Thursday, April 03, 2008

Housing Crisis Solutions are a Mess

In the WSJ, there's a nice article on the sub-prime crisis.

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.

What a disaster. They have it right, all banks will only put things worth less than 85% in there. And then borrowers who borrowed too much are rewarded, all on the government's dime. Crazy.

The funny thing, as the article points out, is that once housing values fall below the value of the mortgage, people just walk away. As housing prices have fallen more than anyone's memory, a sufficient number of lenders just didn't anticipate this, just as people didn't anticipate internet equity prices falling 75%, and that's their fault. But that's why you need to look at not just the collateral, but the credit score, because the credit score tells you a lot about willingness to pay, in that people with high credit score tend not to walk away from debts even if they can, or in the calculus above, it makes some economic sense. But I think most of this problem is centered on non-traditional residential mortgages, predicated on rising housing prices, involved too little money down, if any, too low credit scores, and insufficient incentives for mortgage originators. For example, there was an originator who received 3% on the mortgages he originated but only kept a 1.5% skin in the game, meaning he had zero incentives to do proper underwriting. But it is important to remember that no one will securitize his loans anymore, so that game is over.

There just isn't a way to solve this problem without rewarding people who borrowed more than they should, or people who lent more than they should.

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