Banking Law

Last Thursday?s The Wall Street Journal had a scathing editorial entitled "Uncle Subprime." The gist of it is that Congress is aiming to make Uncle Sam the "subprime lender of last resort."

In the name of preventing foreclosures, House Financial Services Chairman Barney Frank wants to transfer the risk of further declines in home prices to taxpayers from lenders and borrowers.

Here?s Barney?s "risk transfer plan":

Mr. Frank's idea is that, for mortgages originated between the start of 2005 and mid-2007, a lender and borrower would be able to agree on a federal refinancing plan. Lenders would have to write down their loan to no more than 85% of the current appraised value of the property ? which means the banks will use this opportunity to unload the biggest stinkers in their loan portfolios.

For the borrower, the deal is even sweeter: a low fixed monthly payment and a reduction in the principal to market value. The Federal Housing Administration would then guarantee the loan, up to a total of $300 billion in total Frank Refis. The deal is so sweet that even Mr. Frank is concerned that otherwise reliable borrowers may "purposely default" to be eligible for assistance. His solution is to require borrowers to "certify" that they really, truly aren't doing this simply to get on the taxpayer gravy train.

As you would expect, The Wall Street Journal thinks that bailing out buyers who made a bad bet on the future rapid increase of housing prices to hedge a poor credit decision, and the inevitable bailout of the lenders who were their enablers, makes lousy public policy. Not only were a large number of the borrowers fraudsters, but The WSJ makes the case that many of the non-fraudsters are hardly "victims" of being duped into taking on debt that they can?t repay. Instead, they?re "players" without "sufficient skin in the game" to incentivize them to repay their loans when the value of the collateral that secures the loan, to the chagrin of all parties concerned, heads south.

A new study from the Boston Federal Reserve destroys the myth of the victimized subprime borrower. Boston Fed economists examined 1.5 million homeownerships over nearly 20 years and found that the overwhelming reason for subprime foreclosures is not unsustainable debt foisted on ignorant borrowers or even financial setbacks. People walk out on subprime mortgages when the value of their home declines.

Homeowners who've suffered a 20% decline in home prices are 14 times as likely to default as those who have enjoyed a 20% gain. "Subprime lending played a role but that role was in creating a class of homeowners who were particularly sensitive to declining house price appreciation, rather than, as is commonly believed, by placing people in inherently problematic mortgages," says the Boston Fed study. In other words, even if the government moves these borrowers into FHA-guaranteed mortgages with fixed rates, but home prices keep falling, lots of borrowers will stiff the taxpayers like they've been stiffing private lenders.

In the old days ("B.S.": before subprime), I couldn?t get a loan to buy a house without putting at least 5% down (I never qualified for an FHA loan, which requires 3%, although borrowers can scam that through DAP). There was a reason for that. If I walked away from the loan, I lost my downpayment. With the advent of the subprime lunacy, and the arrival of borrowers who aren't required to put any money down, when the collateral?s value subsequently declines below the outstanding balance of the loan, they often simply say "hasta la vista, baby," and head on down the road.

The editorial also notes that Barney?s bill would "water down" the FHA underwriting guidelines by raising the permissible percentage of debt to gross monthly income from 43% to 55%. I?m so old I remember when that figure was 33% for conventional loans. The bill would also prohibit the FHA from denying a borrower FHA insurance solely on the basis of delinquency on an existing loan or because of a low credit score. Inasmuch as the intent of Frank?s legislation is to bail out subprime borrowers who financed during the period from 2005 to mid-2007, those lax underwriting guidelines for this subset of loans make sense as a matter of logic, if not as a matter of public policy.

Barney wants $300 billion of taxpayer dollars for this purpose. Chris Dodd wants $400 billion.Pretty soon, they'll start discussing real money.  As The WSJ observes, this is all to bail out, under a worst case scenario, a few million bowers. The Mortgage Bankers Association, which tracks 46 million borrowers, asserts that 42 million of them are paying their loans on time.

Don?t expect any objective analysis of what might be the actual expected affect on the economy if such a bailout doesn?t occur. This is an election year. In addition, inasmuch as the US Government recently stepped in to arrange the "rescue" of Bear Stearns (although at a price that ensures that its shareholders will lose most of their equity), the Democrats can always make the apples-to-oranges argument that if the government rescues big business, it certainly can?t deny the "little guy" his time to stick his snout in the public through and grunt. There are enough voters who don?t understand the economic basics, and a sufficient lack of objective information and analysis, to support the superficial political case for a bailout.

After all, whether it?s a big biz broadsheet like The WSJ or some liberal rag like the WAPO or The Grey Lady, the last thing anyone wants is a balanced approach, much less the old Joe Friday admonition: "The facts, mam. Nothing but the facts."

How do you plan to spend that $300 to $1200 tax rebate that's coming down the pike? Me, I?m banking mine and assuming that I?m giving it all back to bailout subprime borrowers or on some other government boondoggle. Then again, I?m a "glass-half-full" kind of guy.