Thursday, May 28, 2009

Unintended Consequences?

How many times can you claim that what has happened is an unintended consequence before it appears that it’s actually an intended consequence? This is a question that I have been pondering and was brought to a head this week as the U.S. Treasury notes and bonds sold off dramatically. The 10- year Treasury note, which was trading early Thursday at a yield of 3.17%, sold off Thursday afternoon as one rating agency announced that the U.S. debt instruments had been lowered from a Triple A rating. Moody's came out on Friday and refuted that, stating the U.S. Treasuries were still Triple A. Nevertheless, the Federal Reserve didn't increase their buying of the Treasuries and the 10 year finished the week at a yield of 3.44%. That is an increase of over 0.25% in a little over 24 hours. What does this mean to us and why should we care?

It means that those in this world who are buying our debt want higher interest rates to act as our banker. We will have the largest deficit in the history of the country and it needs to be financed. If the buyers want higher rates, our costs go up and this can lead to inflation, which affects all of us. From a purely selfish standpoint, this can also directly affect the mortgage rates we have in this country. We now have amazing low rates which are being used to stimulate the purchases of real estate and helping the turn around this core industry needed for economic revival. Rates are artificially low because of the $1.25 trillion being used by the Federal Reserve and the Treasury to buy mortgage backed securities, but eventually the money will be spent and rates will increase.

Could the movement of the bond market last week start a reversal of our plans prematurely and have the mortgage program end before it does its intended work? In other words, could an unintended consequence finish off an intended one? It just might happen.

Perhaps this is just a "shot across the bow" to wake us up and let us know that there is an end to everything. In the meanwhile, let's look at some of the unintended consequences of the recession we faced (or are facing) and the cure which could possibly be worse than the problem. Real estate has seen prices falling for several years and, combined with the low down or no down purchases of years past, have given rise to a large number of homeowners who find their loans exceed the value of their houses in a very large way. (Writers Note: FHA offers purchases with 3.5% down and V.A. has zero down to $417,000 today.) What we do for the people in the aforementioned predicament is a consequence which has created a large debate.

The problem, in simple terms, is people without equity tend to go into foreclosure faster than those with equity. Should we ignore them and let the housing market get much weaker before it turns? Help all of those in this situation; help those who have given up and stopped making payments first and foremost? Or help those who have made the payments more than those who haven't? I will give you a big clue: common sense was not used to formulate the answer. Many believe politics played a significant part.

The answer to the prime question of helping those who are considered underwater (value of the house is less than the value of the mortgage[s]), is yes, if done responsibly. How do you do that? Reduce the payment on the mortgage to the point that the borrower can make the payment and give the borrower a year or two to "right the financial ship". After that time, the unpaid interest going forward would be tacked onto the mortgage balance. What was done?

The government helped those who stopped making payments by giving the banks an incentive to cut the size of the mortgage and lower the payments to a ratio that would insure that payments would and could be made on time. The results are mixed.

Those who made their payments have little or no help. The amount you can be "underwater or upside down" is 5%, meaning that if you have $200,000 in one or more mortgages, your house must be worth $190,000. This should cover about 1% of those who are underwater and have made their payments on time. You also must have a Fannie Mae or Freddie Mac loan, generally a fixed rate loan, not larger than $417,000. Time to reduce the 1% to about 3/4%. If you are not quite underwater, but your mortgage is over 80% of the value of your house, then you can get help if you meet the criteria above. You will not have to pay mortgage insurance if you currently do not pay it, however if your first mortgage equals 95% of the value of your house or more, you must pay a one-point (1% of the loan) fee. If you have a second mortgage or HELOC, you cannot include it into the loan, but instead must subordinate it (put it behind the new mortgage). If your combined loan to value exceeds 90%, you must pay 1.5 points as a fee to subordinate.

So few people can be helped by this plan that it isn't worth discussing, but what is worth discussing is why does this all seem to be backward? Why are we sending a message that if you don't meet your responsibility you will be helped, but if you do you won't be helped? To be absolutely fair, you might be helped a little, maybe.

I will be happy to give you an answer when I stop shaking my head.

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