Tuesday's enthusiasm for the new administration was not reflected in stock prices. Most markets dropped and continue to be on a downslide. Why are investors so pessimistic? Mostly it has less to do with the Obama administration than concerns about major banks such as Bank of America and CitiGroup. Share prices for banking stocks have taken a beating the last year, but in the last few days prices have dropped closer to dangerous sub $5 zones ($3 for Citi and $5 for BofA). WellsFargo and JP Morgan Chase are not far behind. Even with equity from the TARP 'bailout' investors fear these firms lack enough liquidity to absorb more loan losses.
Some estimates suggest US banks have written off $1 Trillion so far (yes "T") and have another trillion to go...so they are only halfway there. As share prices drop the bank's equity erodes further. This makes creditors nervous so they demand higher returns. The cycle continues as just as banks need more capital they are forced to pay more for it. All of this hurts their ability to make loans and truly make markets. It hurts the firms and the economy.
So the rumor now is one of more of these firms will be 'nationalized'. This could take many forms. Shareholders might be wiped out. This strikes some policy makers as sweet revenge. These firms were mismanaged and the shareholders rode that wave to extraordinary profits year after year. In other models shareholders might be weakened but still alive--similar to the Fannie Mae and Freddie Mac 'conservatory' models. Prices would plummet, but the potential for a comeback might exist. In either case the federal government would manage the banks until they could be sold off--probably in smaller chunks.
But while nationalization may seem to be a way to just 'get the mess cleaned up and move on', it is not so easy. FDIC take overs generally result in heavy costs to the Treasury. Viable parts of the business are sold to existing firms at a discount and the losers get government bail outs. This would take some time and quite a lot of money. Not to mention someone to manage these firms.
Even if it saved some firms, it might undermine others. The markets will become nervous about every bank not on the nationalization list and dump it for fear it might go on the list. And in doing so, more firms would need help and the list grows.
Does any of this matter for consumers? Yes and no. Banking will continue, but the cost of services/products will increase. Borrowers on the margin of qualifying for a loan will be further excluded. And for many years shareholders will likely punish any bank that lends to consumers viewed as 'risky'--which could be code for not White or living in an inner city or even a small business. So this is important in the long run to keep an eye on.
And there is always the danger consumers over react and we need a FDR style bank holiday to restore order. Unless the FDIC looks insolvent this is unlikely however.
What are the alternatives to nationalization? Creditors could be wiped out or debt could be re-organized under bankruptcy provisions. The Treasury has already guaranteed some bank debt so that would be an added cost. Of course more cash infusions could be arranged. This did not seem to work last time (in Oct-Nov) but arguably there the Treasury's investment were not big enough. Another $400 billion just might do the trick. But no one really knows. This is all a grand experiment.
A final option is do nothing. Banks will need to look for ways to shore up their balance sheets without worrying about common stock. Making policy based on volatile share prices is probably never a good idea. Maybe the best approach is wait and see.
Did Obama tip his hand in his address Tuesday? He stated our financial crisis reminds us that “without a watchful eye, the market can spin out of control.” He also stated "The question we ask today is not whether our government is too big or too small, but whether it works." Perhaps we will see some bold new approaches in the coming days and weeks. Or maybe the wait and see approach will prove to be exactly the bold action required.
Thursday, January 22, 2009
Thursday, January 8, 2009
Cram Downs
There have been several articles about mortgage cram downs of late. Today there are reports major lenders may even be willing to accept a new bankruptcy provision in which judges can reduce mortgage principal owed unilaterally so that lenders must write off any balance above the market value of the home. Even the National Association of Home Builders (NAHB) is now in favor.
This idea has been around for a while--but forcefully opposed by industry. The problems often cited include: lenders won't issue mortgage loans or will raise interest rates; judges won't know what true market values are; borrowers will rush to file bankruptcy just to get out of a loan they should have known better than to take out (moral hazard); the bankruptcy courts cannot handle the volume in the exisiting system; and, only lawyers benefit from this.
What's to gain? First, this is one of the only proposals where consumers get a direct 'bail out.' Second, the mere threat may force lenders to do more loan modifications, and may even give lenders more power to force investors to let them do more modifications. Third, it uses an existing structure to get through a financial problem.
There is a long history of the bankruptcy law, revisions and court precedents I won't go into. From an economic point of view having bankruptcy laws are important. They allow firms and consumers to take risks -- think of it a bit like an insurance against financial disaster. (Alternatives like debtor's prison have proved to be less than ideal models.) For various reasons education loans and mortgage loans have received special treatment in bankruptcy. The terms of the loans might be altered in bankruptcy during a repayment period, but the principal cannot be washed away. Cram downs change all that.
Is this a good idea? Well, let's just say it is an idea. Like so many other ideas suggested over the last year to address foreclosures. It will have effects, some intended and some not intended. The key will be to set some limits around how this 'cram down' provision is used. The bankruptcy system would choke if the estimated 8-10 million borrowers who owe more than their home is worth tried to file. Some borrowers would no doubt abuse the system. Judges will make mistakes in marking homes to market values. Some lenders would restrict lending for some time. In the end this is unlikely to be either a disaster or silver bullet...
My guess is lenders are now in favor to (1) throw a political bone as they digest their billions in government investments (2) provide some threat to investors to allow more modifications (3) hope maybe this slows the cycle of foreclosures and falling home values (this is the NAHB's talking point).
The reality is bankruptcy is costly for consumers. Not just the fees (which certainly benefits bankruptcy attorneys, a sector of the profession with some less than reputable actors), but also the damage to credit records which remains for 10 years - 3 more than a foreclosure. And to file consumers have to get counseling prior and take financial education after, account for all income, assets and expenses, and restructure their budget. When they do go back to the credit market they will for sure pay more for credit than before.
Will lenders cut back on lending in the future? Probably, but only at the margins. Low downpayment non-recourse loans seem far less likely for lower-income borrowers, especially those more likely to file for bankruptcy or in historically volatile housing markets. This may not be entirely a bad turn of events.
Will more consumers seek out risky mortgage loans armed with the knowledge of a potential cram down? Probably not. The lure of homeownership remains strong, so few are likely will decide to buy a home only if cram downs are passed.
Some homeowners who are on the fence about defaulting because they owe more than their home is worth may ride out a slump in home values, keep on paying and not file for bankruptcy because they know the costs -- which is exactly the 'insurance-like' role we might hope for.
Other homeowners in real trouble - from a job loss or because of a predatory loan - may really benefit from filing and getting principal reduced (let's hope any illegal predatory loans get prosecuted however).
A few sophisticated borrowers may even be able to use the threat of bankruptcy to induce lender concessions in or before default.
Like so many other strategies proposed in this crisis, only time will tell. A few provisions being suggested may help--such as only for loans made before the cram down law passed and only partial reductions in principal unless there was a violation of lending disclosures. Anything that helps target this to the consumers best served will go a long way.
This idea has been around for a while--but forcefully opposed by industry. The problems often cited include: lenders won't issue mortgage loans or will raise interest rates; judges won't know what true market values are; borrowers will rush to file bankruptcy just to get out of a loan they should have known better than to take out (moral hazard); the bankruptcy courts cannot handle the volume in the exisiting system; and, only lawyers benefit from this.
What's to gain? First, this is one of the only proposals where consumers get a direct 'bail out.' Second, the mere threat may force lenders to do more loan modifications, and may even give lenders more power to force investors to let them do more modifications. Third, it uses an existing structure to get through a financial problem.
There is a long history of the bankruptcy law, revisions and court precedents I won't go into. From an economic point of view having bankruptcy laws are important. They allow firms and consumers to take risks -- think of it a bit like an insurance against financial disaster. (Alternatives like debtor's prison have proved to be less than ideal models.) For various reasons education loans and mortgage loans have received special treatment in bankruptcy. The terms of the loans might be altered in bankruptcy during a repayment period, but the principal cannot be washed away. Cram downs change all that.
Is this a good idea? Well, let's just say it is an idea. Like so many other ideas suggested over the last year to address foreclosures. It will have effects, some intended and some not intended. The key will be to set some limits around how this 'cram down' provision is used. The bankruptcy system would choke if the estimated 8-10 million borrowers who owe more than their home is worth tried to file. Some borrowers would no doubt abuse the system. Judges will make mistakes in marking homes to market values. Some lenders would restrict lending for some time. In the end this is unlikely to be either a disaster or silver bullet...
My guess is lenders are now in favor to (1) throw a political bone as they digest their billions in government investments (2) provide some threat to investors to allow more modifications (3) hope maybe this slows the cycle of foreclosures and falling home values (this is the NAHB's talking point).
The reality is bankruptcy is costly for consumers. Not just the fees (which certainly benefits bankruptcy attorneys, a sector of the profession with some less than reputable actors), but also the damage to credit records which remains for 10 years - 3 more than a foreclosure. And to file consumers have to get counseling prior and take financial education after, account for all income, assets and expenses, and restructure their budget. When they do go back to the credit market they will for sure pay more for credit than before.
Will lenders cut back on lending in the future? Probably, but only at the margins. Low downpayment non-recourse loans seem far less likely for lower-income borrowers, especially those more likely to file for bankruptcy or in historically volatile housing markets. This may not be entirely a bad turn of events.
Will more consumers seek out risky mortgage loans armed with the knowledge of a potential cram down? Probably not. The lure of homeownership remains strong, so few are likely will decide to buy a home only if cram downs are passed.
Some homeowners who are on the fence about defaulting because they owe more than their home is worth may ride out a slump in home values, keep on paying and not file for bankruptcy because they know the costs -- which is exactly the 'insurance-like' role we might hope for.
Other homeowners in real trouble - from a job loss or because of a predatory loan - may really benefit from filing and getting principal reduced (let's hope any illegal predatory loans get prosecuted however).
A few sophisticated borrowers may even be able to use the threat of bankruptcy to induce lender concessions in or before default.
Like so many other strategies proposed in this crisis, only time will tell. A few provisions being suggested may help--such as only for loans made before the cram down law passed and only partial reductions in principal unless there was a violation of lending disclosures. Anything that helps target this to the consumers best served will go a long way.
Monday, January 5, 2009
Foreclosure Assistance
Much has been made in the media of late about the quality of loan modifications being made and if these really prevent foreclosures or just delay them. The data on re-default of modified loans looks like at least half run into further payment problems. Although we really need to know more about which loans were offered mods and on what terms before reading too much into this. In the past lenders used mods as a 'last resort' to borrowers in deep trouble. For better or worse mods are starting to be used earlier and for more borrowers with a better balance sheet going in. Of course unaffordable payments and being under water (debt>home value) can happen under a mod, too, so we'll never see stellar performance unless the mod cuts principal and interest.
Thanks to my colleagues at MortgageKeeper Referral Services Inc. the data below provides some evidence of the situation borrowers in default face. MortgageKeeper is used by credit counselors and loan servicers--most notably the 888-HOPE Hotline counselors--to make referrals to local services depending on what the borrower talks about on the phone. For example, a borrower who is behind may blame being out of work as a cause of falling into default, so the counselor looks up a number for an unemployment office in the MortgageKeeper database. There are something like 16 service categories for service agencies in MSAs with the highest rates of foreclosure (45 cities and counting). The chart below is based on 67,500 referrals made to borrowers in 2008 (one borrower could have more than one referral). The red bars are as of December, the blue bars as of June.
Source: MortgageKeeper Referral Services, Inc.
2008 referrals to services (67,500 total referrals)
What is notable here are the jumps in the last two categories: Job Training and Heating/Utility Bills. Heating and Utility assistance moved from 1 in 5 to almost 1 in 3 referrals. December's weather likely plays a role here, but clearly this is a major expense stretching budgets (see previous post).
More interesting is the Job Training category. Job training has jumped from 13% to 23% of all referrals. This suggests people are not just unemployed ("Unemployment Assistance" covers that), but looking to change what they do. Obviousily this will take time. It also suggest workers are trying to adapt to changes in the overall economy, as whatever they used to do no longer seems viable. While a small share of all referrals, child care more than doubled to 7% of referrals. This is likely connected as people move into new jobs requiring different child care arrangements or lower-cost/subsidized care.
Note also the incidence of legal services. The exact nature is unclear, but likely related to financial issues - perhaps the mortgage, another source of credit or even intent to file for bankrupty. If proposals to change the bankruptcy law to allow judges to "cram down" changes in mortgages (basically in involuntary modification) this category is likely to grow signficantly.
The Misc/Other category includes issues such as "Substance Abuse" "Reverse Mortgages" "Income Tax Assistance" "Worker's Comp/Disability" "Mental/Family Counseling" and "Pharmaceutical and Medical Costs". In general these have not garnered many referrals however.
What's all this tell us? Well, first that consumers probably need more than just a 'new' loan. They need to get childcare, get re-trained in another field, get organized and back to work. This a bigger task than most lenders are willing to support. Local services can play a role, but consumers need to know enough to take some steps. Second, the data on utility bills suggest basic budgeting is in demand. Consumers should be prepared for higher energy costs each winter. On the bright side falling energy cost ought to lending a helping hand to borrowers trying to stretch their budgets.
Thanks to my colleagues at MortgageKeeper Referral Services Inc. the data below provides some evidence of the situation borrowers in default face. MortgageKeeper is used by credit counselors and loan servicers--most notably the 888-HOPE Hotline counselors--to make referrals to local services depending on what the borrower talks about on the phone. For example, a borrower who is behind may blame being out of work as a cause of falling into default, so the counselor looks up a number for an unemployment office in the MortgageKeeper database. There are something like 16 service categories for service agencies in MSAs with the highest rates of foreclosure (45 cities and counting). The chart below is based on 67,500 referrals made to borrowers in 2008 (one borrower could have more than one referral). The red bars are as of December, the blue bars as of June.
Source: MortgageKeeper Referral Services, Inc.
2008 referrals to services (67,500 total referrals)
What is notable here are the jumps in the last two categories: Job Training and Heating/Utility Bills. Heating and Utility assistance moved from 1 in 5 to almost 1 in 3 referrals. December's weather likely plays a role here, but clearly this is a major expense stretching budgets (see previous post).
More interesting is the Job Training category. Job training has jumped from 13% to 23% of all referrals. This suggests people are not just unemployed ("Unemployment Assistance" covers that), but looking to change what they do. Obviousily this will take time. It also suggest workers are trying to adapt to changes in the overall economy, as whatever they used to do no longer seems viable. While a small share of all referrals, child care more than doubled to 7% of referrals. This is likely connected as people move into new jobs requiring different child care arrangements or lower-cost/subsidized care.
Note also the incidence of legal services. The exact nature is unclear, but likely related to financial issues - perhaps the mortgage, another source of credit or even intent to file for bankrupty. If proposals to change the bankruptcy law to allow judges to "cram down" changes in mortgages (basically in involuntary modification) this category is likely to grow signficantly.
The Misc/Other category includes issues such as "Substance Abuse" "Reverse Mortgages" "Income Tax Assistance" "Worker's Comp/Disability" "Mental/Family Counseling" and "Pharmaceutical and Medical Costs". In general these have not garnered many referrals however.
What's all this tell us? Well, first that consumers probably need more than just a 'new' loan. They need to get childcare, get re-trained in another field, get organized and back to work. This a bigger task than most lenders are willing to support. Local services can play a role, but consumers need to know enough to take some steps. Second, the data on utility bills suggest basic budgeting is in demand. Consumers should be prepared for higher energy costs each winter. On the bright side falling energy cost ought to lending a helping hand to borrowers trying to stretch their budgets.
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