Something is On The Way

CNN "reports" Obama's foreclosure fix on the way ("reports" in scare-quotes because Obama's plan is on the way, whether or not it will prove to be a fix is, for the moment, a matter of conjecture).

NEW YORK (CNNMoney.com) -- Obama administration officials are hammering out the details of a $50 billion foreclosure prevention program that the president is set to unveil Wednesday in Arizona, sources said...

The multipart plan will for the first time commit government money to spur loan modifications. One likely component will be interest-rate subsidies for at-risk borrowers, with the government matching the servicer's rate reduction. Borrowers would have to take an affordability test to see whether they could handle the monthly payment on the reworked loan...

On deck is controversial legislation to allow bankruptcy judges to modify loans on primary residences. The financial industry is staunchly opposed to this measure, but administration officials told them last week to expect it to happen this year.

As commented here before, the reworking of debt is one of the things that the free market, ordinarily, does rather well. Incentives are, generally, aligned. Lenders want to be in the business of collecting predictable payments, not seizing and selling homes and borrowers want to live in their homes with payments they can safely afford. When economic circumstances change, markets are, ordinarily, pretty good at renegotiating debt to reflect those changes. Credit Card debt -- which is frequently renegotiated -- is a particularly good example of markets at work. There are three primary reasons why that is not happening as much in the mortgage markets as it otherwise might:

1. Mortgage securities are generally pooled and tranched. Even when renegotiation would favor the pool as a whole (i.e.: maximize the Pool's net income), it is contra the interest of the lowest tiers. Pool Managers/Servicers who do renegotiate face the threat of lawsuit by the lower tranche-holders.
2. Pool Managers/Servicers are often themselves owners of lowers tranches and so face a conflict of interest.
3. Given the -- now proven reasonable -- expectation that the Government will in the future subsidize this debt, it is generally irrational to renegotiate without subsidy.

Again, as noted here, these clogs can all be addressed reasonably without expense to the taxpayer.

1. Pass laws to protect Pool Manager/Servicers who renegotiate from lawsuit.
2. Pass conflict-of-interest laws, to ensure that Pool Manager/Servicers are not beholden to the interests of a particular tranche.
3. Make explicitly clear that no subsidies will be forthcoming.

One has to take a pretty dim view about the efficacy of markets to believe that this can't be sorted out without political or judicial intervention. If markets can't do this, what can they do?

Judicial modification is a particularly hard to understand policy. Without Judicial modification, modification is by negotiation. Lenders, generally, will agree to modifications that they believe maximize their expected revenue, which is to say, turn a more expensive loan which the borrower is less likely to be able to repay into a less expensive loan which the borrower is more likely to repay. With Judicial modification, Judges can force modifications that lenders do not feel will maximize their expected revenue. In as much as we face a national crisis of under-capitalized banks -- we are told that our financial system would have collapsed without TARP providing public capital to banks; "Swedish" style plans where the Government acknowledges the general under-capitalization, seizes bank assets and sorts out winners and losers are increasingly considered -- it is hard to understand how the public interest lies in policy like this that will, above all, serve to reduce bank capital. In as much as we are being told only the government can get credit flowing again, its odd to see the same government pursuing policy which makes lending less attractive.

The $787 billion stimulus package set to be signed into law Tuesday increases the loan limits for mortgages insured under the Federal Housing Administration, as well as those that can be bought by Fannie Mae and Freddie Mac, to as much as $729,500, up from $625,500. The higher limit, which was in effect last year, is designed to help those with larger mortgages refinance into more affordable loans and to make it easier for people to purchase homes in high-cost areas.

To spur home sales, first-time buyers will get a tax credit worth up to $8,000 on their 2008 or 2009 taxes, under the stimulus package. The credit starts to phase out for buyers who make more than $75,000 for singles or $150,000 for couples. This measure, which builds on a tax credit enacted last year, is intended to help soak up the inventory on the market, which is also depressing home values.

There is, perhaps, some sensible argument along the lines of "We have all this bad debt in the system that needs to work its way out quickly, Government can facilitate that happening quicker." It is hard for me to understand arguments for shoveling new soon-to-be-bad debt -- encouraging people with less money to buy more expensive homes -- in the system.