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December 7, 2007

The Mortgage Bailout — Isn’t

by Brad Warbiany

The plan coming out of the administration and treasury to prop up the mortgage industry has caused quite an uproar. In particular, there’s been a big debate even within the ranks of contributors to this blog about exactly how smart of an idea this is.

The problem, however, is that we were largely arguing in a vacuum. The particulars of the plan were largely unknown (or not fully understood), even last night as I was writing my own post on the subject. Thus, in a vacuum people are throwing out terms like “bail-out”, and voluntary vs. forced renegotiation (hereafter I will use the term “modify”, as that appears to be the agreed-upon industry term). In general, we were arguing the rhetorical point about government intervention in the market, without really having a handle on what the government was proposing.

Enter a post by Tanta over at Calculated Risk. First, before you continue reading this post, click on the link and read it. Then come back.

As far as I can understand, it boils down to a few key points:

1. Due to the regulatory/contractual structure, lenders did not know whether they could modify loans without violating the contract of the debt instruments they’ve sold to investors.
2. Investor contracts (Pool & Servicing Agreements, or PSA’s) are not uniform, but most are designed such that loans can only be modified under certain circumstances (when in danger of foreclosure). This is due to the fact that the investments are tax-advantaged, and there are very specific rules within the tax code regarding the regulation of such instruments.
3. Lenders and investors wanted a way to modify loans (instead of foreclosing), but they weren’t sure if they could do so, as the typical language in a PSA says “you can follow agreed-upon practices that don’t violate REMIC standards or jeopardize the investment’s Q-status.”
4. The government decided to clarify the meaning of their tax regs and say that such modifications would not violate said standards.

That’s basically it. It looks like lenders and investors were very confused about whether the actions they wanted to take (modifying loans to avoid foreclosures) could legally be done without violating their current contracts. When they’re confused, they often simply don’t act. The government came out and said “yes, what you want to do is legal”, and now the lenders feel more comfortable going forward.

This is why there are three classes of borrowers, and that borrowers capable of refinancing are not eligible for the rate freeze. Those who are capable of refinancing their loan are not considered “in danger of foreclosure”, so they cannot be legally modified within the bounds of the PSA. Their only hope is refinancing. For those with low FICO scores, or other conditions that make refinancing impossible, but are in danger of foreclosure, this gives lenders the ability to modify their loans without fear of legal action under the PSA.

But this isn’t really all about helping borrowers, it’s about letting lenders find a way out of this mess without going belly-up. Which, if you think about it, is entirely consistent with a Bush administration proposal: help the corporations, whether it improves the economy, the housing market, or not. It appears this is a lot more complicated than what fits into a 2-minute sound bite on MSNBC. And like most government actions, between a thin veneer of “public interest”, it’s really about helping out the lenders and investors, not the borrowers.

Of course, the Administration is selling this to the public as if it’s all about helping borrowers. They’re politicians, and they want the public to believe they’re “doing something”. The media isn’t interested in in-depth analysis of the situation, and your average newspaper reader isn’t very interested in getting knee-deep in PSA, REMICs, Q-status, and the like. So only out in the blogosphere does anyone have an incentive to actually call this a non-action, which is what it is.

This isn’t a giveaway to borrowers.
This isn’t a violation of investors’ contracts with lenders.
This isn’t costing the taxpayer money.

This isn’t a bailout.

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8 Comments

  1. Thanks for the update Brad….I’ll put down the pitchfork…for now.

    Comment by Greg — December 7, 2007 @ 4:07 pm
  2. I know very little about this stuff, but…

    This isn’t a giveaway to borrowers.
    This isn’t a violation of investors’ contracts with lenders.
    This isn’t costing the taxpayer money.

    So there is no “seen” bailout, but I don’t see how you can say this…

    But this isn’t really all about helping borrowers, it’s about letting lenders find a way out of this mess without going belly-up.

    …without there being some sort of “unseen” bailout.

    Comment by Jeff Molby — December 7, 2007 @ 4:18 pm
  3. LOL… Jeff, I was wondering if someone was going to catch that.

    If anything, it’s “bailout” of lenders rather than borrowers. The reason I said it wasn’t a bailout is that it’s the borrowers that everyone is mad about, because this is seen as a giveaway to them.

    At the same time, it’s not really a “bailout” of the lenders, because the feds aren’t actually giving them money, loans, etc to prop them up. All they’re really doing is giving them legal cover to do something that might have been a legal gray area previously. I don’t really see that as a bailout, in the traditional sense of the term. It’s more of a “deregulation”, which is still a misnomer because the regulation hasn’t changed, there’s only been a wider interpretation of it by the regulators.

    Comment by Brad Warbiany — December 7, 2007 @ 4:26 pm
  4. Ok, Brad, but someone, somewhere probably made their decision based on the original interpretation, no? Isn’t it possible that that person, whoever it may be, is the one getting screwed by change in interpretation?

    No matter how you slice it, the rules are being changed midway through the game and someone will clearly benefit. How can you be so sure there isn’t someone losing too?

    Comment by Jeff Molby — December 7, 2007 @ 6:54 pm
  5. [...] Interesting post up over at The Liberty Papers: The Mortgage Bailout – Isn’t [...]

    Pingback by Justin Buist » Blog Archive » Mortage Rate Freeze — December 7, 2007 @ 8:23 pm
  6. Jeff,

    I’m not sure that it’s a “new” interpretation, rather it’s a question that hadn’t been asked. I don’t think this interpretation changes an existing interpretation, as much as it clarifies an unclear portion of the rules.

    Comment by Brad Warbiany — December 7, 2007 @ 9:09 pm
  7. Brad,

    You’re totally right. The government doesn’t really care about the average citizen. This bailout is designed for the banks and lenders not citizens. If it cared more about the citizens it would create a plan that benefited the home owners and not the lenders.

    Comment by John Casey (Mortgage Foreclosure Blog) — December 8, 2007 @ 1:47 pm
  8. Brad,

    From what I can tell, this law isn’t targeted at sub-prime mortgages or what’s considered the risking portion of the mortgage industry. This law is targeted at non-conforming mortgages to individuals that were eligible for prime interest rates. It’s applicable to the entire mortgage industry.

    We keep pounding on “sub-prime! sub-prime!” but the law is aimed at preempt a meltdown for the entire industry. Basically, it looks like we’re only at the tip of the iceberg.

    Comment by TanGeng — December 8, 2007 @ 8:09 pm

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