It’s my initial take that a lot of people are going to fall through the cracks on this new plan. Here in Arizona, a bubble state, the vast majority of struggling people are in homes that are upside down in value far more than the criteria for qualifying for the plan. The only way to truly and permanently help these homeowners is via a principal writedown.
Mr. Mortgage has posted his interesting take on the hoopla. You can check out his blog and You Tube videos by searching Mr. Mortgage and looking at the Mortgage Implode-a-Meter.
This article was actually originally circulated on 2/17, but I thought it was worth sharing a few snips (they are inserted in order, but with no segues between snips):
The following report went out to clients prior to the Obama Homeowner Affordability and Stability Plan announcement. Although the news is already out, much of what I covered in this report was a part of the plan and conclusions still valid.
I have never seen such excitement about $50 – $100 billion being spent – especially when the there has been $9.5 trillion committed, the mortgage market is $11 trillion and last month alone there were $30 billion in loans that went into default across the nation. If this is going to be painted as the ‘kitchen sink’, they had better throw a sizeable, targeted amount at it or the market will be disappointed.
Unless negative equity is addressed, all that’s left are underwater, over-leveraged zombie-homeowners unable to sell, move-up, refi, save or shop. If the plan is just one big loan ‘mod in a box’ that assists the banks and investors with losses then I think we are being set up for another disappointment.
With values down 20% – 70% across the nation, even if they were to find a way to successfully and permanently re-lever the borrower, it is too late for most due to house-price depreciation alone. To date all money thrown at this problem has been wasted. I am afraid the plans we are hearing trickle out now will end the same way.
The only way to ‘fix’ the housing and mortgage markets and consumer’s balance sheet is to undo 2003-2007.
Part of Obama’s solution may include cram-down legislation where judges have the power to grant principal balance reductions. While this is half right allowing judges to re-write contracts is a big problem. The error and fraud will be tremendous. It could also force a mass liquidation of distressed assets at prices that are truly ‘fire sale’.
At present the distressed note and housing market is not illiquid – there is just a price dislocation due to sellers holding out for higher prices than the buyers are willing to pay. With bailouts coming ever week and talks of bad banks buying this stuff at above market prices, why shouldn’t the sellers hold out for a higher price?
But there are also other serious unintended consequences to this plan not many know about. Not every mortgage backed security deal is the same – language varies greatly. But most of them have language that say in the event of a bankruptcy the principal loss is taken from bottom up in the cap structure — Not rated, BBB, BB, B, AA, AAA. The same with a foreclosure, jingle mail etc.
But with BK Cram-Downs where principal loss occurs, the loss can be spread across the cap structure evenly. The language that allows this is more prevalent in non-Agency deals such as Alt-A and Jumbo Prime.
As soon as a hit occurs across all tranches, the ratings agencies terminology will assign a ‘D’ rating to that Bond. When that happens, the capital requirements will go from 25% to as much as 100%.
Insurance companies, mutual bond funds, pension and hedgefunds are the largest owners of this stuff. Due to the downgrade, they would have to sell bond at massive loss and put pressure on market or raise capital.