Big business gets corporate subsidy and whines about changes to bankruptcy laws

I am a big fan of Dean Baker, and I think he nails some issues in the housing market.

In his blog today (this is whole post),

Changing Bankruptcy Rules and the Sanctity of Contracts

The banks are very upset over the possibility that Congress may change the law to allow bankruptcy judges to rewrite the terms of mortgage loans as they can other loans when a person declares bankruptcy. Naturally they are pulling out all the stops in making their case. The Washington Post quotes a Bush administration spokesperson saying that the proposed change “is interfering with contracts.”

This is an interesting charge to come from the Bush administration and to be associated with the banks. Those old enough to remember may recall the bankruptcy reform of 2005. This bill altered the enforcement of loans in the opposite direction, making it easier for lenders to collect from debtors. It was applied to loans that had already been contracted not just future debt yet to be incurred, in that sense, it interfered with contracts.

Clearly, neither the Bush administration nor the banks, both of whom eagerly supported the bankruptcy reform bill, have any principled objection to interfering with contracts. Their objection seems to be based more on whom the interference is favoring. The reporters covering this issue should have provided readers with this background.

This reminded me of attempts by Governor Matt Blunt, son of US Representative Roy Blunt, to reduce (or end) the adoption subsidy of families already receiving it. Here is an article on that attempt in 2006.

But with a stroke of the governor’s pen, children already receiving subsidies were immediately cut off from this state funding, and hope of assistance for future adopted kids in this category was dashed.

From my tax and invest perspective, I see this as a perfect example of Republicans concern for business, but not necessarily the general public. Those adoption subsidy agreements are contracts between the state and adoptive parents.

Besides this blog, Dean Baker has a column on Alternet on a similar topic, helping big business in the housing crisis.

The OTS plan has the government come to the rescue in this crisis. It would have existing loans restructured so underwater mortgages would be broken into two parts. A new mortgage would be issued that is equal to the current market value of the house. This new mortgage is guaranteed by the government.

The other portion of the mortgage is turned into a certificate that is equal to the difference between the value of the original mortgage and the current value of the house. This certificate is a claim against the sale value of the house, if it exceeds the value of the new mortgage.

In the example used by the OTS, the original mortgage is $220,000 for a home that is now worth $200,000. In this case, the new guaranteed mortgage is equal to $200,000. The holder of the old mortgage gets a certificate for $20,000. This certificate gives the holder (it can be traded) a claim against any money the homeowner gets from selling the house, after paying off the mortgage, up to $20,000.

The OTS would have us believe this is a win-win for homeowners, investors and the public. While they may have convinced the born-yesterday crowd that reports the news, it’s not hard to find the trick.

House prices are falling. The home appraised (do we have honest appraisers?) for $200,000 today is likely to be worth 15 percent to 30 percent less in a year or two. That means a very high portion of the mortgages guaranteed today will subsequently go bad, requiring the government to make good on the guarantee.

To use the OTS numbers, suppose we put up $100 billion to guarantee 500,000 mortgages ($200,000 per mortgage). Let’s say 40 percent of the mortgages subsequently go bad, costing an average of 50 percent of the face value, since homes will have to be sold at large losses. That means the OTS scheme will cost taxpayers $20 billion.

Yeah, the spend and borrow conservatives will bend over backwards to help out big business, letting the let people eat cake… er, I mean foreclosure notices, but we could do the same thing in a way that helps the homeowner directly. For example, we could have the government buy up loans and restructure them. An economic professor at Princeton (not Paul Krugman) and former Vice Chairman of the Federal Reserve, Alan Blinder, has an idea from the great depression, the Home Owner’s Loan Corporation (HOLC), first the background history.

A third reason for focusing on foreclosures is that we’ve seen this film before. During the Depression, President Franklin D. Roosevelt and Congress dealt with huge impending foreclosures by creating the Home Owners’ Loan Corporation. Now, a small but growing group of academics and public figures, including Senator Christopher J. Dodd, Democrat of Connecticut, is calling for the federal government to bring back something like the HOLC. Count me in.

The HOLC was established in June 1933 to help distressed families avert foreclosures by replacing mortgages that were in or near default with new ones that homeowners could afford. It did so by buying old mortgages from banks — most of which were delighted to trade them in for safe government bonds — and then issuing new loans to homeowners. The HOLC financed itself by borrowing from capital markets and the Treasury.

The scale of the operation was impressive. Within two years, the HOLC received about 1.9 million applications from distressed homeowners and granted just over a million new mortgages. (Adjusting only for population growth, the corresponding mortgage figure today would be almost 2.5 million.) Nearly one of every five mortgages in America became owned by the HOLC. Its total lending over its lifetime amounted to $3.5 billion — a colossal sum equal to 5 percent of a year’s gross domestic product at the time. (The corresponding figure today would be about $750 billion.)

As a public corporation chartered for a public purpose, the HOLC was a patient and even lenient lender. It tried to keep delinquent borrowers on track with debt counseling, budgeting help and even family meetings. But times were tough in the 1930s, and nearly 20 percent of the HOLC’s borrowers defaulted anyway. So the corporation eventually acquired ownership of about 200,000 houses, nearly all of which were sold by 1944. The HOLC closed its books in 1951, or 15 years after its last 1936 mortgage was paid off, with a small profit. It was a heavy lift, but the incredible HOLC lifted it.

Of course, a proposal like this will make right wing pundits come out frothing at the mouth like a rabid animal. They will claim that big business is interfering in the market. That we shouldn’t bail out folks that got into loans they didn’t understand. Of course, the counter to these arguments are, we shouldn’t bail out big business that wrote the bad loans. That we are already interfering in the market. Interest rate cuts anyone?

Now back to how the HOLC could work,

Details matter, so here are a few: First, any new HOLC should refinance only owner-occupied residences. Speculators can fend for themselves — or go into default. Similarly, second homes or vacation homes should be ineligible, as should very expensive real estate. (Precise limits would vary regionally.)

Third, mortgages obtained via misrepresentation by borrowers should be ineligible for HOLC refinancing, but cases of fraud or deception by the lender should be treated generously. Fourth, as the original HOLC found, not all bad mortgages can be turned into good ones. Where families simply can’t afford to be owners, the new HOLC should not be asked to perform mortgage alchemy.

What about the operation’s scale? Based on current estimates, such an institution might be asked to consider refinancing one million to two million mortgages — proportionately less than half the job of its predecessor, and maybe less than a quarter. If the average mortgage balance was $200,000, the new HOLC might need to borrow and lend as much as $200 billion to $400 billion. The midpoint, $300 billion, is one-seventh the size of Citigroup and would rank the new institution as the sixth-largest bank in the United States.

Given current low interest rates, a new HOLC could borrow cheaply and should find it easy to earn a two-percentage-point spread between borrowing and lending rates, for a gross profit of maybe $4 billion to $8 billion a year.

What about loan losses? A 10 percent loss rate, or $20 billion to $40 billion, spread over the life of the institution, seems incredibly pessimistic. (The original HOLC experienced a 9.6 percent loss rate during the Depression.) So the new HOLC seems likely to turn a profit, just as the old one did. But even if it loses a few billion, we must remember its public purpose: to help the economy recover, not to make a buck. By comparison, the new economic stimulus package has a price tag of $168 billion.

So the question, what should the governments role in fixing our bleeding economy focus on, Americans or Corporations? I say Americans, remember We the People, not We the Shareholders. And if HOLC worked in the 1930s, why re-invent the wheel? Well the rabid right wing punditry will have issues with it being a New Deal program, but for those of rational thought, we can appreciate a program that works and helps people!

-Josh

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Mortgage refinancing

I must be good people.  Or at least people with good credit.

Tonight I received an letter, via UPS Next Day Air Saver from Detroit, from CitiMortgage.   I have my primary mortgage and a second mortgage in the form of a home equity loan through CitiMortage.  So they know my payment history, and I am sure checked my credit score.

Now this offer is not that great.  First thing that they do to mislead you is at no point do they talk about the size of the loan, other than with this footnote, “Your new loan and payment is based on an estimated loan balance, including interest.”  While the size of a loan should be a minimum piece of information provided, although ideally the total cost of principal and interest would be included, I can’t find it on this piece of paper.  This matters because who is paying the closing costs, how much will the starting principal be.  I can grab my most recent statement and see exactly how much principal left to pay on my primary mortgage.  I will come back to this issue later.

What I get is pressure, because if I respond within 3 days, by February 28, 2008, I get a $500 credit.

I also get a grid that compares the current and the refinanced loan.  This shows both programs are 30 year fixed, that my current rate is 0.625% higher than the new one, that the principal and interest (what the mortgage company gets) of my monthly payments would go down 11.75, and what I see as very strange is that the tax and insurance amount goes up 15.78%.   The total monthly payment would go down 4.28%.

Second problem and it is huge, is why are they showing the tax and insurance as to different amounts.  The movement up or down (you never see down) in this component of the payment will be the same whether I stay with my current mortgage or refinance it.  So to use two different amounts is so bizarre.  In fact using the higher tax and insurance rate for the refinanced mortgage hurts the case for refinancing as the difference in the total payment would have been a reduction of 8.57% (if both had the same tax and insurance amount) rather than the posted 4.28%.

Now back to the issue of not knowing the amount of this new mortage, how much principal I would owe the mortgage company.  This matters a lot especially in a market with falling housing prices.  If I were to refinance and the amount of principal owed went up significantly and the value of the home went down significantly, I could owe more for my house than I could sell it for.  This leads to three options.

  1. Stay in the home and pay down the principal and eventually have some equity built up.
  2. Walk away, take the black mark on the credit score with the bankruptcy, and let the mortgage company eat the loss.
  3. If move before I start to have equity again, then pay to sell my house.

Now since they are unwilling to disclose the amount of the loan, I took a lazy approach to see if this is a good deal for me, with the signs pointing to no.  I bought the house in May 2000, and refinanced in September 2001.  So I have about 283 months of payments left.  I took that amount and multiplied it by the current amount of principal and interest I pay to calculate the total amount left.  Then I took 360 months (3o years) and multiplied it by the refinanced principal and interest amount.  What I learned from this is that I would pay in principal and interest 12.27% more with the refinanced loan over the whole length of the two loans.  That is not a good deal for me in my current financial status, plus I would rather pay off my house if I stay here at 60, not 67.

I have no fancy economic degree or background.  I was and am very good at math, and understanding information or the lack of it.

-Josh