Monday, December 01, 2008
Tanta's Gone From This Vale Of Mortgages
I am not sure she would approve of making the NY Times this way, but I am sure that she would approve of her passing being mentioned in connection with her trenchant criticisms of stupid bankers and obfuscating reporters. With her departure, a blazing voice of honesty and decency has left the building. The best tribute we could pay her would be to comport ourselves with more honesty and fairness in our business lives.
If there is one thing that depresses me, it is that individuals such as Tanta don't get appointed to high posts in government. Can we stand the truth in our public lives? Can we stand not having the truth in our public lives?
Instead of a Doris Dungey in public life, we get an Austan Goolsbee as Chief Economist of Obama's "Economic Recovery Advisory Board". Now I have no brief at all against Goolsbee. He seems to be a very pleasant man with a good sense of humor who often seems to make sense when writing about academic economics. But in practice?
Read this column he wrote in March, 2007 for the NY Times:
New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much.These airy generalizations obscure the reality that lending standards had passed all reasonable limits. Here Goolsbee argued in favor of spec loans in which current payments are discounted and considerably lower than the eventual payment which will be used to pay off the mortgage, and it is spec loans (the Alt-A exotics as well as the subprime loans) that have blown up in our faces. It was always fated that they would, because the only thing that keeps spec loans from blowing up in people's faces are rapidly increasing home values, and home values can not keep increasing in excess of people's incomes.
Lost in the current discussion about borrowers’ income levels in the subprime market is the fact that someone with a low income now but who stands to earn much more in the future would, in a perfect market, be able to borrow from a bank to buy a house. That is how economists view the efficiency of a capital market: people’s decisions unrestricted by the amount of money they have right now.
Of course, basing loans on future earnings expectations is riskier than lending money to prime borrowers at 30-year fixed interest rates. That is why interest rates are higher for subprime borrowers and for big mortgages that require little money down.
Nor is it in favor of most borrowers to write spec loans in almost all cases. Consider an actual loan example given by Beazer in its sleazy attempts to sell its own homes using this type of loan. In 2006 I summarized it like this.
Purchase price is $288,601. This is one of those no-money down deals.Let's assume the home appreciates by 2.5% a year. The total net sales price to the borrower turned seller assuming 5% sales costs:
Year 1: $824 - 76 (second paid by Beazer) = $748
Year 2: $886 + $529 = $1,415
Year 3: $953 + $529 = $1,482
Year 4: $1,024 + $529 = $1,553
Plus, to achieve the low initial down payment the borrower is signing up for negative amortization, which means that their loan balance rises for a while instead of dropping. The first mortgage is adjustable too, so the payments could go even higher. Very few people who take this deal would be able to keep the house, because unless they brought money to the table they would almost certainly be unable to refi out of it (without double digit price inflation, which is no longer in the cards).
Year 2: $281,025
Year 3: $288,050
Year 4: $295,252.
The borrower went into neg am, so the borrower, at best, will walk away with ready money sufficient for one month's rent in advance plus moving costs if they can stick it out through most of the fourth year. Before that, it's a short sale and a substantial wreck of the borrower's credit rating. The second mortgage is a fifteen year interest only. APR on the first is adjustable 8.1%, on the second prime plus 4.5%.
Yes, this is profitable for the investor, provided that home prices continue to appreciate around 4 or 5%. Home values must appreciate by much more annually to give the luckless borrower a chance to refi out of this death trap (10% equity) into lower mortgage rates.
It's profitable for Beazer. It's profitable for the broker. It's profitable for the sales agent. Heck, it's good for the title service firm. The only person being bent over is the borrower.
I assume if you have read this far without revulsion of feeling that you are a pretty hardened character. Because the next segment of my comments will be most unladylike, I will put them in the comments to the post. I advise you not to read the comment if you object to obscenity.