MORE FINANCIAL HAIR OF THE DOG

10/25/11

Yesterday’s Wall Street Journal featured a page A1 story about the latest scheme concocted by the Bush/Obama administration to somehow revivify our moribund economy by facilitating refinancing of severely underwater mortgages. This latest brainstorm involves, essentially, expanding the existing HARP program to borrowers whose mortgage loans exceed the previous HARP limit of 125% of the value of the home that serves as collateral. Under this newest piece of Washington sleight-of-hand, banks will be able to refinance people, without fear that Fannie and Freddie will force those lenders to buy back the loans due to underwriting flaws, whose home loans exceed 125% of their home value if those borrowers can prove they have a job or an adequate source of passive income and that they have made their last six mortgage payment. One of the on time but upside down borrowers who stands to benefit from this program is quoted in the Journal as describing the program as a “win-win.” But this program, like most things that the Bush/Obama administration and other Washington denizens have come up with to “solve” our economic problems, is more like a “lose-lose.”

One of the problems with these easy refinancing programs was cited by Professor Anthony Sanders of George Mason University, who is quoted in the Journal article as saying

“Somebody’s going to get hit. This isn’t a free good.”

What Dr. Sanders was arguing was a point I brought up in my 9/6/11 piece “EXCUSE ME, SANDY, BUT IF I KILL ALL THE GOLFERS, THEY’RE GONNA LOCK ME UP AND THROW AWAY THE KEY”, i.e., that there is another side to this trade, the holders of the mortgage loans, that will lose from early refinancing of their asset that is paying an above market interest rate. But as the Journal reported,

“That doesn’t faze (one of the beneficiaries of such a program). ‘We’ve certainly done enough to prop the banks up. These are loans that everyone knew could prepay.’”

There are at least two things wrong with that statement. First, while it is certainly fashionable, and in some (but not nearly as many as is popularly believed) cases justifiable, to bash the banks, as I said in the aforementioned 9/6/11 piece,

One must have to assume that the mortgages are held by those evil banks to think that refinancing will be the elixir that its proponents would have us believe it will be. But the despicable banks’ holding the lion’s share of this paper is highly unlikely; these mortgages have been packaged into mortgage backed securities (“MBS”s) that serve as the collateral for collateralized mortgage obligations (“CMO”s). These CMOs are held by a whole range of investors either directly or, more likely, indirectly through mutual funds, pension funds, hedge funds, or any number of investment vehicles more or less widely available to individual and institutional investors. When the mortgages are refinanced, these investors must accept even lower yields on their investments. These are people who spend money, or invest money, too; will not their reduced incomes have an impact on the economy?

Second, “everyone knew” these loans could prepay? Well, then, why didn’t they? If “everyone knew,” and, presumably, still knows, that these loans could prepay, why are the taxpayers being asked to subsidize refinancing? But this is something of a digression. The major point is that, like any other trade, a refinancing involves two parties; one wins, another loses. This is true even if one does not like the party that loses, but, in this case, the party that loses may be at least as meritorious, financially, economically, and ethically, as the party that wins. This is not a win-win trade.


Besides the holders’ of the mortgage paper being, er, disadvantaged courtesy of the taxpayers, there is another problem with this particular easy refinancing scheme. While the current standard Republican wisdom that the financial “crisis” from which we are supposedly emerging was the exclusive fault of government intervention in the mortgage markets is overstated and self-serving, such intervention was without a doubt one of the causes of the financial problems our nation, and the world, experienced. In the interest of promoting “putting people into their own homes,” a cause for which George W. Bush was at least as dewy-eyed and sweat browed as Barney Frank, Fannie and Freddie, along with other organs of the government, put the taxpayer on the hook for some very questionable loans. (Yes, I know that Fannie and Freddie were not technically organs of the government and that their guarantees were not guarantees of the U.S. Treasury. How did it turn out, though? That’s right; the implicit guarantee turned out to be quite explicit and the taxpayers were left holding the bag for the Bush/Frank experiment in social engineering.) This was a part, but only part, of the problem.

So what does the Bush/Obama administration propose as a solution to a problem that had part of its genesis in the government guaranteeing shaky loans? Having the government guarantee more shaky loans. One might argue these won’t be shaky loans, but it’s hard to argue that having a job and making one’s mortgage payments for the last six months makes one a stellar borrower. Furthermore, one of the reasons mortgage loans are the most advantageous loans the typical borrower will find in his lifetime, besides the government’s long history of putting its thumb on the scale in favor of "home ownership," is that such loans, properly underwritten, provide the lender with plenty of security, in the form of its mortgage on the underlying property, in the event something goes wrong. The loan, underwritten properly, is well secured. But under the latest Bush/Obama scheme, these loans will not be well secured; the collateral will be worth less, in some cases, far less, than the loan. When I was first being trained in banking, we were forbidden from calling such poorly collateralized loans “secured.” We called them “supported.” But that was a long time ago at a bank (the old National Bank of Detroit) that had a reputation for carefully looking out for the interests of its depositors and shareholders. Such quaint notions are increasingly non-existent now that the sophisticates have taken over the world of finance. But I digress. I don’t know if such terminology is in place in today’s brave new financial world, but, if it were, we would call such loans not “secured,” but “supported,” if indeed we could give them that much credit.

The Bush/Obama administration’s attempting to solve a problem partially born of the government backing lousy loans by having the government back more lousy loans is not at all unusual. In the wake of this crisis, caused not so much by a collapse in housing as by too much spending and too much debt, the braintrusts in both Washington and on Wall Street, broadly defined, have counseled solving the problem by, you guessed it, encouraging people to spend and borrow more. Such is that state of financial, economic, and political thinking today.