Wednesday, August 18, 2010

Solving the Residential Mortgage Crisis

I have long argued that the solution to resolving the collapse in housing prices is to leave the problem in the hands of the private sector.

The government attempts to prop up the sector simply delay and distort the inevitable. The trillions of MBS instruments purchased by the Federal Reserve have simply resulted in those securities not being marked down to their true value and little being done for those trapped in those who, causing many who can not afford the monthly payments to abandon them.

A recently announced government program will provide money for some who are delinquent in their mortgage payments by at least three months.

So how would the private sector deal with these problems, if the government wasn't distorting the market? Sometimes it is hard to envision how some type of  market would develop if that market is fully operating.

Indeed, for the most part, that is the situation with most of the housing market. However, there are small pockets of free market activities in the housing market that can teach us how a large scale private sector resolution of the housing crisis might occur. WSJ, today, details one such pocket of free market activity:

Anna and Charlie Reynolds of St. George, Utah, were worried about losing their home to foreclosure last year. Then they got a lucky break—from an unlikely savior.

Selene Residential Mortgage Opportunity Fund, an investment fund managed by veteran mortgage-bond trader Lewis Ranieri, acquired the loan at a deep discount and renegotiated the terms with the Reynolds. The balance due was cut to $243,182 from $421,731, and the interest rate was lowered. That reduced the monthly payment to $1,573 from $3,464, allowing the family to stay in their home despite a drop in Mr. Reynolds' income as a real-estate agent. "It was a miracle," says Ms. Reynolds.

But Mr. Ranieri isn't your typical miracle worker. As a fund manager who was once vice chairman of the bond-trading firm Salomon Brothers, he's a member of the Wall Street crowd that is often pilloried for helping inflate the housing bubble, though he sat out the excesses of recent years. The 1989 book "Liar's Poker" made him famous for billion-dollar trades in mortgage bonds and junk-food "feeding frenzies" with his trading-desk buddies.

As the nation struggles with the worst foreclosure crisis since the 1930s, Mr. Ranieri's investment fund and others like it are emerging as the best hope for the roughly seven million U.S. households behind on their mortgage payments. Nimble, flush and willing to strike deals with borrowers, these funds have an edge over banks and other lenders that can be mired in bureaucracy and hampered by government rules about which loans can be renegotiated and how....

Cutting the loan balance is one of the most effective ways to motivate borrowers to resume payments because it gives them more hope of eventually owning the home, say nonprofit groups that work with distressed borrowers...

Around 90% of Selene's loan modifications involve reducing the principal, compared to less than 2% of the modifications done by federally regulated banks in the first quarter...

Selene buys loans to make a profit on them, not as a public service, but company officials say it is often more profitable to keep the borrower in the home than to foreclose. If a delinquent loan can be turned into a "performing" loan, with the borrower making regular payments, the value of that loan rises, and Selene can turn around and either refinance it or sell it at a profit. Mr. Ranieri declines to discuss the fund's performance. But one of the shareholders, the Public Employees Retirement Association of New Mexico, reported that its holdings in the fund had a market value of $19.8 million as of June 30, up from $18 million in late 2008. That excludes distributions of profits to shareholders in the funds.

Once Selene acquires a loan, the firm immediately tries to contact the borrower, sometimes sending a FedEx package with a gift card that can be activated only if the borrower calls a Selene debt-workout specialist...

Paul Cheatham, a Houston oil-field engineer with two children, says he was worried about payments rising on his adjustable-rate mortgage and so was eager to talk when he got a registered letter from Selene saying it had acquired his loan and might be able to help. He says Selene was able to arrange lower payments and a fixed interest rate for him within about a month. "They helped me out," says Mr. Cheatham, who had fallen behind on payments because of a drop in income. Selene reduced his balance by $16,000, to $80,000, and his monthly payments to $541 from $831...

One reason Selene has the leeway to help borrowers is that it generally bypasses the federal government's $50 billion Home Affordable Modification Program, or HAMP. The program offers financial incentives to lenders and servicers to modify loans. When President Barack Obama announced HAMP 18 months ago, the program raised hopes among millions of borrowers. As of June 30, however, only about 389,000 households were benefiting from long-term reductions in payments under that program, and 364,000 were in "trial" periods, trying to qualify by showing they could make reduced payments.

Critics say the program is overly complex, unwieldy and revised so often that servicers have a hard time keeping up with the latest requirements for modifications.
It's really time Obama and Geithner get out of the delinquent mortgage business where they are doing nothing but propping up bad loans made by their crony buddies on Wall Street. The entire business should be turned over to the private sector where private operators use price signals to know which mortgages can be saved via restructuring and which should be liquidated.

With the private sector in charge the residential mortgage crisis would have been over months ago. Instead, we have funny money payments to some mortgage holders, banks who aren't writing down their loans and. most scary, a trillion dollars of excess reserves hanging over the economy that could at any moment trigger a huge tidal wave of inflation.


  1. You write: "With the private sector in charge the residential mortgage crisis would have been over months ago. Instead, we have funny money payments to some mortgage holders, banks who aren't writing down their loans and most scary, a trillion dollars of excess reserves hanging over the economy that could at any moment trigger a huge tidal wave of inflation."

    My response is that squatters and bankers both benefit from the FASB 157 entitlement set up by both AICPA and approved of by the SEC.

    Sue McAllister and Eve Mitchell in Oklahoman/McClatchy Tribune article Millions Stay Put, Await Foreclosure Or Help report from San Jose, CA that millions of homeowners are trapped in a bizarre real estate limbo, living in houses but no longer paying for them, waiting and wondering if someone will help them — or throw them out. Some 3.5 Million squatters are now living payment free as the banks are unwilling to foreclose and take a loss on their books, exercising their FASB 157 entitlement and mark the property to managers best estimate rather than mark the property to market.

    FASB 157 is the foundation that enabled the Federal Reserve to proceed with its QE program that traded out 1.2 Trillion and accepted in every kind of toxic debt, like those in Fidelity Capitol and Income mutual fund FAGIX. And in so doing the banks, KBE, and the too large to fail financial institutions, RWW, were capitalized at taxpayer expense, and the overall stock market, VT, was kept from collapsing, at least temporarily. There was a major benefit to the bankers in that they were nationalized and integrated with the US Federal reserve, effectively creating a new form of government, that being state corporatism. The gains of this bloodless coup were privatized to the banks and insightful traders who went long the banks, KBE; the losses were socialized to the taxpaying public.

    Stocks will fall massively lower soon; and banks will commence a new business plan, that being property leasing.

    Once there is a liquidity evaporation stemming from a fast sell off the current sizzling hot US Ten Year Notes, IEF, and the 20-30 US Government Bonds, TLT, due to rising interest rates, ^TNX and ^TYX, or once the Euro, FXE, falls below 127, then the European Financials, EUFN, and banks, KBE, and financials, XLF, will fall significantly, causing European stocks, FEZ, world stocks, VT, and the Russell 2000, IWM, to fall significantly as well.

    Once this happens, banks will become ever more stock market decapitalized, and will turn to foreclosing and leasing properties, as credit and lending becomes non-existent, and as their FASB 157 entitlement and lifeline of support fails to sustain their ability to stay in business: yes a new business model is coming to banking, that being property management on behalf of government.

    With regard to the 1.2 trillion of excess reserves, I believe that the banks will simply keep them on reserve at the Fed in as much as they and the Fed are one-in-the-same.

    I believe in inflation will come as $TYX, and $TNX, the 30 year rate and the 10 year rate skyrocket as bond holder rush to the bond market exit doors.

    Debt Deflation commenced April 26, 2010, brining deflation to currencies, stocks and commodities. There has been a carry trade investment in bonds as well as a monetization of bonds by banks acting as proxy for the Fed. Soon bond deflation will commence. Then total debt deflation will commence. Gold has arisen to be the Sovereign Currency and storehouse of investment value as it broke out August 6, 2010.

  2. I agree fully that the private sector can solve the crisis more effectively than the government. Most real estate investors and private mortgage lenders have recovered despite the fact that bank loans are scarce.

    They don't wait for buyers to come along who will qualify for bank loans, there are too few with the lack of bank lending. Investors create the financing and bundle it with the sale, dramatically expanding the number of buyers.

    The only solution we see to the banks' inability to lend, is for them to implement the TACT Program. Thus they can convert their toxic assets into performing assets, and fix their balance sheets.

    The key challenge is to get bank executives to look into the mirror and find out who's holding them back. It's not the economy, government, or the housing market. Banks need to finance the sale of their own toxic assets. They will be able to sell them at market value rather than perpetuating the downward spiral in prices they create when they dump properties to avoid FDIC takeover.