Great acting comes from great genius. And our Governor has just demonstrated to us, at least in regards to housing policy, that he is striving for an Oscar in public policy. This week he announced that he had worked out a magical plan with four lenders to bailout subprime lenders, I mean borrowers from impending mortgage resets her in California:

“In an unprecedented move designed to save thousands of California homeowners from foreclosure, Gov. Arnold Schwarzenegger announced a deal Tuesday with four mortgage lenders to freeze adjustable interest rates for some of the state’s highest-risk borrowers.

The state’s agreement with Countrywide Financial Corp., GMAC Mortgage, Litton Loan Servicing and HomeEq Servicing covers more than 25 percent of California’s subprime mortgage loans, which generally involve homebuyers with weak credit and require periodic increases in payments after initial low-teaser rates.”

First, we need to clarify that this doesn’t begin to cover the majority of subprime loans in the state. According to the release, this may cover 1 out 4 subprime loans. There are other lenders that have offered subprime loans and they are not included in this deal. The false assumption made by the governor is that only people that took out subprime loans are facing trouble. Well we all know that people with high incomes and decent credit will also lose their homes. When you dig into the ambiguous details, you realize that this has more to do with political posturing and being ahead of others in the game:

“Schwarzenegger aide Sabrina Lockhart said his office negotiated an agreement with Countrywide Financial Corp (CFC.N: Quote, Profile , Research), GMAC (GMA.N: Quote, Profile , Research), Litton Loan Servicing LP and HomeEq Servicing Corp that will allow their mortgage borrowers in California to continue paying loans at initial rates if they live in their homes and make payments on time but are unlikely to afford higher payments when their mortgage interest rates reset.”

“Along with loan modification, the lenders have agreed to seek out borrowers before their loan terms reset and to improve the process of determining if borrowers can afford bigger mortgage payments when loan rates rise, Lockhart said.”

As the weeks unwind, as in our foreclosure story number 2, we are going to start seeing that many subprime loans were made under unbelievable pretenses. The lack of financial prudence was done by these lenders and the Governor is entrusting them in bailing out the same people they have put into financial peril? Where are the logic police? It would be different if they setup a third party to oversee the restructuring of debt but they are putting a group of people that have demonstrated that they should never be allowed near a mortgage again. Let us go through 4 reasons why this plan is an absolute ruse and will do nothing for the states financial problems.

#1 – Mortgage Investors will Kill Adjustable Rate Mortgages

You need to remember that lenders rarely hold mortgages in their portfolios. Rating agencies on Wall Street in collusions with large investment banks worked their financial alchemy and bought any kind of mortgage for the large part of the decade. They sold many of these mortgage backed securities to investors seeking higher returns. Silly labels such as AAA were given to loans that benefited from absurd inflated titles. This secondary market created and fueled the housing bubble. Many times, subprime loans paid investors a higher premium for the implied risk. Now if the loan can be modified at any time, how are investors going to be compensated? It is as if you purchased a 10 year Treasury note and suddenly state legislation tells you it is only a 1 year note with a much lower interest rate. This move if it spreads into other states and becomes common, will slam the door shut on subprime loans and also, other adjustable rate mortgages. Oh, and let us talk about adjustable rate mortgages in California shall we? According to DataQuick which tracks housing information:

“Most of the loans that went into default last quarter were originated between July 2005 and September 2006. The median age was 18 months. Loan originations peaked in August 2005. The use of adjustable-rate mortgages for primary purchase home loans peaked at 77.8% in May 2005 and has since fallen.”

So looking at this information, the vast majority of loans since August of 2005 were adjustable rate mortgages in California. Subprime is a tiny facet of the overall adjustable rate mortgage market which includes prime borrowers (the Alt-A category) loans that in fact, may have no ability to pay their mortgages when rates reset as well. We know that many lenders overlooked any semblance of ability to pay to push these products. With the height of irresponsibility showing when people making $14,000 a year taking out $720,000 mortgages. How is reworking this going to help? And we are going to give these same lenders the responsibility to determine who is able to repay and rework mortgages? Bwahaha! The fox is guarding the hen house folks. If you don’t believe this you need to read a scathing look at Countrywide written by the New York Times called Can These Mortgages be Saved?:

“To be sure, customers who borrowed from many lenders other than Countrywide are also experiencing difficulties with their loans. But because Countrywide was one of the most aggressive purveyors of adjustable-rate loans — the kind with interest rates that rise significantly after a low, two- or three-year teaser rate expires — it is not surprising, borrower advocates say, that overall problem mortgages are ratcheting up. The Mortgage Bankers Association said that adjustable-rate mortgages to subprime borrowers accounted for 44 percent of all new foreclosures in the second quarter of this year.

Even as Countrywide maintains that helping its borrowers modify their loans is its top priority, its investors have heard a slightly different story. In a conference call with analysts and investors in late July, Kevin Bartlett, Countrywide’s chief investment officer, counted about 2,000 loan modifications done in June. Most of those, he said, involved deferring overdue interest or adding the past due amount to a loan. The company rarely provides workouts that reduce interest rates on loans, Mr. Bartlett told investors.

Yet reducing rocketing interest rates is exactly the relief that many borrowers are seeking because, consumer advocates say, that is the only way they can afford to stay in their homes. Loan experts say that when workouts involve deferring overdue interest or tacking amounts owed onto the back of a loan, borrowers often wind up in trouble again in just a few years.”

This plan is more of an insurance policy guaranteeing lenders get their due even if they have to squeeze out every penny on people that have no potential of repaying an inflated mortgage. That is the true problem.  They would know this if they spent 10 minutes scrutinizing loans instead of trying to sell as many mortgage products as humanly possible. Sadly the Governor is not encouraging legislation for cram-downs and instead of aligning with these purveyors of the bubble, he should go after them forcing them to restructure loans at current market rates thus making them partly responsible for their mistake. Instead, he wants subprime borrowers to pay no matter what and make up for the financial irresponsibility of lenders:

“Borrowers need to do their part, too,” Schwarzenegger said in a statement. “If these lenders are willing to meet more than halfway, it’s important that consumers don’t run when they reach out. It was a two-way street that got us into this mess and it will be a two-way street that gets us out.”

I like this two-way street. I’ll give you a loan you have no financial way of paying off and you pay us even if you don’t have the money to begin with. Think about it folks! Subprime loans by default are loans given to people with bad credit and income ratios that are extremely risky. And these lenders are shocked that people are defaulting? In fact, losing their home may be a better solution instead of keeping someone in a home for 5 years, hoping the housing market inflates through asset inflation and a declining dollar and then all will be well. These people are gambling with a call option betting the entire house that housing prices will be up in 5 years. Well here is another view, what if housing isn’t up? What if incomes don’t rise? What will you do then? Will you allow rates to reset and amortize even at a higher rate for lost time? This is only buying time for lenders and make no mistake about it, this is not in the best interest of current subprime owners.

#2 – The Assumption is People in California Have Attachments to Homes

The assumption is that all people want to keep their homes. We’ve seen countless times on Flip this House or Property Ladder that many people in California have very little attachment to a home. In fact, there is a large segment that views a home simply as a commodity. There is no data on this but it would be interesting to see how many recent buyers in the last 3 years expected their homes to go up by 15, 20, or 25 percent in California? How bad is it here in California? Well it is good to look at a state that is one-year ahead of us in the housing bust to get a sense of how shady things really got:

“MIAMI (Reuters) – At first glance, the 43-story building in Miami‘s international banking district seems little different from other high-rise condominiums overlooking the turquoise waters of Biscayne Bay.

But the 643-unit condo known as the Club at Brickell is a leader in mortgage foreclosures and it appears also to stand at ground zero in a blizzard of fraud that may lie behind many of the failed loans threatening to bury the U.S. property market.”

It gets even more interesting when the actual nuts and bolts of the deals are looked at under a microscope:

“Mortgage scams involve a cartel of inside players — colluding property appraisers, real-estate brokers and accountants willing to draw up fake income statements and tax returns — who recruit people with good credit histories to serve as a decoy or “straw buyer” in a real-estate deal.

The conspirators inflate the price of the property, to get the biggest loan possible, pay the sellers the original price and then pocket the excess loan money as “cash back” at the closing of the deal.

The decoy buyer is paid off — often with just $5,000 — and the property is quickly abandoned to foreclosure, said Theobald, a senior official with the Miami-Dade Police Department.”

I’m not sure about you, but I wouldn’t want the lenders or folks involved in the industry to have anything to do with a workout plan for this mortgage debacle. The story goes on:

“But Doug Dewitt, a real estate broker contracted to work with several lenders on the valuation and disposal of foreclosed properties, said nearly 70 percent of the sales or closings at the Club over the last 18 months were questionable.”

That works out to more than 200 possibly shady deals in a single building, he said.”

70 percent of the deals were under potential false pretenses. I wonder how many of these 200 shady deals are buyers that are going to worry about losing their home. This again is a play at the American ideal of owning a home. Many people in non-bubble states that lost their jobs and have modest mortgages that fall within current government cap guidelines do have options and the restructuring of debt should be available to them. But reworking a deal in California where an unscrupulous lender gave a $400,000 or $500,000 mortgage to a family making $40,000 or $50,000 a year is flat out criminal. And then to make them pay for the lender;s financial irresponsibility is nothing resembling a two-way street; it is asking the buyer to subsidize the lenders lack of judgment.

#3 – Prolonging the Inevitable

When you look at this information, do they really assume these borrowers will have a chance to repay the note after 5 years? Say the interest is deferred for a few years but then what happens when the note fully amortizes? This is a horrible move by the Governor because we have a second wave of resets coming in 2010 and 2011 of option ARM mortgages. So now, instead of dealing with one mortgage tsunami at a time we are pushing this current wave to the other wave and creating a mutant hybrid wave that will compound this mess exponentially. Not admitting a mistake is problematic and the Governor’s deal doesn’t face the reality of the matter. That housing was inflated by lenders, Wall Street, and the unscrupulous housing industry and instead of taking a stand against them, he’s joining their side. And why do we think that the Governor is prolonging this bubble? Take a look at a letter he sent to Congress about rate caps in September of this year:

“Accordingly, as you consider various legislative proposals related to home mortgages, I write to express my strong support for raising the current loan limits imposed on the Federal Housing Administration (FHA) and raising Government Sponsored Enterprises (GSE) loan limits in high-cost areas of the country.

Just when the safety and affordability of FHA-insured loans are needed most, they have virtually disappeared from the California marketplace. The current FHA loan limit is $362,790, well below the median-priced home in California. In testimony before the U.S. Senate Committee on Banking, Housing and Urban Affairs this summer, Brian D. Montgomery, U.S. Department of Housing and Urban Development Assistant Secretary for Housing, said California has “seen its [FHA] loan volume drop from 109,074 to just 2,599; that’s a decline of 98 percent and a loss of $13.6 billion.” This has been a significant factor in the increasing use of nontraditional mortgage products in California. The prospect of mounting losses on nontraditional mortgages has harmed the availability of home financing nationwide.

Increasing the FHA loan limit would have a positive impact on expanding financing options for hardworking Californians hoping to obtain a piece of the American Dream. In addition to increasing the FHA loan limits, consideration should be given to raising the conforming loan limits for the GSEs (Fannie Mae and Freddie Mac) in high-cost areas of the country. The current GSE conforming loan limit for lenders willing to originate conforming mortgage loans for median-priced homes in California is $417,000; however, according to the California Association of Realtors, the median price of a single family residence in July was $586,030. Again, this disparity makes these products practically irrelevant in California. This means that, for the majority of California homebuyers, the only option is to obtain a larger “jumbo” loan and pay higher interest rates and fees. Raising the FHA and GSE loan limits will help ensure that more financial resources are available to help facilitate lending in California.”

I wonder if he would have said this knowing the problems now facing Fannie Mae and Freddie Mac? Either way, you can see that he doesn’t see inflated prices as the problem but the lack of creative lending solutions as the main issue. In fact, him quoting the California Association of Realtors as his source for the incredible price of $586,030 is troubling since it doesn’t bother him that housing in California is completely unaffordable for the vast majority and these bubblicious products have created an unsupportable environment.

#4 – Who is Subprime?

Who really is subprime after all? The Governor’s office estimates that 500,000 subprime loans will reset in the next 2 years here in the state. Instead of asking why half a million loans were given to people that most likely should have never gotten a loan in the first place, he talks with lending institutions about methods of keeping troubled buyers longer in homes while they can bleed every single penny from them. Lenders are wising up that receiving one quarter instead of zero is much better than pushing for the full dollar. Unbelievably many of these lenders are pinching pennies and taking more money from these same people facing financial trouble. In another piece called “Dubious Fees Hit Borrowers in Foreclosure” we see that lenders are willing to kick owners when they’re down:

“In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.

In one example, Ms. Porter found that a lender had filed a claim stating that the borrower owed more than $1 million. But after the loan history was scrutinized, the balance turned out to be $60,000. And a judge in Louisiana is considering an award for sanctions against Wells Fargo in a case in which the bank assessed improper fees and charges that added more than $24,000 to a borrower’s loan.”

And these are the same people that will be in charge of determining who is subprime. They will also have reign over the details of the shady loans they have dished out. I’m not surprised. In fact, bringing in a third party would cause a stronger and faster decline in the housing market because the public will fully realize the extent of the financial imprudence in the industry. They claim that what is occurring is making the process more transparent when in fact, it is only sweeping more dirt under the rug out of the public’s vision. This mortgage restructuring plan sounds like a script out of Kindergarten Cop. Instead of terminating these lenders the Governor is jingling all the way to the mortgage bank.

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