FDIC Takes Mortgage Proposal to the Public

Two months after the collapse of Lehman Brothers, there has still been no broad-based action to help restructure delinquent mortgages and slow down the flood of foreclosures; the Fannie/Freddie plan announced earlier this week is a very small first step, because it is limited to a small portion of the mortgages outstanding – those controlled by Fannie and Freddie, which tend to have relatively low default rates anyway.

Sheila Bair, head of the FDIC, said that that plan “falls short of what is needed to achieve wide-scale modifications of distressed mortgages.” Apparently frustrated by the failure of negotiations with the Treasury Department, yesterday the FDIC posted its mortgage modification proposal to its web site (Washington Post summary), basically breaking with the rest of the administration and hoping the Congressional Democrats can make it happen.

This plan (which we’ve heard about in some form or another for weeks) would apply to all owner-occupied homes that are at least 60 days past due; mortgages would be reduced so monthly payments are no more than 31% of the borrower’s income. Based on FDIC experience at IndyMac, most of those reductions would be made by reducing the interest rate as low as 3% and extending the term; principal would only be reduced in a small number of cases. (From a net present value perspective, of course, lowering the interest rate and lowering the principal are two ways to get at the same thing.)

Because the government does not have the power to force loan servicers to modify loans, the incentives would be a $1,000 fee per restructured mortgage and, more importantly, a government guarantee for up to 50% of the loan value in the case of a re-default. Participating servicers would also have to systematically review their entire portfolios for loans eligible for modifications, to prevent them from picking and choosing. The FDIC’s high-level estimates are that 4.4 million loans will become sufficiently past due by the end of 2009, 2.2 million could be modified, and 1/3 of those will re-default; the total cost to the taxpayer would be $24 billion, mainly for paying off the guarantee on defaults.

The basic principle of the plan is sound: providing a government incentive to get servicers to do something that will help borrowers and the communities they live in. However, I don’t see anything in it that will get around the securitization problem – servicers are legally bound only to act in the interests of the investors who own the bits and pieces of the loan, and some of them may sue if loans are modified in ways they don’t like. Solving that problem will almost certainly take new legislation.

By the way, this is Treasury’s response, according to the AP:

[FDIC] officials want to use part of the $700 billion bailout of the financial industry to pay for it. But the Treasury Department is opposed to that idea.

Testifying on Capitol Hill Friday, Neel Kashkari, the Treasury Department’s assistant secretary for financial stability, said the intent of the $700 billion plan was to make investments with the hope of getting the money back. That, he said, was “fundamentally different from just having a government spending program” that would disburse money with no chance of ever seeing any returns.

Is there really a fundamental difference between (a) making investments that theoretically could get a positive return but are really bad investments you are consciously making to shore up the financial system and (b) extending loan guarantees that you know will cost you some money, but will help stabilize the housing market, increase state and local tax revenues, and keep people in their homes?

10 responses to “FDIC Takes Mortgage Proposal to the Public

  1. Neel “Ferarri” Kashkari’s reaction is no surprise. This administration has made their own decisions with little outside input for eight years. It’s almost a slap in the face at this point. A final “F you” before they’re all gone. We can only hope they don’t create more issues than they solve in the next two months.

  2. I respect Sheila – or did until I heard on Planet Money today (11/14 podcast) that the FDIC is now insuring gift cards issued by retailers. No doubt this will help the holiday season but I now feel that I am in a bad dream where nothing makes rational sense. I would love to see what the insurance premium structure will be. I went through the banking crisis in the late ’80’s and watched the FDIC push banks into insolvency that could have easily survived. Now they are insuring non-bank retailers.

  3. The Federal mortgage plan and Sheila Bair bailout would reward the reckless and punish the prudent. Please just look at the historical facts.

    Consider the lesson and unintended consequences this imparts to promote bailouts to the reckless. City by city, neighborhood by neighborhood, people who live beneath their means and manage money carefully will see more careless neighbors supported by federal decree. What about the 30 percent of this nation who were smart enough to rent? Or how about the large percentage of us who gave plenty of warnings out to these same people the government now wants to redistribute my taxes to so they can stay in a house twice the size the home I live in. Those who are current on mortgage payments, but still squeezed will stop paying. Prudence in areas of life will be flushed down the toilet in 1 month’s time.

    The backlash to the 700 B bailout package was not only because of the bailout of Wall Street but also the bailout of the reckless homeowners and their relentless ATM/HELOC spending. As it is now these people can live in their home for over a year rent free by just not paying their mortgage while they find a home they should have been living in from the start.

    We are becoming a nation of people who feel it is not only okay but justified to cheat, lie, and swindle each other and the rest of the population. Personal responsibility is discouraged by the government and the mainstream media. White collar crimes are rarely prosecuted because FBI is so stretched. Our nation is eating ourselves from within just to keep a facade of prosperity. Hope is being replaced by anger and desperation. Welcome to the new dawn.

    An example of what your tax dollars will be bailing out:

    Unfortunately, in the Western states (and Florida) as well as elsewhere, there is the problem of the debtor/investor who claims multiple properties as a principal residence (like my sister-in-law, a nurse who just “returned” a pack of single family residences up and down the central valley of California).

    This is a far greater problem than a rational thinker would imagine possible (many of her co-workers are in, or now out of, the same sinking boat). All of them would just love to take multiple fraudulent bites out of your apple, and return themselves to the imagined path to a real estate empire, off of which they all feel they have been unjustly ejected.

  4. Sheila Bair’s plan makes sense at this time. If we continue down the current path of rising foreclosures, house values are certain to continue their decline.This is not good for anyone, Neighborhoods and communities would not benefit with empty homes and the possibility of rising crime rates.
    This is a major issue nationally, not just an isolated incident.Those who look at this from the perspective of “giving help to people who made bad decisions”, may not realize the volume of homeowners who reach for the american dream everyday, without the benefit of an accountant to totally balance their budgets. If the bank stated that they could afford the home, then that was probably good enough. Do you think the bank cared for these people when they were writing or approving the loan? Anyway, at this time we need to concentrate on fixing the problem, which is what Sheila Bair is trying to do. This plan works. It has been tested with the IndyMac experiment. The current administration sits and watches the country go more down hill every day without lifting a finger to help, except to bailout big business. Has anyone looked at where the initial $250 billion went? Well it went to banks (some of which do not even need the money, but were forced to take it).They in turn used the money to buy other banks?? How is this helping the country out of this crisis? How can people who need the money to survive get a loan, if the guidelines do not allow for a loan approval. To get a loan you need a 700+ credit score. Who has that? ….the rich people who already have the money. What a mess.What an embarrassment this administration has turned out to be.We need to allow for the mortgage assistance so the housing crisis can stabilize. If people are going to default, that will happen anyway. This is no time to be shortsighted. This is no time to pick and choose who to help. Pass the proposal and fix the damn country .

  5. NOTE: I POSTED THIS COMMENT IN ANOTHER SPOT. IT SEEMS MORE APPROPRIATE POSTED HERE.

    One problem with attempting to intervene in the housing sector and eliminate foreclosures by renegotiating mortgages is that many subprime mortgages have been securitized as collateralized mortgage obligations. If a mortgage is part of a security, it cannot be renegotiated without breaking a contract to owners of the security.

    One possibility would be to have the government buyout the mortgage and then issue a new mortgage at better terms for the borrower. In this case the government takes over the role of lender. This could be very costly for the government, particularly if the borrower runs into trouble making payments again. If the terms of the new mortgage allow the borrower to continue paying it off, then eventually the government could make money off of it.

    The difficulty in restructuring mortgages which have been securitized makes me wonder if it is such a good idea to securitize mortgages. I understand it is necessary to do this to provide a robust housing market. I wonder if it wouldn’t be possible to structure CMOs in such a way that failing mortgages that are part of the CMO might be adjusted after the fact. Surely this would be to the benefit of the security holder since a renegotiated mortgage which pays a smaller interest rate is certainly preferable to a failing mortgage which pays nothing back.

  6. FDIC’s proposal is the height of myopia and naivete. People behave according to the incentives they are given. If defaulting on a mortgage for 60 days is how to get a massive, permanent discount on one’s payments, that is what EVERYONE will do. Not just the “poor guy” who overpaid for his house, then over-leveraged it, thinking he could always re-finance it or find a greater fool to flip it to. Consider the cost to the American taxpayer when roughly $12 Trillion of US home mortgages all begin to default in response to the FDIC’s proposed incentive for doing so.

    Another major issue is referred to above: mortgage bond investors, who bought about $5 Trillion of Fannie and Freddie MBS, not including the trillions in bonds they bought from the banks. They don’t care what incentive their servicers are given. They have contracts requiring the servicers to collect the principal and interest due under the current terms of the note, or foreclose and sell the collateral. FDIC’s proposal will look to a bondholder alot like seizure of his property (bonds) without just compensation, among other things. Excellent idea, I think, for adding a whole new class of petitioners for a bailout by taxpayers: domestic and foreign MBS investors. (Different story for whole loans still held by a bank or FDIC; they can agree to take losses on any loan they want.)

    A third example of FDIC’s naivete is ignoring a fundamental issue for many homeowners: the equity in their home. There is no evidence I have seen that a homeowner who has lost all his equity, and sees no probability of recovering that equity in the near future, will continue making mortgage payments, no matter HOW affordable the payments are. There is plenty of evidence, however, that such homeowners in the worst markets (CA, AZ, NV, FL) will make the economically rationale decision to cut their losses, stop making mortgage payments, and start from scratch, saving to buy another house someday. By not addressing the issue of lost equity, FDIC deludes itself and us in the likely effectiveness of its affordability strategy in meaningfully slowing the wave of foreclosures. Only Alan Greenspan and a few others understand, apparently, that until foreclosures recede, will the feedback loop between falling prices and foreclosures be broken. Until then, home prices, MBS values, and the capital of residential lenders will continue to fall.

    We need a plan to reduce foreclosures and stabilize home prices, but we need a better plan than Sheila’s.

  7. There is an interesting article in the NYTs which discusses a proposal for the government buying up subprime mortgages and reissuing the mortgages under terms more acceptable for borrowers, as I suggest above.

    The article is “A Rescue Plan without Tax Payer Money” by Gretchen Morgenson, http://www.nytimes.com/2008/11/16/business/16gret.html?ref=business.

    In the article, Morgenson describes the plan of two investment fund managers, Thomas Patrick and Mac Taylor, proposing that the government eliminate $1.1 Trillion of subprime mortgages, which are now securitized, by buying them out and reissuing them on better terms before the borrowers start defaulting on them.

    I think the idea is an interesting one which could potentially stabilize housing and the mortgage market.

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