That is the question on my mind today as still another absurd proposal comes rolling in. The latest is from Steven Pearlstein at the Washington Post. Before we get to his proposal, let's quickly list the proposals to date.
This started with Bill Gross who I am sure is extremely intelligent but still managed to propose to Bush "Write some checks, bail ‘em out, prevent a destructive housing deflation that Ben Bernanke is unable to do." I talked about this in Bill Gross Wants PIMCO Bailout and again in A Gross Challenge.
Bernanke soon followed with his Congressional Bailout proposal as outlined in Bernanke Proves he is a Complete Fool. I am sure with his PhD he is actually a brilliant man, but nonetheless his proposal is complete foolishness.
Barack Obama who is both very intelligent and extremely articulate offered a bailout proposal that is best described as from "Outer Space". I talked about his proposal in ARM Interest Rates Jump Most on Record.
This was followed by Bush's proposal to bailout lenders as outlined in Bush Moves to Aid Lenders. Bush at least has an excuse. No one has ever accused him of being bright.
The latest bailout proposal comes from Steven Pearlstein at the Washington Post as outlined in Forestalling Foreclosures.
[Existing] initiatives, including the plan to be announced today by the Bush administration, have been pretty much limited to modest expansion of existing state and federal programs to help the easiest cases -- those in a position to refinance loans on a sustainable basis.I am actually stunned by the above proposal. For starters Pearlstein claims to have a "market solution" that the market is "unlikely to serve up without the intervention of Fan and Fred".
But even if the majority of problem loans can be refinanced or renegotiated, which is what some officials now believe, that would still mean that hundreds of thousands of families will be forced from their homes and hundreds of thousands of properties will be dumped on an already glutted real estate market.
So I offer here a market-based proposal to deal with the hardest cases -- those in which homeowners find themselves with no equity in the house and incomes so low they cannot possibly sustain their current level of mortgage debt.
The Pearlstein workout process starts where things should have started in the first place -- with the household income of the borrower. Using standard formulas, figure out how much they can afford to pay each month toward interest and principal on a fixed-rate, 40-year mortgage. Then, adjusting for credit score, calculate how large of a mortgage those payments can support.
The size of this new mortgage will be smaller than the old one (otherwise, a simple refinancing would have been possible). The difference between the old amount and the new would define the extent of the problem, the financial gap that now needs to be closed.
.....
But while this is a market solution, it is not one that the market is likely to serve up without the intervention of Fan and Fred. No other entities have the knowledge or the market influence to set the standards for the new instruments or the resources to create a liquid market for them. It is what they were invented for and what they do better than anyone else.
But the companies probably couldn't launch such an initiative without the approval and encouragement of the Bush administration, which hasn't come up with any better ideas but somehow still can't seem to get past its free-market hangups about government-sponsored enterprises.
So, over this Labor Day weekend, when you hear the president or Treasury secretary or their fellow travelers at the Federal Reserve declare they are doing everything they can to deal with the mortgage crisis, remember the old Gershwin song: It ain't necessarily so.
Excuse me, but if it takes intervention, how the heck can it possibly be called a "market solution"? As for Fannie Mae and Freddie Mac, they were NOT a "Market Idea" in the first place but rather a misguided proposal by Congress to make housing more affordable.
There have been some 300+ government initiatives to make housing more affordable and every one of them failed including Fannie Mae and Freddie Mac. The reason they failed is because by promoting housing with tax breaks, cheap loans, the ownership society, etc etc home prices are bound to rise. And rise they did until a blowoff top was reached which is exactly where we are now.
Who Owns the Mortgage?
Let's start with a simple construct. Many of those in trouble have subprime mortgages not owned by either Fannie Mae or Freddie Mac. In fact it might be next to impossible to decide who owns them to see if the lenders are willing to renegotiate the terms of the loan.
Collateralized loans were sliced and diced into tranches, further pooled and sliced again into "CDOs squared" with some investors buying a single tranche and others buying a slice of all tranches. Roughly 18-20% of those debt packages to foreign investors, 18-20% going to pension plans, 18-20% of it going to life insurance companies, and 18-20% of it going to hedge funds (some of which are now bankrupt). I defy anyone to straighten that all out.
To top it off, Fannie Mae cannot state earnings for three years yet a claim is made "No other entities have the knowledge or the market influence to set the standards for the new instruments or the resources to create a liquid market for them. It is what they were invented for and what they do better than anyone else."
Wow! The fact that no one is better than Fannie Mae is either shocking or scary depending on how one looks at it. Nonetheless, let's assume a miracle occurs. Let's assume the complete derivatives mess is untangled immediately (both at Fannie Mae and everywhere else in the universe) and all parties in the mess agree to implement Pearlstein's solution. That's quite an assumption is it not? But I am a known optimist willing to assume nearly anything for the sake of an argument. Are we out of the woods yet?
The Pearlstein Formula
"Using standard formulas, figure out how much they can afford to pay each month toward interest and principal on a fixed-rate, 40-year mortgage. Then, adjusting for credit score, calculate how large of a mortgage those payments can support.
The size of this new mortgage will be smaller than the old one (otherwise, a simple refinancing would have been possible). The difference between the old amount and the new would define the extent of the problem, the financial gap that now needs to be closed."
Under this proposal a person making $25,000 who took out a liar loan on a $500,000 home would only have to make payments based on a $25,000 salary. Brilliant! The bigger the lie, the bigger the reward. No doubt Pearlstein wants to change his proposal already to exclude liar loans. So I will let him. Liar loans are deemed excluded.
But what about the person who decides to lose his job to take advantage of the process? Certainly if one does not have a job one cannot afford to pay a dime. Handling this "properly" requires still more government intervention to decide who can afford to pay what and who is losing a job on purpose.
And what about the obvious drawbacks of discouraging someone from seeking higher paying jobs, working overtime etc etc out of fear of being bumped into a "you can afford a bigger mortgage payment" bucket.
Is there a monitoring agency that keeps track of job status, kids, health, etc etc etc to decide whether or not a mortgage can be adjusted and/or if someone should be working overtime to pay off the original mortgage?
And what happens on a home sale where a guy making payments on a $500,000 home, now worth $250,000 but is making payments based on a $25,000 salary? Untangle that for me.
Which finally leads us to the guy that just says "screw this"! Are there going to be laws preventing someone from moving away? And so on and so forth.
Those are just the easily seen problems. On second thought, those are the problems that should be easily seen by any intelligent person. Yet I see now that they are not easily seen. And what about the unseen consequences of such proposed intervention?
If Obama's proposal was from outer space, then Pearlstein's proposal is perhaps best described as being from the Twilight Zone.
So why do seemingly bright people (obviously excluding Bush) keep proposing absurd bailout plans one right after another after another? It can't be to make the "Mish List of Absurd Housing Bailout Proposals" can it?
Why then is it so hard to simply let the market correct itself?
Questions for Steven Pearlstein
I am really curious. My questions are:
- How can you possibly label "intervention of Fan and Fred" a "Market Solution"?
- Why is it that when it should be perfectly obvious the Fed, Congress, and Fannie Mae etc caused this problem that the proposed solution (yours and others) is still more intervention by the Fed, Congress, and Fannie Mae?
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