A Case for Mortgage Principal Reductions by Mark Hanson

by 11 Jan 2009
The housing market will 'fix' itself over time and constant meddling only prolongs the inevitable. But regulators, politicians and banks are hell-bent of 'saving' us all with programs that will just not work. The only way to 'fix' the housing and mortgage markets and consumer?s balance sheet is to undo 2003-2007. To 'undo' means to: ? a) force de-lever the home owner/consumer through mortgage principal balance reductions based upon what the borrower really earns using market-rate financing ? b) make it so home owners can freely refinance and sell their homes ? c) make it so the vitally important move-up buyer comes back ? d) significantly reduce defaults and foreclosures without making home owners underwater, fully-leveraged, renters for the rest of their life as the present FDIC, Fannie/Freddie and bank mortgage modification plans do ? e) allow home prices to fall to attractive multiples of rents and incomes without exotic loan programs or artificial, temporarily, government induced low mortgage rates This can all be accomplished quickly if the right steps are taken. HOME OWNERS AS A WHOLE ARE NOT TO BLAME The reality is that at the time most troubled loans were made, most borrowers really could ?afford? their payments. This is because during the ?bad years? everyone earned as much as necessary for the purposes of qualifying for a loan due to the way the loans were structured. This greater housing and mortgage crisis is not a result of millions of borrowers going wild, buying beyond their means blinded by greed or some massive consumer driven multi-year mortgage fraud era where everyone lied to buy a home. Nor was is caused by gangs of mortgage brokers didn't cruise the streets with 1003's and pens in hand recruiting straw buyers to steals homes. The greatest real estate bubble of all time was only able to occur because of the investment and commercial bank?s constant re-engineering of loan programs focusing on low monthly payments and the virtual elimination of income and assets as a variable. This extraordinary leverage created through these exotic loan programs and easy credit never existed before and never will again. The problem going forward that most do not realize is that during the bubble years, everything was exotic - even 30-year fixed, fully documented loans. PEOPLE VIEW THEIR HOME AS AN INVESTMENT - NOT A PLACE TO LIVE What?s worse is that over the past five years there was a fundamental shift of how people viewed their home - from ?a place to live? to their single ?largest investment?. How could they not when all loan programs from Subprime to Prime allowed 50% of gross income (greater when considering limited income doc loans) to be used towards debt. In the good ?ol days when housing was viewed as a place to live, financing was sound with down payments required and no more than 28% of gross income going towards housing debt. When homes prices fell it was alright because home owners could still save money and do the things they wanted to in life. 50% debt-to-income ratios changed the game. Make no mistake about it ? most ALT-A, Jumbo Prime and Prime borrowers are not walking away because they can?t technically ?afford? their payments. They are walking because all of their after-tax income each month is going out in bills and the largest portion is going to a home worth half of what they owe. When they are spending such a large portion of their income on such a massively depreciating asset, it makes good financial sense to dump that asset. When you can?t sell, that means walk away. That being said, there are many who can?t afford their payments because of an ARM adjustment. But at one time they were qualified by the bank and due to the way the loan was structured they could in fact afford the home. Banks and real estate professionals in every city in the nation used high-leverage exotic loans in order get people to qualify for ever increasing loan amounts. By 2005, interest-only was industry standard, so was stated income. You could not turn on the radio or television without being inundated with ads for $350k mortgage loans for 1% and $1000 monthly payments. Lenders didn?t worry too much over what would happen to the loan after it funded because the loan was sold and they lose all liability after six months or so. The 2/28 Subprime ARM was a perfect example of a loan program not designed to hold over the initial teaser period and one that the lender didn?t care about because most were sold and securitized. Therefore, who cares about creating loans that will last - just make loans that will last at least six months. Even the securities investors never planned on holding these securities long-term. Exotic loans with teasers were sold as a ?way to get into the home more cheaply? or a ?way to improve your credit then refi into something better a couple of years from now?. The high churn rate out of these loans was what kept MBS money flowing into this sector. They were short-term, high yield investments. This philosophy was not isolated to Subprime 2/28?s either - Prime 5/1 interest only ARMs and Pay Option ARMs were also sold the same way. ARMs were the majority of mortgages in the bubble states through the bubble years. EVERYONE EARNED $150K PER YEAR Due to the way the loans were structured, from 2003 through 2007 everyone made $150k a year for the purposes of obtaining a mortgage loan. Teaser rates, interest only, negative amortization, high allowable debt-to-income ratios, zero down, stated income etc made all homes affordable and borrowers rich. Home prices responded by surging higher to meet the new found nationally high affordability level. As home prices surged, new loan programs were rolled out what seemed like daily to keep affordability in check. As these loan programs became the norm, folks who really earned $150k a year and put 20% down went out and bought over priced homes based upon flawed and temporary fundamentals. Now they too are upside down in their home by 30% and have seen their life savings evaporate. They overpaid because the hourly day-laborer was bidding against them using a stated income 100% interest only combo - hey, the loan officer at the bank and the Realtor told the janitor that ?based upon his income and credit you qualify for this loan?. Why should he argue with his bank? They know best. They are the experts. REALITY But now it is obvious that the past six years was an illusion and none of the easy credit, high-leverage programs exists any longer. Prices are coming down to the real affordability levels using 15 and 30-year fixed rate loans and a down payment, which has rendered the nations financial institutions and millions of home owners instantly insolvent. The same $85k per year household that two years ago could buy a $650k home with no money down can now buy a $275k - $300k home with 10% down. It now takes at least $150k a year and a large down payment to buy a $650k home. 100% stated interest only and Pay option ARMs will not return. Nor will 100% HELOCs. They were doomed to fail from their creation. The banks and raters had modeling systems that they never stress tested. You mean to tell me that it never occurred to the smartest guys in the room to plug into the model that home prices could actually fall? That was a fatal error that the world is paying for. This is why crisis was never and will never be ?contained? to Subprime. This is why those who put down 20% are walking away from their homes - it makes for a sound financial decision. Negative equity is now the leading cause of loan default among higher paper grades ? if even only for the fact that as a homeowner experiences a rough spot, she can?t sell or refi to solve it. As house prices fall further, more will walk. Yes, there were people who took advantage of the system. But, that was a small percentage of everyone who bought or refinanced a home based upon temporary and flawed market fundamentals induced by easy credit and exotic loan programs that never should have existed in the first place. This five year period of absolute recklessness and blind greed on the bank?s part was the real driver of home prices. Taking that consumer leverage away and ?going straight? was the straw that broke the market?s back. Now fundamentals are taking over and housing prices are just going to the levels determined by incomes, rents, interest rates and the macro-economy. ARTIFICIALLY LOW RATES WILL NOT HELP EITHER Who Can Really Benefit From a 5% CONFORMING (=<$417K) Mortgage? With a 69% home ownership rate at the peak, values down around 50% in the bubble states, negative-equity at an epidemic level, base-rates for most loans only available to those with high credit score and low LTV?s and Jumbo money still in peril, who is left to take advantage of these low rates? While for those that qualify low rates are a great thing, it is very possible that the excitement over low mortgage rates will end up being exactly like the excitement surrounding the previous 20 bailouts, acts, proposals over the past year -- 'lights at the end of the tunnels' that ended up being trains. ?Back Then? In the good-old days, when rates dropped 50bps in a short period of time, the entire country would refinance for a lower rate, for cash out, to combine a first and second into new first mortgage and then add a new HELOC, etc. Back then when values went up every month and there were hundreds of lenders with thousands of programs and interest rate structures it was very easy to pump the mortgage money. Back then the refi waves came every 6-8 months and within a few months after a wave began it was noticeable how this injection rejuvenated the consumer. This can?t happen any longer. Refinances Now Negative Equity - Within the states that need to most help and are most beneficial to the macro-economy, the vast majority can?t refi due to negative-equity. In CA for example, 60% of mortgagees are either underwater or ?near? underwater and will not be able to take advantage of the rates. NV, FL and AZ are even worse. Most home owners in the top 10 trouble states in the nation are stuck underwater in their homes, unable to move or refinance. Rates are lower than last month for sure, but these ?low rates? that are being heralded are ONLY for the best AAA Prime gold borrowers with 80% CLTV?s and 740 scores. This represents a small fraction of borrowers. The rest will still get rates above 6% or pay unrealistic fees in order to close the loan. As a matter of fact, most borrowers with the profile needed to refi at 5.25% today likely did not participate in the past several years of serial refinancing and many already have low 30-year fixed rates at 5% attained in 2003-2004. These rates are not for anyone less than perfect. Folks don?t qualify - ?Back then? nearly everyone could benefit from a drop in rates because values always went up and because stated income and interest only loans made it so everyone could qualify. Until mid 2007, lenders actually funded 75-80% of all loan applications! Now, lenders are funding 30-40% of applications. That is serious fall out. Now, most need two years tax returns, a current pay stub, great credit and sizable equity to take advantage of the best rates. This profile represents a small minority of borrowers. Purchases Now With respect to purchasing, since over half the market is distressed sales of foreclosure related properties, rate does not matter as much - home price does. While rates dropping may encourage more to shop, rates falling 1% will not significantly change things - it?s about how cheaply they can buy. Everyone wants a ?deal? on a foreclosure. Many ?investors? pay cash and for them it is all about price, rents and cap rates. Renters and first time home buyers are a different story and should see some benefit to lower rates if they hold. They will either save money or qualify for slightly more house. But remember, first time home buyers and renters are the weakest portion of the market and have always been. What is missing is the all-important move-up buyer, which lower rates will not help to any great degree. This is because of the gross amount of negative equity already discussed here and because without all of the exotic loan programs and easy qualifying many can?t even afford to re-buy the home they live in now. LOW MORTGAGE RATES TO SPUR NEW WAVE OF LOAN DEFAULTS & SENTIMENT BUST Talk about unintended consequences. This is especially important for those of you thinking that these low mortgage rates will lead housing and the consumer to the Promised Land. In my opinion, the government artificially pushing rates down this quickly not only will cost the originators plenty but quickens the pace at which the Alt-A, Jumbo Prime, and ?Prime? implosions could begin in earnest. In the past the mortgage process involved getting a completed loan application, ordering the credit report and appraisal and processing the loan. In a couple of weeks when the appraisal came back from the appraiser, the loan was submitted into underwriting for approval. Everything went smoothly because the appraisal always came at or above borrower?s estimates. These days the process has changed a bit. Now the first thing done after the loan application is taken is to call the appraiser for a comparable sale check to see if the value at which the home owner states the house is worth is on target. Therein lays the rub. From early reports since rates fell sharply in early December, 80% of the loan applications are not getting out of the starting gate easily. Loan officers are all saying the same thing ? that appraisals are not coming at value due because ?all of the foreclosures and REO sales have taken the value down?. In the majority of these cases, this kills the loan. The loan officer then notifies the borrower of the news and they are in disbelief. All home owners think that their home is worth the most on the block and I have been told that this is a tough pill to swallow. This brings the crisis home instantly. Everyone trying to refinance into lower rates at once should hasten the national reality that the largest portion of the home owner?s net worth has evaporated in the past year. One loan officer I spoke with equated this call to a Doctor notifying a patient that they had a terminal illness. The other three top reasons that loans are not making it out of the application phase are because of credit scores coming in too low, interest rates not really being what the borrowers are hearing hyped and Jumbo money is near all-time highs. This harsh reality could spur a new wave of defaults and walk-aways from borrowers that were not considered at-risk before. This takes the crisis into the ?Prime? universe very quickly because Prime borrowers represent the majority of new refi applicants. This new wrinkle brings the Prime Implosion to the forefront much quicker than my original, more linear time-line of Subprime to Alt-A to Jumbo Prime then Prime with some overlap. In a nutshell those that don?t need the credit can get it and those that do can?t. This is the perfect credit crisis storm - one which low rates can?t fix. POSSIBLE FANNIE/FREDDIE GUIDELINE CHANGE WILDCARD The only thing that can be done to get mortgage money into more borrower?s hands quickly is to waive appraisals for Agency and FHA loans as Lockhart has suggested. That is of course if the borrowers are ignorant enough to consider this option. ?James Lockhart, Fannie and Freddie?s regulator, said last week they were considering waiving the requirement to get new home price appraisals before refinancing loans they hold ? a move that could greatly increase the scope for refinancing.? But ?no appraisal? refi?s are a disaster that takes the housing crisis to an entirely different level because now the tax payer will be on the hook for trillions in mortgages that are essentially unsecured credit lines. Nobody will ever buy these loans or securities derived from them. But even if they tried this there will still be millions who won?t benefit because the rate is still too high, whose scores are too low or who have a Jumbo loan amount who will not benefit. That being said, given the extent of the negative-equity in America with no way to fix it other than aggressive proactive loan modifications allowing principal balance reductions, my money is on them seriously considering this radically destructive move out of sheer panic. THE PERMANENT SOLUTION ? FORCE DE-LEVERING THROUGH MORTGAGE PRINCIPAL BALANCE REDUCTIONS The permanent solution is not about the regulators forcing interest rates down to artificially low levels temporarily - that's what got us here in the first place. That being said, sustainable low rates are good for the housing market. But low rates mean very little when millions will default and lose their homes over the next few years because all of that added supply can't be absorbed by the available buyers. The fact is that there are much fewer buyers than ever before given home ownership was at 69% a couple of years back and now the largest sector of the purchase market, move-up buyers, are all but non-existent. We are already seeing positive signs that the Subprime crisis is on the other side of the hill mostly on its own. The problem is that the Alt-A, Jumbo Prime and Prime mountains lie ahead. The present course of action are multiple versions of the same ?lever them back up? mortgage modification initiatives, which will all prove to be failures in the end. The recidivism rate across older vintage loan mods is over 50% and there is no reason that new vintage will not follow the same path as housing prices continue to fall. To fix the housing market and greatly aid the economy you must focus on two important segments that made up 80% of all housing activity - the refinance borrower and move-up buyer. Now they are the minority. This is a major problem. We need to get these people back into the market. Investors, vacation home buyers, renters and first-time home buyers have always been the smallest segments of the market and now they are its primary participants. While low rates may be great for low priced homes in foreclosure epicenters, but as the default crisis jumps tracks into Alt-A, Jumbo Prime and Prime, higher end areas will follow down the same path. Without any reasonable financing available for loans over $417k, it is already a foregone conclusion. Prices are coming down fast and the market will clear at some point and at some level. But that level could be years away. As with the financial institutions, the quicker the borrowers de-lever and raise cash the better for the housing market and macro-economy. It is worth spending money directly on the problem and quickly de-leveraging US households so they are free to save and spend money on other things besides an underwater house. So far, most of the money has been spent on the symptoms. Undoing the Past 5-Years It won?t be too long before the permanent solution must be implemented ? that is to re-underwrite every loan originated between 2003 - 2007 using prudent underwriting guidelines for anyone who wishes to participate. Even 30-year fixed ?Prime? loans were allowed to got o 50% DTI and higher during the bubble years and are at-risk. Then reduce the principal balance to what the borrower really earns using time-tested 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered to 28/36 DTI they are able to save money and live a decent lifestyle. If they go upside down in their property it is less consequential - they are still able to save money and live the lifestyle their income level allows. At 28/36, their home once again becomes a place to live. When a mortgage loan is re-underwritten under sensible terms that can be repaid, the value of the loan will increase, as the risk of default lessens. Entire securities of loans could conceivably gain in value as mortgage defaults nationally wane. But write-ups are only possible if the financial institution has written them down to present value, which is highly unlikely across mortgage universe. Even underwater, worthless HELOC?s are still carried at face value by most of the nations leading banks. If reducing the principal balance to 28/36 on a market rate 30-year fixed loan winds up being considerably lower than the present value of the home, the bank should receive the differential through an equity warrant to 90% of the value of the property. This way the home owner is not upside down in the home, they can freely sell or refi, they are not getting anything more than they deserve and the bank is still protected. But the home owner should get all of the upside. Anything less and the program will fail. If the distressed borrower can?t prove income or significant reserves through bank statements at the very least, then they need to leave the house and rent. They should have been renters all along. For the small percentage of folks who can afford the payments just fine with DTI's under 28/36 but are underwater solely due to house price depreciation, principal balance reductions to 90% of the present value of the property is likely in order WITH a full-recourse provision to thwart fraud. The minority with equity who may owe $200k on a $400k home or have no mortgage at all get a multi-year tax break and a lollipop. Many already have 5% to 5.5% rates obtained 5-years ago. Additionally, they are benefited because as this de-leverages and stabilizes the consumer, house prices will stabilize much faster. Left unchecked or pushed out through bad loan modification initiatives, the consumer de-leveraging and housing price depreciation will continue for years, which brings every home down. These things will not prevent housing prices from coming down over the next few years to reach a level of affordability consistent with present mortgage rates and lending guidelines. But at least it would be the best way to begin to undo the irresponsibility of the past five years and get back to basics where house prices and affordability are based primarily on traditional factors such as rents, incomes, interest rates, macroeconomic conditions and sentiment. Best Regards, Mark Hanson Mark@TheFieldCheckGroup.com Analysis by Mark Hanson, Field Check Group Real Estate & Finance Data in partnership with Foreclosure Radar The housing market will 'fix' itself over time and constant meddling only prolongs the inevitable. But regulators, politicians and banks are hell-bent of 'saving' us all with programs that will just not work. The only way to 'fix' the housing and mortgage markets and consumer?s balance sheet is to undo 2003-2007. To 'undo' means to: ? a) force de-lever the home owner/consumer through mortgage principal balance reductions based upon what the borrower really earns using market-rate financing ? b) make it so home owners can freely refinance and sell their homes ? c) make it so the vitally important move-up buyer comes back ? d) significantly reduce defaults and foreclosures without making home owners underwater, fully-leveraged, renters for the rest of their life as the present FDIC, Fannie/Freddie and bank mortgage modification plans do ? e) allow home prices to fall to attractive multiples of rents and incomes without exotic loan programs or artificial, temporarily, government induced low mortgage rates This can all be accomplished quickly if the right steps are taken. HOME OWNERS AS A WHOLE ARE NOT TO BLAME The reality is that at the time most troubled loans were made, most borrowers really could ?afford? their payments. This is because during the ?bad years? everyone earned as much as necessary for the purposes of qualifying for a loan due to the way the loans were structured. This greater housing and mortgage crisis is not a result of millions of borrowers going wild, buying beyond their means blinded by greed or some massive consumer driven multi-year mortgage fraud era where everyone lied to buy a home. Nor was is caused by gangs of mortgage brokers didn't cruise the streets with 1003's and pens in hand recruiting straw buyers to steals homes. The greatest real estate bubble of all time was only able to occur because of the investment and commercial bank?s constant re-engineering of loan programs focusing on low monthly payments and the virtual elimination of income and assets as a variable. This extraordinary leverage created through these exotic loan programs and easy credit never existed before and never will again. The problem going forward that most do not realize is that during the bubble years, everything was exotic - even 30-year fixed, fully documented loans. PEOPLE VIEW THEIR HOME AS AN INVESTMENT - NOT A PLACE TO LIVE What?s worse is that over the past five years there was a fundamental shift of how people viewed their home - from ?a place to live? to their single ?largest investment?. How could they not when all loan programs from Subprime to Prime allowed 50% of gross income (greater when considering limited income doc loans) to be used towards debt. In the good ?ol days when housing was viewed as a place to live, financing was sound with down payments required and no more than 28% of gross income going towards housing debt. When homes prices fell it was alright because home owners could still save money and do the things they wanted to in life. 50% debt-to-income ratios changed the game. Make no mistake about it ? most ALT-A, Jumbo Prime and Prime borrowers are not walking away because they can?t technically ?afford? their payments. They are walking because all of their after-tax income each month is going out in bills and the largest portion is going to a home worth half of what they owe. When they are spending such a large portion of their income on such a massively depreciating asset, it makes good financial sense to dump that asset. When you can?t sell, that means walk away. That being said, there are many who can?t afford their payments because of an ARM adjustment. But at one time they were qualified by the bank and due to the way the loan was structured they could in fact afford the home. Banks and real estate professionals in every city in the nation used high-leverage exotic loans in order get people to qualify for ever increasing loan amounts. By 2005, interest-only was industry standard, so was stated income. You could not turn on the radio or television without being inundated with ads for $350k mortgage loans for 1% and $1000 monthly payments. Lenders didn?t worry too much over what would happen to the loan after it funded because the loan was sold and they lose all liability after six months or so. The 2/28 Subprime ARM was a perfect example of a loan program not designed to hold over the initial teaser period and one that the lender didn?t care about because most were sold and securitized. Therefore, who cares about creating loans that will last - just make loans that will last at least six months. Even the securities investors never planned on holding these securities long-term. Exotic loans with teasers were sold as a ?way to get into the home more cheaply? or a ?way to improve your credit then refi into something better a couple of years from now?. The high churn rate out of these loans was what kept MBS money flowing into this sector. They were short-term, high yield investments. This philosophy was not isolated to Subprime 2/28?s either - Prime 5/1 interest only ARMs and Pay Option ARMs were also sold the same way. ARMs were the majority of mortgages in the bubble states through the bubble years. EVERYONE EARNED $150K PER YEAR Due to the way the loans were structured, from 2003 through 2007 everyone made $150k a year for the purposes of obtaining a mortgage loan. Teaser rates, interest only, negative amortization, high allowable debt-to-income ratios, zero down, stated income etc made all homes affordable and borrowers rich. Home prices responded by surging higher to meet the new found nationally high affordability level. As home prices surged, new loan programs were rolled out what seemed like daily to keep affordability in check. As these loan programs became the norm, folks who really earned $150k a year and put 20% down went out and bought over priced homes based upon flawed and temporary fundamentals. Now they too are upside down in their home by 30% and have seen their life savings evaporate. They overpaid because the hourly day-laborer was bidding against them using a stated income 100% interest only combo - hey, the loan officer at the bank and the Realtor told the janitor that ?based upon his income and credit you qualify for this loan?. Why should he argue with his bank? They know best. They are the experts. REALITY But now it is obvious that the past six years was an illusion and none of the easy credit, high-leverage programs exists any longer. Prices are coming down to the real affordability levels using 15 and 30-year fixed rate loans and a down payment, which has rendered the nations financial institutions and millions of home owners instantly insolvent. The same $85k per year household that two years ago could buy a $650k home with no money down can now buy a $275k - $300k home with 10% down. It now takes at least $150k a year and a large down payment to buy a $650k home. 100% stated interest only and Pay option ARMs will not return. Nor will 100% HELOCs. They were doomed to fail from their creation. The banks and raters had modeling systems that they never stress tested. You mean to tell me that it never occurred to the smartest guys in the room to plug into the model that home prices could actually fall? That was a fatal error that the world is paying for. This is why crisis was never and will never be ?contained? to Subprime. This is why those who put down 20% are walking away from their homes - it makes for a sound financial decision. Negative equity is now the leading cause of loan default among higher paper grades ? if even only for the fact that as a homeowner experiences a rough spot, she can?t sell or refi to solve it. As house prices fall further, more will walk. Yes, there were people who took advantage of the system. But, that was a small percentage of everyone who bought or refinanced a home based upon temporary and flawed market fundamentals induced by easy credit and exotic loan programs that never should have existed in the first place. This five year period of absolute recklessness and blind greed on the bank?s part was the real driver of home prices. Taking that consumer leverage away and ?going straight? was the straw that broke the market?s back. Now fundamentals are taking over and housing prices are just going to the levels determined by incomes, rents, interest rates and the macro-economy. ARTIFICIALLY LOW RATES WILL NOT HELP EITHER Who Can Really Benefit From a 5% CONFORMING (=<$417K) Mortgage? With a 69% home ownership rate at the peak, values down around 50% in the bubble states, negative-equity at an epidemic level, base-rates for most loans only available to those with high credit score and low LTV?s and Jumbo money still in peril, who is left to take advantage of these low rates? While for those that qualify low rates are a great thing, it is very possible that the excitement over low mortgage rates will end up being exactly like the excitement surrounding the previous 20 bailouts, acts, proposals over the past year -- 'lights at the end of the tunnels' that ended up being trains. ?Back Then? In the good-old days, when rates dropped 50bps in a short period of time, the entire country would refinance for a lower rate, for cash out, to combine a first and second into new first mortgage and then add a new HELOC, etc. Back then when values went up every month and there were hundreds of lenders with thousands of programs and interest rate structures it was very easy to pump the mortgage money. Back then the refi waves came every 6-8 months and within a few months after a wave began it was noticeable how this injection rejuvenated the consumer. This can?t happen any longer. Refinances Now Negative Equity - Within the states that need to most help and are most beneficial to the macro-economy, the vast majority can?t refi due to negative-equity. In CA for example, 60% of mortgagees are either underwater or ?near? underwater and will not be able to take advantage of the rates. NV, FL and AZ are even worse. Most home owners in the top 10 trouble states in the nation are stuck underwater in their homes, unable to move or refinance. Rates are lower than last month for sure, but these ?low rates? that are being heralded are ONLY for the best AAA Prime gold borrowers with 80% CLTV?s and 740 scores. This represents a small fraction of borrowers. The rest will still get rates above 6% or pay unrealistic fees in order to close the loan. As a matter of fact, most borrowers with the profile needed to refi at 5.25% today likely did not participate in the past several years of serial refinancing and many already have low 30-year fixed rates at 5% attained in 2003-2004. These rates are not for anyone less than perfect. Folks don?t qualify - ?Back then? nearly everyone could benefit from a drop in rates because values always went up and because stated income and interest only loans made it so everyone could qualify. Until mid 2007, lenders actually funded 75-80% of all loan applications! Now, lenders are funding 30-40% of applications. That is serious fall out. Now, most need two years tax returns, a current pay stub, great credit and sizable equity to take advantage of the best rates. This profile represents a small minority of borrowers. Purchases Now With respect to purchasing, since over half the market is distressed sales of foreclosure related properties, rate does not matter as much - home price does. While rates dropping may encourage more to shop, rates falling 1% will not significantly change things - it?s about how cheaply they can buy. Everyone wants a ?deal? on a foreclosure. Many ?investors? pay cash and for them it is all about price, rents and cap rates. Renters and first time home buyers are a different story and should see some benefit to lower rates if they hold. They will either save money or qualify for slightly more house. But remember, first time home buyers and renters are the weakest portion of the market and have always been. What is missing is the all-important move-up buyer, which lower rates will not help to any great degree. This is because of the gross amount of negative equity already discussed here and because without all of the exotic loan programs and easy qualifying many can?t even afford to re-buy the home they live in now. LOW MORTGAGE RATES TO SPUR NEW WAVE OF LOAN DEFAULTS & SENTIMENT BUST Talk about unintended consequences. This is especially important for those of you thinking that these low mortgage rates will lead housing and the consumer to the Promised Land. In my opinion, the government artificially pushing rates down this quickly not only will cost the originators plenty but quickens the pace at which the Alt-A, Jumbo Prime, and ?Prime? implosions could begin in earnest. In the past the mortgage process involved getting a completed loan application, ordering the credit report and appraisal and processing the loan. In a couple of weeks when the appraisal came back from the appraiser, the loan was submitted into underwriting for approval. Everything went smoothly because the appraisal always came at or above borrower?s estimates. These days the process has changed a bit. Now the first thing done after the loan application is taken is to call the appraiser for a comparable sale check to see if the value at which the home owner states the house is worth is on target. Therein lays the rub. From early reports since rates fell sharply in early December, 80% of the loan applications are not getting out of the starting gate easily. Loan officers are all saying the same thing ? that appraisals are not coming at value due because ?all of the foreclosures and REO sales have taken the value down?. In the majority of these cases, this kills the loan. The loan officer then notifies the borrower of the news and they are in disbelief. All home owners think that their home is worth the most on the block and I have been told that this is a tough pill to swallow. This brings the crisis home instantly. Everyone trying to refinance into lower rates at once should hasten the national reality that the largest portion of the home owner?s net worth has evaporated in the past year. One loan officer I spoke with equated this call to a Doctor notifying a patient that they had a terminal illness. The other three top reasons that loans are not making it out of the application phase are because of credit scores coming in too low, interest rates not really being what the borrowers are hearing hyped and Jumbo money is near all-time highs. This harsh reality could spur a new wave of defaults and walk-aways from borrowers that were not considered at-risk before. This takes the crisis into the ?Prime? universe very quickly because Prime borrowers represent the majority of new refi applicants. This new wrinkle brings the Prime Implosion to the forefront much quicker than my original, more linear time-line of Subprime to Alt-A to Jumbo Prime then Prime with some overlap. In a nutshell those that don?t need the credit can get it and those that do can?t. This is the perfect credit crisis storm - one which low rates can?t fix. POSSIBLE FANNIE/FREDDIE GUIDELINE CHANGE WILDCARD The only thing that can be done to get mortgage money into more borrower?s hands quickly is to waive appraisals for Agency and FHA loans as Lockhart has suggested. That is of course if the borrowers are ignorant enough to consider this option. ?James Lockhart, Fannie and Freddie?s regulator, said last week they were considering waiving the requirement to get new home price appraisals before refinancing loans they hold ? a move that could greatly increase the scope for refinancing.? But ?no appraisal? refi?s are a disaster that takes the housing crisis to an entirely different level because now the tax payer will be on the hook for trillions in mortgages that are essentially unsecured credit lines. Nobody will ever buy these loans or securities derived from them. But even if they tried this there will still be millions who won?t benefit because the rate is still too high, whose scores are too low or who have a Jumbo loan amount who will not benefit. That being said, given the extent of the negative-equity in America with no way to fix it other than aggressive proactive loan modifications allowing principal balance reductions, my money is on them seriously considering this radically destructive move out of sheer panic. THE PERMANENT SOLUTION ? FORCE DE-LEVERING THROUGH MORTGAGE PRINCIPAL BALANCE REDUCTIONS The permanent solution is not about the regulators forcing interest rates down to artificially low levels temporarily - that's what got us here in the first place. That being said, sustainable low rates are good for the housing market. But low rates mean very little when millions will default and lose their homes over the next few years because all of that added supply can't be absorbed by the available buyers. The fact is that there are much fewer buyers than ever before given home ownership was at 69% a couple of years back and now the largest sector of the purchase market, move-up buyers, are all but non-existent. We are already seeing positive signs that the Subprime crisis is on the other side of the hill mostly on its own. The problem is that the Alt-A, Jumbo Prime and Prime mountains lie ahead. The present course of action are multiple versions of the same ?lever them back up? mortgage modification initiatives, which will all prove to be failures in the end. The recidivism rate across older vintage loan mods is over 50% and there is no reason that new vintage will not follow the same path as housing prices continue to fall. To fix the housing market and greatly aid the economy you must focus on two important segments that made up 80% of all housing activity - the refinance borrower and move-up buyer. Now they are the minority. This is a major problem. We need to get these people back into the market. Investors, vacation home buyers, renters and first-time home buyers have always been the smallest segments of the market and now they are its primary participants. While low rates may be great for low priced homes in foreclosure epicenters, but as the default crisis jumps tracks into Alt-A, Jumbo Prime and Prime, higher end areas will follow down the same path. Without any reasonable financing available for loans over $417k, it is already a foregone conclusion. Prices are coming down fast and the market will clear at some point and at some level. But that level could be years away. As with the financial institutions, the quicker the borrowers de-lever and raise cash the better for the housing market and macro-economy. It is worth spending money directly on the problem and quickly de-leveraging US households so they are free to save and spend money on other things besides an underwater house. So far, most of the money has been spent on the symptoms. Undoing the Past 5-Years It won?t be too long before the permanent solution must be implemented ? that is to re-underwrite every loan originated between 2003 - 2007 using prudent underwriting guidelines for anyone who wishes to participate. Even 30-year fixed ?Prime? loans were allowed to got o 50% DTI and higher during the bubble years and are at-risk. Then reduce the principal balance to what the borrower really earns using time-tested 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered to 28/36 DTI they are able to save money and live a decent lifestyle. If they go upside down in their property it is less consequential - they are still able to save money and live the lifestyle their income level allows. At 28/36, their home once again becomes a place to live. When a mortgage loan is re-underwritten under sensible terms that can be repaid, the value of the loan will increase, as the risk of default lessens. Entire securities of loans could conceivably gain in value as mortgage defaults nationally wane. But write-ups are only possible if the financial institution has written them down to present value, which is highly unlikely across mortgage universe. Even underwater, worthless HELOC?s are still carried at face value by most of the nations leading banks. If reducing the principal balance to 28/36 on a market rate 30-year fixed loan winds up being considerably lower than the present value of the home, the bank should receive the differential through an equity warrant to 90% of the value of the property. This way the home owner is not upside down in the home, they can freely sell or refi, they are not getting anything more than they deserve and the bank is still protected. But the home owner should get all of the upside. Anything less and the program will fail. If the distressed borrower can?t prove income or significant reserves through bank statements at the very least, then they need to leave the house and rent. They should have been renters all along. For the small percentage of folks who can afford the payments just fine with DTI's under 28/36 but are underwater solely due to house price depreciation, principal balance reductions to 90% of the present value of the property is likely in order WITH a full-recourse provision to thwart fraud. The minority with equity who may owe $200k on a $400k home or have no mortgage at all get a multi-year tax break and a lollipop. Many already have 5% to 5.5% rates obtained 5-years ago. Additionally, they are benefited because as this de-leverages and stabilizes the consumer, house prices will stabilize much faster. Left unchecked or pushed out through bad loan modification initiatives, the consumer de-leveraging and housing price depreciation will continue for years, which brings every home down. These things will not prevent housing prices from coming down over the next few years to reach a level of affordability consistent with present mortgage rates and lending guidelines. But at least it would be the best way to begin to undo the irresponsibility of the past five years and get back to basics where house prices and affordability are based primarily on traditional factors such as rents, incomes, interest rates, macroeconomic conditions and sentiment. Best Regards, Mark Hanson Mark@TheFieldCheckGroup.com Analysis by Mark Hanson, Field Check Group Real Estate & Finance Data in partnership with Foreclosure Radar

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