The next bailout?

Posted by: Dean Foust on April 23, 2007

Given all the political posturing in house-foreclosure.jpgWashington over whether we should have a federal bailout or lifelife for subprime borrowers (some advocacy groups are lobbying for at least a six-month moratorium on foreclosures), Christopher Cagan, director of research at First American CoreLogic, has put a figure to the cost: $122 billion. That’s because, by his estimates, 1.1 million homeowners will be forced into foreclosure over the next six years. Here’s a link to a copy of his study (registration required, and warning: Study is 188 pages and a 3 MB download) and a story about his conclusions. (Interestingly, Yahoo has a new feature that allows you to enter a zip code and see foreclosures in your community, although you have to pay for the exact street addresses. Click on this link, then click on “Foreclosure Center.”)

Importantly, Cagan notes that this isn’t enough to sink the economy or mortgage markets. The foreclosures will represent roughly 1% of total lending. So why a bailout? I don’t see the rationale. Proponents of a bailout say it’s necessary to keep millions of people from losing their houses. I’m sure there are a number of borrowers who suffered unexpected hardship — the loss of a job, or death of a spouse — that imperils their ability to keep their house and they will suffer significant financial losses. My sense, however, is that many of these individuals who have made serious equity at stake — they put down a big downpayment — will do everything in their power to keep their homes. They’ll cash out their 401(k)s, sell their cars and walk, and wear sackcloth if that enables them to preserve their nest egg.

It’s also my sense that a number of the foreclosures are going to hit marginal buyers who got one of the millions of low-doc, no-doc, no-money-down mortgage written in recent years and didn’t have much skin in the game — a safe assumption given the number of 95%, 100% and 125% mortgages that were written in recent years. In those instances, who’s being bailed out? The homeowners who lose their homes without having made a downpayment aren’t losing any money; it’s the lenders who take the hit, and I don’t see any rationale for making Goldman Sachs, Bear Stearns whole, nor the investors who bought the mortgage-backed securities. And I certainly don’t see the rationale for saving the subprime lenders who made the loans. And I worry that imposing a federally mandated moratorium on foreclosures could have unintended consequences. Most lenders will be willing to provide some forebearance, since the last thing they want to do is take back a home on which they wrote a mortgage.

Yeah, I know there are many instances where individuals may have been duped by the terms of the loan — an option ARM that resets higher, includes $10,000 in dubious closing costs. But no one holds a gun to anyone’s head and makes them take out a mortgage. If I’m missing something, feel free to take the other side of the argument.

UPDATE: Just stumbled across this commentary on bailouts at Mish’s Global Economic Trend Analysis. Good read…

Reader Comments

Stan

April 23, 2007 4:27 PM

Does anybody want to bail out the investors who lost money in the stock market?I know some people even use their IRA or 401K to speculate on stocks when the Market was going skyroketing in early 2000.Should those people be bailed out 1st?If there should be any bailout at all in realestates.

Frank

April 23, 2007 8:52 PM

Congress bailed out Chrysler under Lee Iocacca. There are lots of bail outs for the corporations. What's wrong in helping average citizens?

lizziebeth

April 24, 2007 7:53 AM

"Congress bailed out Chrysler under Lee Iacoacca. There are lots of bail outs for the corporations. What's wrong with helping the average citizens?"

Well, let's start with Chrysler had thousands of employees(the average citizen)that were helped by the bailout. Why not help the average citizen? For one, If it sounds too good to be true it probably is. If the average citizen fell for the no money down, low monthly payments...without reading the fine print, it's their problem. Not mine or the governments. Should the government crack down on the predatory loan practices? Absolutely!

Brandon W

April 24, 2007 8:37 AM

A bailout would make citizens pay for the speculation and irresponsibility of others. Then, those who are looking to buy a home would be hit twice - first by taxes to pay for the bailout and then by home prices that haven't been allowed to adjust down to normal levels. The crash needs to happen, and people need to get hurt. Too bad, that's life. Free market capitalism is Darwinian, and when there's a misallocation of resources, someone has to lose.

gepetoh

April 24, 2007 11:19 AM

"Congress bailed out Chrysler under Lee Iacoacca. There are lots of bail outs for the corporations. What's wrong with helping the average citizens?"

Because I'm an average citizen who didn't go for the quick, easy bucks, and spend money that they didn't have. I'm an average citizen who decided to pay attention to whether I can afford a place or not. I have no interest in bailing out the irresponsible "average citizens" who neither cared nor had the common sense to do the same, with my tax money. That is what's wrong.

Sally

April 24, 2007 11:30 AM

What would a bailout look like? Would the govt (taxpayers) give a cash grant to the homeowner to keep the home? Somebody explain how that would work. Or would the cash grant go to the mortgage companies on the brink?
More money down the drain...no wonder our economy is cracking.

Crash Man

April 24, 2007 12:13 PM

The Government:

LEFT HAND: Programs to make housing "affordable"

RIGHT HAND: Programs to make housing "unaffordable"


FINALLY, affordability is inching back into the market - something the govenment has been agonizing over all these many years - and, now when it appears on the horizon as a self correcting market - BAM! - the government NOW thinks the market doesn't need to be more affordable - quite the contrary - it needs to be artificially propped up with a bailout to the risk takers .....

People - you would be wise to race out and get your ARM today - because the high rate will never kick in ... in a couple years just go get your low govt save your butt refi ....

I think I saw that as a sales pitch on a flyer the other day ....

NEG AM - NO RISK - GOVT GUARANTEE!

stan

April 24, 2007 4:09 PM

Good points from lizz,brandon and gep.You all make very good sense,because I believe you guys are not politicians!I know some people own 2 or 3 houses right now,and in trouble.They're really hoping for a bailout!Any bailout for the,used to be,absolute win, speculative real estate will be very wrong,and unfair for the prudent "average" citizens

robert joseph

April 24, 2007 5:51 PM

Oh YES! Let the taxpayer bailout the subprime opportunists and the banks that PROFITED so handsomely. Did not the CEOs 'make' their numbers and get large bonuses for participating in this **** of UN-qualified borrowers? Yes, heaven forbid the Wall Street-types take a bath...much better to nail the taxpayers with underfunded Social Security, Medicare, no retirement plans, no healthcare coverage...YES, let the S&L Debacle II begin!!! Its a new election cycle; what better way to shake the money tree?

Michael Hoskinson

May 10, 2007 11:00 AM

As a real estate broker with over 20 years of experience, I wanted to weigh in on the current sub-prime debacle.

In this last housing boom, lenders created loan products to meet consumer's hearty desires, they created a huge amount of equity but missed a vital point; they allowed consumers to buy a payment, not a house. Items like "Stated Income" and "Hybrid ARMs" made an egregious amount of money for banks and brokers but put people in places they should never have been allowed to go. The sad part is that the public will end up paying for the lender’s mistakes.

One of the biggest problems is how the market defines "sub-prime", they label it as 640 FICO or less. One 30 day late can unjustly bring you to that level, to use that against borrowers is criminal. Banks have been manipulating borrowers with excellent credit so that they can put them into lousy loans that make the bank a ton of money but place the borrower into a larger payment that is built to fail sooner or later. If the credit scoring mechanisms (FICO) were realistic and banks rated a borrower's credit correctly, allowing for mistakes and some unavoidable items, it would result in borrowers being put into the proper loans. Banks would have made a bit less money but not bankrupted their customers eventually. It is a system in which the borrower has very little leverage; you play on the bank's field or you go home……..if you have one.

Of vital need for change is the way loan brokers are compensated. The YSP or "Yield Spread Premium" is nothing more than the Bank's kickback to the broker for doing the loan. The worse the loan, in terms of interest rate, that the broker gets the borrower to agree to, the higher the YSP dollars go to the broker. What exactly, other than honesty, is the broker's motivation for helping a borrower get the best available deal? Combine greed, low barrier to entry and minimal mandated disclosures and you have a recipe for a lending disaster at the borrower level. Until there are mandated disclosures that spell out, in 14-point type and plain language, what exactly a borrower is encumbering themselves to in total and how the broker or bank is compensated this system will continue to fail the public.

I have personally seen lenders and brokers lie to consumers about their credit-worthiness and play bait-and-switch games to get them into appalling loans. The residential industry is rife with such tactics and their bill is coming due for it. They killed their own Golden Goose; we're going to get stuck with the feathers.

Michael Hoskinson
Foundation Realty
Huntington Beach, Ca

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About

BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.

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