I as have mentioned previously, I have some involvement in the mortgage industry. And it’s not pretty right now. There are plenty of applicants, but not many banks are bothering to underwrite many loans.

But a friend of mine wrote this essay which I think does as succinct a job as possible in explaining what is going on now post-bailout (and why with low rates and fresh government capital the market isn’t starting to move again).

Read it. If you like it, copy and paste it and email the heck out of it. People should understand what is happening and who the real culprits are.

And yes, he knows what he’s talking about…he’s in the business of evaluating mortgage borrower default risk.

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Wanna know who to blame the current banking crisis on? by Frank H. Bria

Well, a lot of people got us in this mess, but there’s only one group one whom to blame keeping us in this mess: the government!

First, let me explain what’s going on. Banks are losing money on mortgages. They are losing money for two reasons: 1. accountants require them to record a lower value mortgage when housing prices drop. 2. when borrowers are underwater, they are more likely to walk away from their mortgages – regardless of their credit.

Because banks’ assets are lower, they need more capital (think cash, but not really) to protect themselves from future losses. If they use cash to shore up their capital, they can’t lend. If they can’t lend, they can’t refinance or lend for cars, credit cards, whatever, and people stop spending money. In fact, it gets worse because banks cut credit limits, cut off credit lines for businesses, all commerce slows down.

So, in comes the government to the rescue. It’s called TARP, the $700 billion bailout. Remember that? Where did all that money go? It was supposed to solve the lack of cash (called the liquidity crisis, in case you hear that term). Well, it went to shore up the capital of these banks. In other words, it’s sitting in a hole in their balance sheet. They’re not using it to lend.

Well, you ask, what if it helps me meet their capital requirements so they can lend? Well, have no fear! Here come the regulators. Because they’re concerned with losses piling up, they *increased* the capital requirements for banks. So, the government gives them money to help with their balance sheet – then on the other hand the government raised the bar and made it more difficult to lend. With friends like that, who needs enemies?

So, our $700 billion goes to waste sitting around in banks doing nothing but satifying the regulatory requirements which the government just arbitrarily made worse.

What about mortgage modifications you ask? Well, I’m glad you did!

Here’s where the government does some of their best work. I’ve personally analyzed the performance data from mortgage mods across the country. It turns out the government rules on modifications shuts out the most willing and capable borrowers from the mortgage market. Only the very worst borrowers qualify for modifications. Oh, yeah, and you think the modifications mean the payment goes down? No. The brilliant mortgage servicers don’t really care about keeping people in their homes, so they pile on the fees and penalities and they “modify” the mortgage so the new payment is actually higher than the one that got them in trouble to begin with.

What does that mean? Foreclosure is inevitable and is just delayed by six months. So the housing market gets worse and worse.

Oh, but you’ve paid your mortgage on time and your credit score is good, you say? Too bad. You don’t qualify. You have to have a debt-to-income (DTI) ratio of greater than 38%. Sure, you could buy a new car and rack up your credit cards to hit that ratio, but folks who are already there qualify now. If you’re not late and not buried in debt, you are stuck with that mortgage. If you’re overtaxed with debt, 3 months late on your mortgage, and couldn’t have afforded the home in the first place, you’re first in line for the mod. But, beware, your payment will most likely *not* go down. Meaning, you’ll end up being foreclosed on eventually. And all of our homes will decrease in cost.

Oh, and guess what that means? That means the banks write down their mortgages more and have even less money to lend! Great idea, huh?

Oh, and one more thing. What about all those good people who are underwater in their homes, by, say, $50,000 or $100,000? They won’t default on their loans because they don’t want the hit on their credit report, right?

Well, what does that actually mean? That means you pay more interest for loans because you’re a bigger risk, and in a few years, if you pay your bills, it’ll approach “normal” after about 2 years or so. So, how much extra money will that cost you? $50,000? $100,000? Probably not. It starts to make some sense to let that house go and save that money, doesn’t it? Well, you’re not the only one who’s thinking that. Soon, it won’t just be the credit risky that start to default. It’ll be lots of people.

And in 3 or 4 years, when the crisis is behind us and the banks start lending again, it won’t look so bad when you and 7 million other people have a foreclosure on their credit report, will it?

See the problem? It’s government.

What’s the solution? It’s actually really easy.
1. Capital holiday. Have regulators give a break to big banks that are already secured with government funds. Lighten up on capital requirements, or eliminate them for a time. That will free up that $700 billion (our $700 billion) to start lending again. Also, stop cracking down on completely reasonable loans (read: good credit, bad collateral) and allow banks to get good borrowers refinanced again. This will require less taxpayer money and keep inflation from killing us. (That’s a whole other note.)

2. Principal forgiveness. Find those borrowers who want to stay in the home, but can’t (or won’t) because they’re underwater in their mortgage. Bring them back to something reasonable (95% Loan-to-value (LTV)?) so they feel “invested” in their home. That will lower their payment and get them above water again. There’s a reason banks want you to have a piece of equity in the home. So you stay! Duh! Once people have equity they’ll start refinancing, or moving, or selling, or whatever. Right now, no homes are being bought because no one can sell without short-selling (selling the house for less than you owe and settling with the bank.)

3. Tax credit for home purchase. A short term tax credit will encourage people who have money, but are sitting on the sidelines to buy a home. With #1, more lending will allow “regular” people to take advantage of this too.

4. Stimulate spending through tax policy. Temporarily allow people to deduct the interest on consumer debt. Believe it or not, we used to be able to do this before Clinton. People who have credit or get credit will be encouraged to use it to spend. Hopefully wisely, but the idea is the best jobs package is the movement of money. The government can create fake jobs building roads and bridges to nowhere and such, but in the end, only “real” jobs created by a free economy will be sustained.

5. Prevent this from happening again. The market that got us in trouble was the Mortgage-Backed Securities (MBS) market. It took groups of mortgages and bundled them together and split the payments up into groups of investors (called “tranches”…French for “warring parties”). These groups of investors do not have the same interesting in making sure the mortgage performs. Some groups want the mortgage to fail, because they get back their investment while others need the mortgage to keep paying – even anything is better than nothing – because they keep getting money. The investors have no data to analyze the performance of distressed assets, and the mortgage servicing companies (like Countrywide, et al) don’t have an interest in fixing this problem. But the only ones who can really do anything about the mortgage is the servicing company. They don’t really care if you stay in your home. They get paid when the payment comes in, but only a little. If you’re too much trouble (read: they have to work with you), then it’s just better to get rid of you. Oh, sure, the government can come in and make things difficult…they can make a foreclosure moritorium, but eventually, if they want you out of the house, you’re gone. They have the data to analyze, but won’t give it to anyone who cares. So, the people who can do something don’t care. And the people who care, can’t do anything.

This needs fixing. Create a new secondary market that aligns the incentives. Investors have control. Servicers get punished for screwing up their job. Mortgage insurers can force the “right” thing to be done in case someone can save the loan. Right now, they just pay the claim, the servicers cash the check, and the family’s gone. That’s not good for anyone.

Want proof? How’s your home value? Mine sucks too.

Anyways, hopefully this helps explain how the market it screwed up and how it’s all the government’s fault now. Obama wants to use the $700 billion to start buying mortgages. That may help get the banks lending a bit again, but not if the regulators still crack down. And if mortgage servicers don’t change their ways, even after that mortgage gets purchased, the families will end up on the street and home values will continue to decline. Good borrowers with good credit need the mods, not the riff raff.

Forward this on. I hope people start to get educated about what’s going on and why it’s all wrong.

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