by Bill McBride on 12/08/2007 05:05:00 PM
Saturday, December 08, 2007
Update: OK, eleven!
10) This is not a bailout. There is no federal money involved.
9) The Paulson mortgage plan does not violate any contracts. Tanta nailed this immediately: The Plan: My Initial Reaction
A lot of people are very worked up over the idea that the New Hope Plan is, in essence, the government mandating a kind of reneging on private contracts (the PSAs or Pooling and Servicing Agreements that govern how securitized loans are handled). I personally think you can all stand down on that one.... it is clear to me that it is in fact structured with the overarching goal of making sure that it stays on the allowable side of the existing contracts.James Hymas of Prefblog (via Econbrowser) dug up this contract language. I've highlighted section Y, what Tanta pointed out immediately!
EMC, as master servicer, will make reasonable efforts to ensure that all payments required under the terms and provisions of the mortgage loans are collected, and shall follow collection procedures comparable to the collection procedures of prudent mortgage servicers servicing mortgage loans for their own account, to the extent such procedures shall be consistent with the pooling and servicing agreement and any insurance policy required to be maintained pursuant to the pooling and servicing agreement. Consistent with the foregoing, the master servicer may in its discretion (i) waive any late payment charge or penalty interest in connection with the prepayment of a mortgage loan and (ii) extend the due dates for payments due on a mortgage note for a period not greater than 125 days. In addition, if (x) a mortgage loan is in default or default is imminent or (y) the master servicer delivers to the trustee a certification that a modification of such mortgage loan will not result in the imposition of taxes on or disqualify any trust REMIC, the master servicer may (A) amend the related mortgage note to reduce the mortgage rate applicable thereto, provided that such reduced mortgage rate shall in no event be lower than 7.5% and (B) amend any mortgage note to extend the maturity thereof, but not beyond the Distribution Date occurring in March 2035.8) There will be no lawsuits from investors (other than lawsuits that would have happened anyway).
There have always been different interests of the various investors - what Tanta referred to as "Class Warfare". These different interests may lead to lawsuits, but this isn't the result of the Paulson plan. Earlier this year Tanta wrote a series MBS for Ubernerds, and in the April edition she pointed out:
... the notion of a multi-class security is generally premised on the happy assumption of a bunch of different investors with different investment needs—fixed income, hedges, what have you—all of whom can come together, take the piece they want, and play “support bond” for each other, while the REMIC issuing trust happily takes the leftovers in the residual out of the kindness and generosity of its heart. What lurks beneath this premise—and will get crucial when we start talking about credit risk again—is that multi-class can introduce “class warfare.”The proposed changes in the interest rates (the freeze) may be tough for a particular investor, but they are permitted under the PSA (Pooling and Servicing Agreements).
One thing you can say about the various part-owners of a big single-class pass-through is that they’re all in the same boat, since they’re all getting a pro-rata share of whatever is going on—fast prepayments, slow prepayments, high-coupon, low-coupon—in the underlying pool. In a multi-class REMIC, fast prepayments could be great for me and tough luck for you. Changes in the underlying interest rates on the loans could be tough for me and great for you.
7). These are not teaser rates.
The freeze rate is usually in the 7% to 8% range. Some people hear "teaser rate" and think 1% or 3%. Nah. These loans started at a much higher rate. In the above EMC agreement, the minimum rate was 7.5%.
6) The plan is voluntary - not a mandate - and this is not government regulation.
5) The plan targets homeowners with weak credit who owe more than their house is worth.
All this talk about LTV greater than 97% makes it sound like this plan is for homeowners with LTVs from 97% to 100%. Nah. This is plan is for homeowners with weak credit (maybe 1.2 to 1.8 million) that are underwater - or about to be underwater - on their homes. They can't sell. They can't refinance. And they probably can't make the new payment.
Imagine the headlines if they had set the level to 105% LTV or greater. The actual number of eligible homeowners wouldn't decrease much - most of these people are probably more than 5% underwater already and will be further underwater soon - but the headlines would blare: the government wants people to pay on mortgages that are for more than their collateral is worth!
And that is the goal.
Of course the level was set at 97% or greater LTV because the industry recognizes that anyone with less than 3% equity cannot refinance. For those with a 96% LTV mortgage - no worries - just wait a few months and the value will probably decline enough to put you in the plan.
4) This is an industry / investor plan. Don't be confused about the happy talk about helping homeowners stay in their homes. This is about helping the investors, and trying to slow the impact of the housing Depression on the economy.
Some homeowners will be helped, but as Tanta wrote:
In my reading of this, giving a deal to a borrower almost seems incidental.3) The savings for the investors will be small. Professor Krugman took a stab at the numbers:
Only a small fraction of borrowers will be covered. According to one estimate, we’re talking about maybe 145,000 mortgages. And because of the nature of the borrowers, these aren’t big mortgages — average value almost surely under $200,000.2) Recidivism will be high. Again from Tanta:
Now, the idea of the deal is that it will avoid foreclosures, which are very costly — losing 40 to 50 percent of the value of the mortgage, according to some estimates.
Suppose that’s right — and that virtually all the benefits of the deal go to investors, not homeowners. Then we’d be talking about $100,000 per mortgage, over say 150,000 mortgages. All told, $15 billion.
In reality, it would be substantially less than this, both because borrowers will get something, and because some of the rescues will fail. So we’re almost surely looking at less than $10 billion in losses avoided.
Meanwhile, estimates of subprime losses to investors are currently running in the $300 -$400 billion range.
So the back of my envelope suggests that this plan is a drop in the bucket.
I want to comment on this little statistic, that is getting thrown around a lot:I suspect the percentage defaults (recidivism rate) after a rate freeze will be in "uncharted territory". And this means the losses for investors aren't being avoided, just postponed.Modified loans frequently re-default. Joshua Rosner at Graham-Fisher & Co. says 40% to 60% of subprime and Alt-A borrowers who have their loans modified end up defaulting anyway within the next two years. Fitch Ratings puts the recidivism rate at a slightly lower 35% to 40% for good modification programs.Let us bear in mind that such statistics have to be based on loans that were modified no more recently than 2005 (newer mods would not have a 24-month post-modification history). It is quite possible, indeed it is likely, that modifications done in 2005 and earlier (when there were many more refi opportunities and most borrowers could sell their homes for at least the loan amount) were done for borrowers with problems like job loss or illness that either simply recurred or that created other (non-mortgage) debt problems down the road.
This is not to argue that modifications done now for loans originated in 2005 and after would perform better. Or worse. Or the same. It is to say that we are probably in uncharted territory and that "past history" was a lousy guide when we made the loans and might be a lousy guide when we have to work them out.
1) For the Home Builders: Nothing.
There is an investment myth that this freeze will help the homebuilders because there will be fewer distressed homes on the market next year. This seems silly. The homebuilders are getting crushed because of the current inventory levels. Sure, the freeze will probably keep a hundred thousand - maybe a few hundred thousand - distressed homes off the market. That is a drop in the bucket.
And most of this distressed inventory is coming - it's just being postponed - and that will prolong the slump.
AND FINALLY: The purpose of the plan is to publicize that lenders will modify loans.
All of these modifications could have been made anyway without the freeze. But the problem was very few homeowners called their servicer before defaulting on their mortgages - and most homeowners didn't answer their servicer's calls once they were delinquent.
By having a standard, the guideline can be publicized. The goal of this plan is get homeowners to pick up the phone.
Posted by Bill McBride on 12/08/2007 05:05:00 PM