by Anonymous on 3/14/2008 10:37:00 AM

Barney Frank has released draft details of a new plan for FHA to insure "short refis," or refinances that involve the old lender accepting less than full payoff. I know you mortgage junkies are on the edge of your seats, so here's the dirt.

A draft proposal of the plan is available here. According to Rep. Frank's website, comments and suggestions are being solicited, so consider yourself encouraged to look it over and let Rep. Frank know what you think.

The proposal is to allow FHA to insure up to $300 billion in refinance "Retention Mortgages" in the next two years that involve lender write-downs of principal ("short refis"). In the context of FHA, $150 billion a year is a very large number: it is nearly double FHA's volume for 2006. In the context of loans that are now or will be underwater in the next two years, it's as little as 10% of distressed mortgage loans. (That depends on whose estimates of price declines you use, and also whose estimates of the eligible borrower universe you choose.) So it's either a deluge or a sizable drop in the bucket; take your pick.

How it works:

1. The new mortgage may have an LTV of no more than 90%, and no subordinate financing (all existing subordinate liens must be extinguished). If I am reading the draft correctly (page 4), the new mortgage LTV includes financed allowable closing costs, as well as the special one-time up-front mortgage insurance premium (UFMIP).

2. All loans require a UFMIP of 5.00% of the new loan amount, in addition to an annual mortgage insurance premium (MIP) of 1.50% (which is added to the interest rate) and the "exit premium" (see below). The 5.00% UFMIP is essentially paid by the old lender in the form of principal write-down.

3. The old mortgage lender must therefore accept payoff proceeds (as "payment in full") that allow the new mortgage amount to be 90%. For example: assume an existing $110 loan on a property with a current valuation of $100. The maximum new loan amount is $90. Out of that $90, $4.50 (5.00% of $90) must be paid to HUD for the up-front insurance premium. Assuming 5.00% in allowable closing costs and prepaid items (escrow funding and per-diem interest), another $4.50 is paid at closing of the new loan. There is therefore $81 left to satisfy the old lender, and so the payoff amount is written down to $81. The old lender's loss is $29 ($110 minus $81, or 26%). Any and all prepayment penalties or fees related to prior delinquency or default must be waived (written off) by the old lender.

4. Some kind of principal reduction of an existing first mortgage is required under this loan program in the draft bill; any refinance that could achieve a 90% LTV without principal reduction of the first mortgage would presumably be processed under a standard FHA program, without the additional premia. It appears, then, that if a current loan had both a first and a second mortgage, with the current LTV of the first being 85-90%, the first mortgage could be refinanced into a standard FHA or FHASecure, with the existing second lien extinguished or subordinated. This would be a better deal for borrowers than the Retention Mortgages, since the MIP would be less expensive (5.00% is a giant UFMIP in FHA terms; the current maximum UFMIP is 1.50-2.25%). Loans fall into the Retention Mortgage bucket when necessary write-offs get to the first lien.

5. When the new loan is originated, HUD gets a second lien that involves no payments or interest. It is designed to recapture an "exit premium" of at least 3.00% of the original mortgage amount, up to as much as 100% of the property appreciation. Upon sale or refinance of the loan, the borrower must pay HUD the greater of 3.00% of the original loan loan amount or a share of appreciation. The appreciation is adjusted for capital improvements (as defined in section 1016 of the IRS code). The shared-appreciation provisions (although not the 3.00% exit premium) phase out after five years, so the amount due is the greater of 3.00% of net proceeds or

100% during the first year
80% during the second year
60% during the third year
40% during the fourth year
20% during the fifth year
0% thereafter

What this appears to mean is that the borrower cannot "cancel" this provision by doing a rate/term refinance of the loan into a conventional mortgage, although it isn't exactly clear to me how the actual calculation works in a refinance. Presumably, a refinance would be treated for calculation purposes like a sale, meaning that the borrower would have to refinance for a high enough loan amount to pay HUD the forgiven principal according to the schedule above.

6. All new mortgages must be fixed rate, and are subject to whatever loan limits are currently in place at the time of refinance. (This draft does not commit to the new higher limits within the two-year period of the program.)

Eligibility for the program is as follows:

7. Owner-occupied principal residences only

8. The borrower must establish lack of capacity to pay existing mortgage or mortgages: the borrower must "certify" that default on existing mortgage has not been "intentional," and must demonstrate that as of March 1, 2008 the borrower's mortgage debt to income ratio on all existing mortgages is greater than 40%.

9. The existing first mortgage must have been originated on or after January 1, 2005 and before July 1, 2007.

10. The mortgage debt ratio must be "meaningfully reduced" from the existing first mortgage. This devil will undoubtedly get worked out in the details of HUD guidelines promulgated to implement this program. It isn't clear to me, for instance, what one would do with an existing interest-only mortgage, which, even with principal reduction, could result in a higher payment, since the new loan must be an amortizing fixed rate loan. The bill clearly requires that the base interest rate on the new loan be a "market rate," but with the 1.50% annual MIP added, the rate on the new loans may be not that far under what a subprime borrower is currently paying. (The draft clearly states that there must be a reduction in debt load in terms of the first mortgage, so elimination of a second lien payment would not "count" here.) The draft mentions that the reduction in payment can come from extending the mortgage term, although I see nothing here specifically authorizing terms on the new mortgage of greater than 35 years (what I believe to be the current limit, although 40 years is in the currently proposed "modernization" bill).

11. Full verification of income is required.

12. The borrower's current FICO, or any prior delinquency of the old loan, is not counted against the borrower in qualifying for the new loan.

13. The new loan may not have a total debt to income (DTI, which includes debt other than the mortgage payment) of more than 40%, if the lender expects immediate endorsement (FHA insurance certification) of the loan. New loans may be made with a DTI of up to 50% or 55%, but in those cases the loan remains uninsured until the first six mortgage payments are made on time. This means that the originating lender holds the default risk on those loans until they have performed for six months.

My thoughts on this so far:

I give points for attempting to balance incentives and protect against abuse. The draft bill does not come right out and limit this explicitly to subprime loans, but in practice it would probably do so, since it limits the program to high-rate existing loans. If the new loan payment has to be an improvement over the old loan payment, and the new loan requires a 1.50% MIP, it would be difficult for a borrower with a prime loan that does not carry private mortgage insurance to be "in the money." Even an existing prime loan with mortgage insurance would probably have a current rate less than the rate offered on these Retention Mortgages. I would still like to see clarification of the maximum loan term allowed here. If the maximum term on the new loan is 40 years, then borrowers with an existing 30-year loan at a relatively lower interest rate may still qualify under the "reduced debt load" guideline.

I hope I am correct about financed closing costs being included in the maximum LTV, since this would have an important impact on preventing "fee loading" on the new originations. That is, the new lender may want to lard the loan up with origination fees, but if those are essentially being paid by the old lender in the form of reduced payoff, then the old lender exerts some counter-pressure on closing costs and fees. (I am simply assuming that eligible borrowers are unlikely to be able to pay their closing costs in cash.) I would like, however, to see an explicit provision in this bill for no premium rate/YSP deals (where the borrower is charged a higher interest rate on the loan, with the "yield spread premium" paid by the wholesaler for the higher-rate loan used to pay closing costs instead of financing them into the loan). It isn't necessarily likely that a premium-rate/YSP deal could work out anyway, given the requirement that the payments on the new loan be lower than the payments on the existing first lien, but it's possible if the rate on the old loan was high enough and market rates in the next two years are low enough. If you remove the possibility of paying closing costs with premium, then you're making the old lender pay them, and that will exert downward pressure on what the new lender will charge. If you don't do that, this can turn into just another fee-extraction opportunity for the slimier mortgage brokers. If HUD allows premium pricing here, it needs to hold the line very firmly on what fees can be charged and put into place strict quality-control measures for making sure that the YSP does not exceed allowable fees.

The shared-appreciation provision seems reasonable enough to me, given that it exempts appreciation due to improvements made by the borrower, which removes a major disincentive of shared-appreciation provisions (the borrower's failure to maintain or improve the property).

I certainly like the idea that lenders wishing to write high-DTI loans have to carry the risk for the first six payments. I suspect we would see, after passage of this, just how much lenders really do believe that high DTIs are sustainable.

As far as HUD's risk, there is certainly always the risk that values will continue to decline, although having 5.00% of the loan amount up front as a loss reserve, in addition to the MIP and the "exit premium," will certainly help. This certainly doesn't seem any riskier to me than HUD's current willingness to insure 97-100% LTV purchase-money loans.

Whether lenders will go for it--or be allowed to go for it--is the real question. The draft bill says that "The Secretary (of HUD) may take such actions as may be necessary and appropriate to facilitate coordination between the holders of the existing senior mortgage and any existing subordinate mortgage to comply with the requirements." It doesn't say what necessary actions might be to force second lien holders to roll over and die--threats? bullying? shunning at cocktail parties?--but that's likely to be a sticking point given current second lien holder behavior. The problem for first lien lenders comes back to the issue of what securitizations do or do not allow. A separate bill is on the table in Congress (Castle-Kanjorski) that gives a legal "safe harbor" to servicers who write down principal on a loan, as long as the net present value of the write-down is greater than the NPV of foreclosing. If that is enacted and clearly applies to short refi payoffs as well as modifications, then it would certainly encourage more servicers of securitized loans to participate.

The final question of how much of that $300 billion could get used in two years is, then, hard to gauge at this point. There are undoubtedly going to be trillions of dollars worth of underwater loans in the next two years, but I'm certainly not convinced that all of them would meet the 40% DTI requirement or, if so, involve borrowers willing to sign that shared-appreciation agreement.

As far as mortgage relief proposals go, this isn't anywhere near as dumb as most. It puts the up-front loss on the existing lender, it is fairly careful to exclude outright speculators, flippers, and abusers, and it limits the outsized-profit potential of the originators of the new loans. It is hardly the dumbest kind of loan FHA insures (see the 97% purchases with "down payment assistance" for the ultimate in dumb). I therefore expect that lenders won't like it much, but perhaps I am just cynical.

by Calculated Risk on 3/14/2008 10:12:00 AM

From DataQuick: Bay Area home sales remain at two-decade low

A total of 3,989 new and resale houses and condos sold in the nine- county Bay Area in February. That was up 11.2 percent from 3,586 in January, and down 36.7 percent from 6,305 for February 2007, DataQuick Information Systems reported.

January and February are the two slowest months in DataQuick's statistics, which go back to 1988. They are the only months with sales below 4,000.

"The lending system has been in lockdown mode the last half year, especially when it comes to so-called jumbo mortgages which have traditionally been the majority of Bay Area loans. Sure there are price declines out there, especially in inland markets. But it's not realistic to think many sellers are going to drop a $600,000 or $700,000 asking price down to $550,000 just so a buyer can finance with a conforming loan. We can only conclude that a lot of activity is just on hold, hence the spectacularly low sales counts," said Marshall Prentice, DataQuick president.
...
The median price paid for a Bay Area home was $548,000 last month, down 0.4 percent from $550,000 in January, and down 11.6 percent from $620,000 in February last year. Last month's median was 17.6 percent lower than the peak median of $665,000 reached last June and July.
...
Foreclosure activity is at record levels ...

by Calculated Risk on 3/14/2008 09:38:00 AM

From the WSJ: Bear Stearns to Get Backing From J.P. Morgan, N.Y. Fed

J.P. Morgan Chase & Co. and the Federal Reserve Bank of New York have agreed to provide, as necessary, secured funding to Bear Stearns Cos. for an initial period of up to 28 days.

J.P. Morgan is also "working closely with Bear Stearns on securing permanent financing or other alternatives for the company."

It was just last Monday that former Bear Stearns CEO "Ace" Greenberg responded on CNBC to the rumor that Bear faced a liquidity crisis:

"It's ridiculous, totally ridiculous."

Not so ridiculous. The rumors were true.

by Calculated Risk on 3/13/2008 09:01:00 PM

Northern Trust Chief Economist Paul Kasriel writes: Why Did the Fed Raise Rates in October 1931?

Kasriel reviews some history, and discusses the implications of the possible end of "Bretton Woods II".

Some commentators have referred to the Chinese and Saudi pegging of their currencies to the U.S. dollar as “Bretton Woods II.” We wonder if the demise of Bretton Woods II is not close at hand. If it is, the greenback could plunge, U.S. consumer inflation could spike, and the Fed would have little choice but to stop cutting its policy interest rate, and, perhaps, even have to raise it, as it did in October 1931.

by Calculated Risk on 3/13/2008 05:31:00 PM

From Bloomberg: Corzine Says Revenue Drop May Force Steeper Cuts

New Jersey Governor Jon Corzine said growing home foreclosures and unemployment are cutting into state tax revenue and he may have to make deeper spending cuts than the $2.7 billion he proposed last month.
...
``It's real and we've seen a dramatic change in revenue at the state level,'' Corzine said today in Trenton during an address to mayors. ``This is not the time to raise spending. We need to have cuts.''
...
Corzine, in an interview later today on CNBC, said the U.S. economy may go into a worse recession than many expect because of a decline in consumer spending and higher costs for energy and food. He said port shipments have dropped 15 percent, the state lost 9,000 jobs in January and sales tax collections are dropping.

This same story is playing out at the state and local level all across the U.S. State governments are responding to the sudden shortfall in revenue by cutting spending, further weakening the economy.

by Calculated Risk on 3/13/2008 04:17:00 PM

From Phil Izzo at the WSJ: Housing Market Has Further to Fall

On average, economists see a 5.3% drop in house prices, as measured by the Office of Federal Housing Enterprise Oversight, in 2008 and a 1.3% decline in 2009.
...
Ethan Harris of Lehman Brothers said the bottom [for house prices] won’t come until the third quarter of 2009, and warned that “home prices will bottom later in many bubble regions.”

Harris makes a key point: the price bottom will happen at different times in different areas. I expect 2008 to be the worst year in terms of percentage price declines, followed by a few years of smaller declines in the bubble areas. For previous local housing bubbles, it took about 5 to 7 years from peak to trough - and that is my expectation this time too.

Separately, the debate continues to rage over which home-price measure — Ofheo or Case-Shiller – provides the best snapshot of the situation. A slim majority 55%-45% chose the Ofheo index, but problems with both indexes were clear. Ofheo was derided for its limitation to loans backed by government-sponsored entities that leaves out jumbo and nonconforming loans, while Case-Shiller’s more limited coverage of U.S.

I believe the Case-Shiller index is more accurate for the cities that they cover. The Case-Shiller National index probably overstates the price declines, but I think it is closer than OFHEO.

by Calculated Risk on 3/13/2008 02:14:00 PM

From the WSJ: Most Economists Say Recession Has Arrived as Outlook Darkens

"The evidence is now beyond a reasonable doubt," said Scott Anderson of Wells Fargo & Co., who was among the 71% of 51 respondents to say that the economy is now in a recession.
...
The economists also expressed growing concerns that a 2008 recession could be worse than both the 2001 and 1990-91 downturns. They put the odds of a deeper downturn at an average 48%, up from 39% in the previous survey.

Still waiting for ECRI and UCLA ...

by Calculated Risk on 3/13/2008 02:06:00 PM

From DataQuick: Southland home sales still ultra-low; median price slips again

Southern California home sales limped along last month at the slowest pace ever for a February, the result of a market crippled by uncertainty and credit constraints. The median sale price dropped by a record 17.6 percent from a year ago, a real estate information service reported.

A total of 10,777 new and resale houses and condos sold in Los Angeles, Riverside, San Diego, Ventura, San Bernardino and Orange counties in February. That was up 8 percent from 9,983 the previous month but down 39 percent from 17,680 in February last year, according to DataQuick Information Systems.

Last month's sales total was the second-lowest for any month in DataQuick's statistics, which go back to 1988. The prior month's total of 9,983 was the lowest ever. Since September, sales each month have been a record low for that particular month.

Of the homes that resold in February, about one-third, 33.5 percent, had been foreclosed on at some point since January 2007. A year earlier the figure was 3.5 percent. At the county level, the percent of homes resold in February that had been foreclosed on since January 2007 ranged from 25.3 percent in Orange County to 48.1 percent in Riverside County.

"Sales remained extraordinarily low, and a significant portion of what did sell was in areas beset by foreclosure activity. That's where sellers are the most motivated and price cuts are largest. Mainly it's in the inland markets, often in newer suburbs, where prices got pumped up artificially with the sort of crazy loans that no longer exist," said Marshall Prentice, DataQuick president.
...
The median price paid for a Southland home was $408,000 last month, the lowest since $402,500 in October 2004. Last month's median was down 1.7 percent from January's $415,000, and down a record 17.6 percent from $495,000 in February 2007.

Last month's median fell 19.2 percent shy of the $505,000 peak reached last spring and summer. ...

Foreclosure activity is at record levels...

If it wasn't for foreclosures, the sales number would really be awful.

by Calculated Risk on 3/13/2008 01:40:00 PM

From Peter Hong at the LA Times: Southern California home prices still dropping at record rate

The median price for a Southland home last month was $408,000, down 17.6% from a year ago, according to DataQuick Information Systems. Area home prices have now fallen 19% on average from their peaks last year.
...
About one-third of Southern California homes sold in February had been foreclosed since January 2007, according to DataQuick. A year earlier, previously foreclosed homes accounted for 3.5% of sales.

Since September, each month's sales totals have been the lowest for comparable months since 1988, DataQuick said.

And from Jon Lansner at the O.C. Register: O.C. home-sales slump hits 29 months in Feb.

O.C. homebuying has started 2008 at half 2007’s pace, according to DataQuick’s February report. Last month marks the 29th straight month that O.C. homes sales failed to beat the year-ago level.

I'll have more as soon as the DataQuick data is available online.

by Calculated Risk on 3/13/2008 11:11:00 AM

This graph shows the year-over-year change in nominal and real (inflation adjusted) retail sales since 1993.

Click on graph for larger image.

To calculate the real change, the monthly PCE price index from the BEA was used (February PCE prices estimated as the same increase as January).

Although the Census Bureau reported that nominal retail sales increased 2.4% year-over-year, real retail sales declined over 1% (on a YoY basis). This is a recessionary level for retail sales.