. You may have seen something on that.

This plan isn't a bailout, and the fact that MY doesn't understand that says everything you need to know.

Posted by Thomas | December 6, 2007 3:46 PM

Thomas,

You seriously think that people who meet all the requirements in Bush's program can't get re-fi's?

Posted by Eric K | December 6, 2007 3:50 PM

Not insulating people from the consequences of their bad decision-making is a nice concept, only it doesn't apply to many or most home-owners caught up in the sub-prime squeeze.

Why? Because the subprime lending industry marketed these loans in unscrupulous ways, often adding onerous terms that they either didn't disclose to borrowers or presented in indeciferable ways. They routinely inflated the incomes of borrowers to justify loans that borrowers couldn't afford (at least after the teaser interest rates expire).

And best of all, they (and colluding appraisers) inflated the valuations of the homes to justify large loan amounts -- which now has the added bonus of making these borrowers ineligible for the Bush rate freeze.

These folks deserve relief, for the simple reason that their predicaments are due as much (or more) to the failure of goverment regulators as to any bad decisions they may have made.

Posted by Dick M | December 6, 2007 3:51 PM

"They routinely inflated the incomes of borrowers to justify loans that borrowers couldn't afford..."

The lenders "routinely inflated the incomes of borrowers"? That sounds about 180 degrees backwards. Do you have any evidence to support this, or are you just proceeding from the premise mortgage lenders = evil; mortgage applicants = good?

Posted by Fred | December 6, 2007 4:03 PM

First, I don't understand exactly how Bush is able to revise the terms of existing mortgages. He can't change terms of contracts by fiat (similarly, Congress can't change the terms of contracts by legislation). I assume that he's offering an incentive (i.e. money) to lenders in exchange for them allowing some borrowers to keep their lower teaser rates. And I assume that if the lenders are accepting this deal, they are doing so because what they are getting from the federal government is worth more than what they would get from enforcing the terms of the subprime mortgages that qualify for this program.

Also, I don't understand what happens to people who are allowed to keep their lower teaser rates. Their mortgage debt won't go away -- they're just paying it off at a slower rate and adding to the term of the mortgage. If housing prices keep falling, won't these people just end up deeper under water? It might be possible to keep some people's monthly payment down, but it's not possible to force housing prices to rise, at least in the long term. Besides, aren't artificially high housing prices what go us into this mess in the first place?

Then again, I rent, so what do I know.

Posted by MikeS | December 6, 2007 4:04 PM

"Eric, actually there's been some discussion in the papers about a credit crunch. You may have seen something on that."

1.) In addition to refis, they can also sell if they owe less than their house is worth.

2.) In the present market, the only way that your house is worth more than you owe AND you can't get a refi is if you have crappy credit -- usually because you missed multiple payments. And those people are already excluded by the plan.

This isn't going to help anybody. The only people who (1) have made all of their payments, (2) have positive equity, and (3) have an ARM resetting in 2008-10, don't need a rate freeze to afford their payments. Thus, they are excluded by the plan.

Posted by Joe | December 6, 2007 4:06 PM

"He can't change terms of contracts by fiat (similarly, Congress can't change the terms of contracts by legislation)."

This is about the third place I've read this assertion. It simply isn't true. Congress can absolutely pass a law changing the terms of existing contracts. This has been pretty uncontroversial for a long time -- at least since the Supreme Court implicitly rejected Lochner in 1937 (google "stitch in time saved the nine" if you don't believe me).

Similarly, as long as there is enabling legislation authorizing it, the President can pass regs to the same effect.

Posted by Joe | December 6, 2007 4:12 PM

This is a small bailout. Locking in teaser interest rates for an additional 5 years is giving the homeowners time that they otherwise wouldn't have had. It's saving them interest that they would otherwise have to pay. It's not a big bailout, since they still have to pay the balance of the loan.

This isn't a failure of government regulators. During great booms, foregoing prudence and existing anti-fraud measures is a natural tendency that must be resisted. It happened in the housing market. It happened in the dot-com boom. Convict and jail the people for the fraud if possible, but regulations won't do anything now and it'll only make mortgages more expensive for those that need to refinance.

A bailout is good in that it can prevent a host of social ills that come with foreclosure. But being too generous with bailouts promotes stupid decision making. It's the moral hazard. In the next big bubble-boom, will people learn prudence or instead will they learn that they can count on government to bail them out?

Posted by TanGEng | December 6, 2007 4:13 PM

Eric, there's considerable evidence for an increase in LTV requirements and tightened underwriting standards for prime loans, and the sub-prime market has almost entirely disappeared. So, yes, many of these people would be unable to go to market and refinance today. (And, no, having crappy credit doesn't mean you've missed your payments. It does mean you can't get a conventional loan.)

Posted by Thomas | December 6, 2007 4:35 PM

"First, I don't understand exactly how Bush is able to revise the terms of existing mortgages. He can't change terms of contracts by fiat (similarly, Congress can't change the terms of contracts by legislation)."

The industry leaders have agreed to do this voluntarily. They've already modified small numbers of loans; this would standardize and accelerate the process.

"I assume that he's offering an incentive (i.e. money) to lenders in exchange for them allowing some borrowers to keep their lower teaser rates. And I assume that if the lenders are accepting this deal, they are doing so because what they are getting from the federal government is worth more than what they would get from enforcing the terms of the subprime mortgages that qualify for this program."

First, remember something: if a variable mortgage (particularly a sub-prime one) that a homeowner could barely afford at 7% is set to re-set to 9% -- and the homeowner put no money down, and the house is worth 15% less than the value of the loan -- what exactly does the mortgage servicer gain from re-setting the mortgage to 9%? The servicer will have to foreclose on the house, and unload it in a weak market for a loss.

There is some self-interest on the part of the mortgage industry here: they clearly estimate that their revenue from mortgage payments will be higher with a larger number of borrowers paying current rates than with a smaller number of (non-foreclosing) borrowers paying higher rates. Also, by reducing the number of foreclosures due to variable mortgage resets, this will enable them to get more money on their current foreclosure sales than they would otherwise, with an even higher volume of foreclosures.

The one bone the Feds seem to be planning is a temporary expansion on the dollar value of FHA loans, which will be a boon to both borrowers and the mortgage industry (but may will put more weight on the sketchy balance sheets of the GSEs).

Posted by Fred | December 6, 2007 4:38 PM

Joe --

Thanks for the info. Do you know what kind of scrutiny the court applies to the federal governments ability to change to terms of contracts? I assume it's limited in some way (or maybe it's not).

The bigger question I guess is if this is a deal with the mortgage industry (which I assume would be structured in a way that benefits the mortgage industry), or is he just ordering the mortgage industry to allow some people to keep paying at lower rates?

Either way, I would bet my left nut that the purpose of this mortgage relief is just a way to preemptively deflect criticism from whatever bailout of Wall Street that you know is coming.

Finally, as to the moral hazard of bailouts, I've taken a person vow to get as deep as I can into the next bubble, whatever it may be. I'm dead serious.

Posted by MikeS | December 6, 2007 4:59 PM

Dick: It was liar's poker all around. Borrowers did not act responsibly -- anyone who doesn't pay a lawyer to look over a document BEFORE they borrow a half-million dollars likely DOESN'T want to know the terms and conditions. Lenders? Well, fucking people is what they do. This is a surprise? I'm kind of slow. Presented with the same dilemma as the poor lambs who borrowed more than they could afford, I took a fixed-rate loan for less than the lender said I could qualify for. I didn't let somebody else do the math for me. And I scarcely understand how propping up bad investments by houseowners will stanch the bleeding in the RE and credit markets.

People knew what they were getting into. A government-directed bail-out fucks responsible savers and borrowers six ways from Sunday. This is NOT about making people homeless; rentals are abundant. This is about expecting people to divest of an asset that they cannot afford to keep.

Posted by Jamey | December 6, 2007 5:04 PM

Mike S.,

I think I've answered some of your questions above, if you want to take a look. As for this:

"Finally, as to the moral hazard of bailouts, I've taken a person vow to get as deep as I can into the next bubble, whatever it may be. I'm dead serious."

Just be sure you don't get in deep as a shareholder. Then no one will come to your rescue. Today's latest victims are the shareholders of Delta Financial Corporation, which was considered, earlier this year, to be one of the most well-run mortgage lenders by a leading value investor.

Posted by Fred | December 6, 2007 5:08 PM

"Do you know what kind of scrutiny the court applies to the federal governments ability to change to terms of contracts? I assume it's limited in some way (or maybe it's not)."

Rational relationship.

In various egregious situations, there might be a Fifth Amendment takings claim. Perhaps if the government passed a law saying that no existing contracts could require borrowers to ever pay back a loan. But the Court has been pretty clear for a long time that regulating economic activity does not constitute a "taking," even where this regulation causes detrimental economic effects to one party or another. Epstein has a quasi-masterpiece on this (called "Takings," I think, though I haven't paid much attention to Epstein since he pelted me with chalk in the late 90s). So a law capping interest rates, even retroactively, would almost undoubtedly be considered constitutional. In fact, I bet this happens all the time with respect to state usury laws and credit cards.

There also is a statutory construction argument -- basically, statutes should always be interpreted in a way that they are (rebuttably) presumed not to apply tetroactively. BUT, (1) this presumption could easily be overcome by simply saying "this law IS intended to apply retroactively" in the preamble or somesuch, and (2) it is debatable whether requiring interest to be paid at certain amounts on a going-forward basis would be "retroactive" (basically, the argument that it wouldn't would be that the law regulated performance under the contract, which has yet to occur).

Posted by Joe | December 6, 2007 5:18 PM

Jamey,

I got my mortgage in the old days, back in 2000. 20% down and a loan equal to only about 2x my annual income (at 8.5%!). I was also told I would qualify for more, but like you I preferred to keep some powder dry. As for this comment of yours though:

"This is about expecting people to divest of an asset that they cannot afford to keep."

As I understand it, this rate freeze won't apply to those who can't afford their current teaser rates -- they'll still get foreclosed if they don't pay. I agree, they won't end up on the streets. They'll just go from a house they couldn't afford to an apartment they can. This doesn't look to be a perfect deal, but it should slow the slide in real estate values somewhat by putting a few tranches of rate reset-caused foreclosures on hold.

In any case, this deal is motivated more by politics than economics. The market seems to already have started the clearing process -- see, for example, homebuilder Lennar's deal to offload hundreds of millions of dollars of its land inventory.

Posted by Fred | December 6, 2007 5:18 PM

No, Fred, I really don't have it backwards. Predatory mortgage lenders -- most of them brokers, or lenders who quickly resell their loans -- really do inflate the incomes of potential borrowers, because they don't care if the borrower defaults. They just want the up-front fees. If it's evidence you want, how's this:
"One of the most common practices committed by predatory mortgage brokers or lenders at the time of application is obtained is falsifying the borrower's information, especially the income level." National Consumer Law Center
http://www.mi.vt.edu/data/files/hpd%2015(3)/hpd%2015(3)_article_renuart.pdf
or this
"Some predatory mortgage lenders knowingly make loans to unsophisticated homeowners who do not have sufficient income to repay the loan... Knowing that these loan files may be reviewed at a later date by subsequent purchasers, such lenders have the borrowers sign a blank application form and then insert false information on the form, claiming that the borrower has employment income that she does not, so it appears that she can make the payments."
Bank Fraud Victim Center
http://mortgage-home-loan-bank-fraud.com/report1a.html
And don't get me started on the other hard-to-believe scams these lenders pull on unsophisticated borrowers: unaffordable balloon payments, immense prepayment penalties, and more. Really a sordid business.
As for the argument that regulation would dry up mortgage opportunities couterproductively, it may sound logical but it just ain't true. North Carolina has enacted by the most stringent laws in the country against predatory mortgage lending, and they haven't slowed the growing in new subprime loans at all. Only subprime refinance loans -- where most predatory lending occurs -- saw a decline.

Posted by Dick M | December 6, 2007 5:28 PM

And Jamey, I don't know how to respond to your comment, except to suggest that you get a clue -- or a heart. Most of the victims of the predatory subprime loans are working poor, mostly minority, often first-time homeowners. Or they're elderly folks whose only asset is their home, and who got blitzed with agressive, misleading marketing come-ons that promised them the world. They aren't getting half million dollar homes and they don't have lawyers. And now they don't have any equity any more either, nothing to pass on to their kids or to fall back on if a crisis hits. Nothing you're concerned about though, huh?

Posted by Dick M. | December 6, 2007 5:40 PM

DickM,

"One of the most common practices committed by predatory mortgage brokers or lenders at the time of application is obtained is falsifying the borrower's information, especially the income level."

Are you suggesting this was done without the consent of the borrower? That they signed an application with their correct salary information and then the mortgage lender crossed it out and wrote something else? As for the mortgage applicants who signed a blank application -- that would seem to be the height of stupidity and imprudence, but I guess neither is a crime.

"As for the argument that regulation would dry up mortgage opportunities couterproductively, it may sound logical but it just ain't true. North Carolina has enacted by the most stringent laws in the country against predatory mortgage lending, and they haven't slowed the growing in new subprime loans at all."

I think more stringent regulation at this point would be like closing the barn door after the horses ran out: there doesn't seem to be much market for sub prime mortgage-backed securities; hence, not much funding for sub prime mortgages; so many of the lenders that focused on that segment are now out of business, since they weren't able to securitize their loans. If it's true that North Carolina has bucked this national trend that would be interesting news.

Posted by Fred | December 6, 2007 5:42 PM

Fred,
Nice pivot on the inflating borrowers' income bit. How about acknowledging that I was right -- not 180 degrees wrong as you suggested?
The answer to your first follow-up question is, yes, this is typically done without the consent of the borrower, either by signing a blank form or allowing the broker to fill it out for you and not double-checking to make sure it's accurate. And yes -- by the ethos of highly educated, financially sophisticated people (which I assume includes you) -- that's not a good idea. But that's not who got swept up in the great sub-prime, predatory mortgage free-for-all, is it?
As to your second question, I'm not an expert on the mortgage market, so I don't know where things are headed in the short-term (in North Carolina or anywhere else). But I still think it's a sound idea to make it illegal for folks to blatantly scam unsuspecting, unsophisticated consumers on the single most important financial decision of their lives.
As Elizabeth Warren at Harvard puts it, if our economy can stay afloat with a consumer product safety commission to make sure our toasters are safe, can't we also afford a financial product safety commission to make sure our financiers are safe as well?

Posted by Dick M | December 6, 2007 6:14 PM

Dick, what does that even mean? I know I don't want my toaster to explode, but there are reasons I might want a balloon payment structure for my mortgage. I have a fixed rate interest only loan, with the initial payment fixed for ten years. Is it "safe"? I think so, but perhaps the good Professor Warren would prefer something else for me (or perhaps would like the right to butt into my financial decisions, since she's so much smarter than me).

We have laws against fraud already. In the examples you give, the lenders have been defrauded by the mortgage brokers. There is civil and criminal liability for the acts. What additional regulation is needed?

Posted by Thomas | December 6, 2007 6:30 PM

"predatory subprime loans"

what a hoot! and the first poster thinks that people who have negative equity should get a rate freeze!

That's right, the government should encourage deadbeats!

The left is criticizing Bush for not going far enough. I long for a real Republican president like Bill Clinton. Seriously, if the government wants to keep neer-do-wells in houses they cannot afford, maybe the government should refi the loans

or Brad and Angelina can

Posted by Jozef | December 6, 2007 6:49 PM

DickM,

If the bulk of loans that didn't require documentation of income (i.e., "liar loans") had the applicants' incomes fudged by mortgage lenders, then you are right. Absent a detailed breakdown on this, I'd have to presume that at least as much fudging was done willingly by borrowers. So perhaps instead of being 180 degrees wrong, you were off by 90 degrees.

As far as regulatory approaches to this, the point of these no-doc loans initially was to used for self-employed business people, who had the means to qualify for mortgages, but not the salary documentation. It is already illegal to falsify mortgage loan application information.

As for complexity and risk of loan terms, the approach that is taken with many sophisticated or illiquid investment products is to limit them to "qualified investors" (i.e., rich people), which I happen to think is undemocratic and unfair -- what if you are sophisticated but don't have millions of dollars in the bank? Perhaps another approach -- for investments and well as mortgages -- would be to require some sort of IQ test before allowing people to get certain types of mortgages (e.g., ones with balloon payments) or buy certain kinds of investments (e.g., restricted stock).

Posted by Fred | December 6, 2007 6:53 PM

"You mean there's a catch?"

"Sure there's a catch," Doc Daneeka replied. "Catch-22. Anyone who wants to get out of combat duty isn't really crazy."

There was only one catch and that was Catch-22, which specified that a concern for one's own safety in the face of dangers that were real and immediate was the process of a rational mind. Orr was crazy and could be grounded. All he had to do was ask; and as soon as he did, he would no longer be crazy and would have to fly more missions. Orr would be crazy to fly more missions and sane if he didn't, but if he was sane he had to fly them. If he flew them he was crazy and didn't have to; but if he didn't want to he was sane and had to. Yossarian was moved very deeply by the absolute simplicity of this clause of Catch-22 and let out a respectful whistle.

"That's some catch, that Catch-22," he observed.

"It's the best there is," Doc Daneeka agreed.

Posted by Jeffrey Davis | December 6, 2007 6:54 PM

because you don't necessarily want to insulate people from the consequences of bad decision-making

You have to be kidding Matt. This is Democrats' whole raison d'etre.

Posted by Homer | December 6, 2007 6:57 PM

Thomas, some predatory practices are clearly misleading or subject to abuse, but still difficult to prosecute on a case by case basis. Until recently, most of the subprime lenders were routinely adding "single-premium credit insurance" as a lump sum into their loans (with or without telling borrowers). That's a product that any financial advisor will tell is a rotten deal. Now you could try to go and find every case in which the lender committed outright fraud in selling this unneeded add-on, or you could just pass a law saying, hey, that's just not a legitimate product and you can't sell it any more. I vote for that second option.

I don't know of any proposed regulations to ban balloon payments outright, but I think it does make common sense to impose rules preventing lenders and brokers from making loans that borrowers clearly won't be able to afford repaying. In general, I'm think it makes sense to regulate any loan term that has been widely used to the disadvantage of less sophisticated borrowers, especially those that are added frequently without the borrowers' knowledge.

And what do I mean by regulate? For some practices (like single-premium credit insurance), an outright ban. For others (like large balloon payments), a clear truth in lending requirement ensuring that borrowers are clearly informed about the loan term and offered other alternatives. The general underlying principle is that the law should require mortgage brokers to act in good faith and not in ways that clearly conflict with the best interests of borrowers.

Posted by Dick M | December 6, 2007 8:17 PM

The people who foolishly agree to be "bailed out" (wink) will go on making monthly payments on an already upside down mortgage for a house in which they have little or no equity and whose value will continue to decline. Any body with one live brain cell in his/her head would drop the keys off at the bank and look for an apartment.

The price of an education is always high.

(Funny nobody remembers George C. Scott's line in the "Flim Flam Man": "You can't cheat an honest man.")

Posted by kafka | December 6, 2007 8:19 PM

Fred, I don't honestly know what percentage of the subprime loans include predatory terms or are sold through predatory means, but it's substantial. I do know that many mortgage brokers receive extra income for steering borrowers to loans with higher interest rates than their credit scores qualify them for. (Maybe regulators could outlaw that practice?) I also know that minorities are disproportionately steered to the subprime market, and that in 2004, Federal Reserve Governor Edward Grammick estimated that half of subprime borrowers have credit scores of 620 or higher -- which should be enough to qualify for a cheaper conventional mortgage.

As for your notion of an IQ test, oh my. Maybe you could just walk that one back a little. For the millions of Americans descended from slaves and subject to segregation and discrimination and widespread red-lining until only a generation ago (at best), for all the tens of millions of immigrant families from lands where the mortgage market doesn't exist, for all the elderly who bought their homes an FHA loan 35 years ago and are getting the hard-sell from slick mortgage brokers promising them the moon... Do you think the only difference between your ability and theirs to find an advantageous loan product is that you have a higher native intelligence? If so, then I'll start wondering about your IQ.

Posted by Dick M | December 6, 2007 8:19 PM

I don't think the problems we see now are the result of unscrupulous mortgage lenders. I do think that there was a glut of mortgage lenders, which resulted in many of them lowering standards in order to sell mortgages. There's a finite number of good mortgage risks and then a whole spectrum of less-than-good risks out there. With so many lenders trying to sell mortgages, they couldn't be as choosy as they might have liked to be. So they started selling mortgages to less than great risks, and now they're paying the price. Some are going out of business. That's the free market for you.

What I've never understood is why a borrower would agree to an ARM in the first place given the historic low rates of the past 5-7 years. If interest rates are more or less bottomed out, then why would anyone think they could go lower? It's a mystery to me.

Posted by Kurzbein | December 6, 2007 8:50 PM

Re: The lenders "routinely inflated the incomes of borrowers"? That sounds about 180 degrees backwards.

For once I agree with Fred, if only because I have seen how this sort of thing works up close (through cousins who were in the housing speculation business recently). Basically the lenders and borrowers colluded on this. The lenders said "You need to say you have X$ in income to qualify" and the borrowers wrote down $X and signed the forms and the lenders accepted it without checking, both parties winking and smiling at the deception.
By the way, if there are lenders who did deceive their borrowers we ought throw the book at them, but there was a lot of fraud on the part of the borrowers too, many of whom were not simple-minded young folk looking to buy a house and start a family, but rather folks like my improvident cousins, looking for a get-rich-quick scheme.

Re: First, I don't understand exactly how Bush is able to revise the terms of existing mortgages.

I'd like to know that too. Of course the Feds do have some very effective ways of leaning on mortgage holders. I would imagine telling them that they either cooperate or they will be banned from selling their mortgages to Freddie and Fannie would make most of these guys pretty eager to sign up.

Re: point of these no-doc loans initially was to used for self-employed business people, who had the means to qualify for mortgages, but not the salary documentation.

Presumably even they would have tax returns and bank statements they could use to document income.

Re: Any body with one live brain cell in his/her head would drop the keys off at the bank and look for an apartment.

And live with ruined credit and bill collectors calling them and, in cases of voluntary abandonment as you suggest, quite possibiliy the IRS coming after them with a whopping big tax bill after the mortgage holder charges off the property and notifies the IRS of a debt amnesty. How much income tax do you think you would owe on, say, 300K of amnestied mortgage loan? Oh, and taxes can't be discharged in bankruptcy either.

Posted by JonF | December 6, 2007 9:14 PM

"What I've never understood is why a borrower would agree to an ARM in the first place given the historic low rates of the past 5-7 years. If interest rates are more or less bottomed out, then why would anyone think they could go lower? It's a mystery to me."

Alan Greenspan publicly encouraged people to use ARMs mortgages for home purchases in January 2004. Any plausible explanation for this wouldn't be reassuring.

Posted by kafka | December 6, 2007 9:18 PM

"I also know that minorities are disproportionately steered to the subprime market..."

This is basically the mirror-image of the standard liberal complaint from ~15 years ago. Back then, the lament was that lenders weren't giving enough credit to minority communities; now lenders are "preying" on them, by giving them too much credit.

"As for your notion of an IQ test, oh my. Maybe you could just walk that one back a little."

I could walk that one back, but then I'd start seeing the logic behind requiring IQ tests for all kinds of stuff: for example, if variable mortgages are too complicated for you to understand, can we trust you to understand enough about debt and interest to vote intelligently on a referendum about a municipal bond issue? Of course, since literacy tests were used in the past in the South to keep blacks from voting, a common sense idea like requiring some minimal level of intelligence to vote is now politically verboten. Even requiring voters to be able to read English or show proof of citizenship is considered unacceptable.

"for all the elderly who bought their homes an FHA loan 35 years ago and are getting the hard-sell from slick mortgage brokers promising them the moon..."

It's tough for even a "slick" mortgage broker to get an old coot to refinance his 5% 30-year fixed-rate mortgage when that mortgage has been paid off for five years.

"If so, then I'll start wondering about your IQ."

If you keep thinking that there is no greed and duplicity among mortgage borrowers trying to live above their means, the suspicion will be mutual.

Posted by Fred | December 6, 2007 10:12 PM

Alan Greenspan publicly encouraged people to use ARMs mortgages for home purchases in January 2004.

What Greenspan said was inexplicable, and I haven't reached the point in his book yet where he tries to rationalize it.

But, I have not understood the logic of this specific critique.

Everyone is saying that the borrowers were on the short end of the asymetric stick, getting into to trouble because the lenders were abusing the borrower's trust. But these same borrowers, who are working 10 hr a day just to try to put food on the table and a roof over their kids heads, seem to not only know who the heck Greenspan even was, but pay close antention to his pronouncements on CNBC and in the WSJ, and adjust their financial arrangements accordingly.

I don't recal the various lenders on TV using Greenspan the way Haynes uses MJ and Cuba Gooding Jr. Not being present at any of the hard sells by the brokers, did they really use the 'trusted figure' sales technique and say, "you know even Alan Greenspan thinks this is a winning deal?"

Just sayin'

Posted by Kolohe | December 6, 2007 11:53 PM

"But these same borrowers, who are working 10 hr a day just to try to put food on the table and a roof over their kids heads, seem to not only know who the heck Greenspan even was, but pay close antention to his pronouncements on CNBC and in the WSJ, and adjust their financial arrangements accordingly."

My comment was not an attempt to turn Alan Greenspan into yet another excuse for the borrowers. It was intended to get people to think about why the chairman of the Federal Reserve (of all people) would proffer such obvious humbug. I probably should have included something to that effect in my post.

Posted by kafka | December 7, 2007 1:23 AM

kafka-
roger. my post was motivated by seeing this same sort of statement on a lot of the other comment sections as well.

Posted by Kolohe | December 7, 2007 2:24 AM

"I don't understand exactly how Bush is able to revise the terms of existing mortgages."

Bush can't; the loan servicers can.

The scheme was explained pretty well at the press conference where the scheme was announced. There are three parties involved in a loan: the borrower, the servicer, and the investors. The role of the servicer is to collect payments from the borrower and pass the money on to the investors. If the borrower is unable to make payments in full, the investors will suffer a financial loss. In that case, the servicer has a contractual obligation to minimize the loss.

The loan servicer has the option of foreclosing on the property when the borrower fails to make payments, but foreclosure is expensive, so investors are typically better off if the loan is modified to allow the borrower to continue to make payments at a reduced interest rate. So the real question is not why the mortage agreements are being modified, but why industry and the government got together to plan the modifications. This question was not answered at the press conference. I think the answers are:

1) Loan servicers are worried about legal liability when they decide not to demand full payment from borrowers. The agreement defines industry standard practices which are approved by the government, making lawsuits less likely.

2) The Bush Administration wants to be seen as taking action to address the problems of borrowers.

Posted by Kenneth Almquist | December 7, 2007 4:36 PM

What I've never understood is why a borrower would agree to an ARM in the first place given the historic low rates of the past 5-7 years. If interest rates are more or less bottomed out, then why would anyone think they could go lower? It's a mystery to me.

Presumably because the initial rates for ARMs were lower than for fixed-rate mortgages. It is my understanding that fixed-rate mortgages (FRMs) usually have rates that are closer to the average rate (i.e. over the past, say, 30 years) than ARMs. In other words, when interest rates are high, FRMs have lower interest rates than ARMs and when they are low, ARMs have lower rates (put another way, FRMs have to take into account what the standard interest rates will be over the next 15 or 30 years, so when they are low, the assumption is that they will average higher, and when they are high the assumption is that they will average lower).

So basically, those investing in ARMs were not hoping that rates would go even lower, they were just hoping that they would stay where they are (and be lower than the FRM rate, and possibly assuming that they could later refinance with an FRM if their ARM rate got too high). That refinancing might not be available did not apparently occur to them.

Posted by Glaivester | December 7, 2007 7:28 PM