Sub-Prime Memories are Short on Capitol Hill
Barney Frank and his dysfunctional House Financial Services Committee held another hearing this week on the financial crisis. This one featured appearances by Paulson, Bernanke, and the other usual suspects who are commanding U.S.S. Bailout. In other words, many captains but still no navigator.
I had an opportunity to listen to some of the hearing live on the radio while driving to an appointment outside the office. (By the way, what is up with Chairman Frank and his diction? If you didn’t know better, you would swear from the sound of his radio voice that he is either drunk, stoned, or recovering from an overdose of dental anesthetic. He makes the late Harry Caray sound like a great orator. It is painful to hear. )
So Maxine offered up her view that Sheila Bair, the FDIC Chair, had a great thing going at IndyMac Federal Bank (the failed bank taken over by the FDIC in July). Yes, Chairperson Bair had developed her own plan for re-structuring mortgage loans owned by IndyMac that were in default. This is how she described the plan in an earlier press release and in testimony at the hearing:
Under the IndyMac program, eligible mortgages will be modified into sustainable mortgages permanently capped at the current Freddie Mac survey rate for conforming mortgages which is currently about 6.5%. Modifications are designed to achieve sustainable payments at a 38% debt-to-income (DTI) ratio of principal, interest, taxes and insurance. To reach this metric for affordable payments, modifications could adopt a combination of interest rate reductions, extended amortization, and principal forbearance.
Don’t you love the government speak in this description? What is a “sustainable” mortgage? A mortgage that goes on indefinitely without change? If so, then the Bair-IndyMac plan will certainly create mortgages that are super-sustainable.
Let’s examine a couple of components of the plan advocated by Bair and now Waters. First, Bair proposes creating affordable mortgage payments by “extended amortization.” In plain language, this means taking a 30 year mortgage and extending it to 35 or 40 years. The Bair plan also includes “principal forbearance.” Once again applying the Tough Money Love plain language interpreter to this government-speak, she means an interest-only loan.
Do 40-year mortgages and interest-only loans ring a bell with you? They do with me. They ring alarm bells actually. These are precisely the type of funny-money loans that the sub-prime lenders pushed into the market to inflate and sustain the real estate bubble. Californians were particularly fond of these gadget mortgages. (Can you guess where Maxine Waters is from?) These are the loans that indeed last forever, with little or no equity being built by the borrower-home owner. And these are the loans that folks like Bair and Waters now want to use to “rescue” those who cannot afford their existing mortages. Pure genius.
Have Bair, Waters, and others on Capitol Hill forgotten where much of this mess started? In fact, have they forgotten that IndyMac itself failed in part because of its own sub-prime loan portfolio? I cannot see any long-term benefit of a government plan that systematically re-generates an entire portfolio of sub-prime loans for underfunded borrowers, guaranteed with taxpayer money. Dear Capitol Hill: The great “sub-prime loans for sub-prime borrowers” party has ended and the social experiment has failed. Merely lowering the payment-to-income ratios is unlikely to significantly change the outcomes. Even if the lowered payments prevent immediate foreclosures, the borrowers are not building equity with these aberrant loan terms and, in fact, may go further underwater. Eventually, they may figure that out and walk away anyway. It’s happening now.
The cliche’ about history is that those who do not study it are bound to repeat it. In the case of Sheila Bair, Maxine Waters, and others on Capitol Hill, memories have faded quickly and history is being forgotten. Standby for the launching of U.S.S. Bailout II.