Lawson for Congress

The White House cheered the markets last week with a plan to ease the mortgage crisis by delaying planned interest rate resets on certain borrowers’ adjustable rate mortgages. Specifically, interest rates for certain subrprime borrowers will have a five-year interest rate freeze, instead of large rate increases that would otherwise be expected.

So how are we supposed to react to this latest news? Well, if you bought mortgages as an investment, you might be upset. On one hand, you were sold a security with an expected level of risk and an expected return. Now the government is telling you that you will not be getting your expected return, because they are freezing interest rates at a lower level.

So did this government intervention effectively seize your property? Perhaps… but on the other hand, if the rate increases cause massive foreclosures as expected, then holders of these mortgage loans will get no income and have a worthless security since they will be stuck with empty houses that are declining in value. So, the owners of these mortgage debts are being forced to take Henry Paulson’s word that the government’s intervention to reduce their investment return is preventing an all-out collapse of that investment. Thanks, I guess.

On the other side of the equation, one must ask how this unilateral government intervention is going to work. What are the specifics behind freezing interest rates for “some” borrowers, holding “some” subprime mortgages? One thing that’s clear about government programs — it’s always fun and exciting to game the system:

One of the main criteria for qualifying for a reset freeze is the FICO score, which measures how well a borrower has repaid debts in the past (the higher the better). Borrowers’ income does not have to be checked. See analysis of program.

To qualify for the fast-track program, borrowers must have a FICO score of less than 660 and it can’t have increased by more than 10% since they took out their original subprime mortgage.

Because income isn’t checked, some experts worry that borrowers who might otherwise be able to afford higher payments will try to lower their FICO score to qualify for a rate freeze.

“The message here is to get your FICO score down,” Mark Adelson, a structured finance expert, said. “Don’t pay some bills, but keep up with mortgage payments.”

Excellent! Just skip a few electric and telephone payments, maybe go a few months late on the credit card, and enjoy a five-year rate freeze on your housing payments!

But will this latest government intervention really solve the problem? Available evidence suggests that “subprime” is just the tip of the iceberg. The coming market adjustment will be memorable for everyone, and will teach us (yet again) that it is impossible to create “wealth” by borrowing and printing paper money:

Sub-prime aren’t the only kind of loans imploding. Second mortgages, hybrid intermediate-term ARMS, and the soon-to-be infamous Pay Option ARM are also feeling substantial pressure. The latter three loan types mostly were considered ‘prime’ so they are being overlooked, but will haunt the financial markets for years to come. Versions of these loans were made available to sub-prime borrowers of course, but the vast majority were considered ‘prime’ or Alt-A. The caveat is that the differentiation between Prime and ALT-A got smaller and smaller over the years until finally in late 2005/2006 there was virtually no difference in program type or rate.

The bailout we are hearing about for sub-prime borrowers will be the first of many. Sub-prime only represents about 25% of the problem loans out there. What about the second mortgages sitting behind the sub-prime first, for instance? Most have seconds. Why aren’t they bailing those out too? Those rates have risen dramatically over the past few years as the Prime jumped from 4% to 8.25% recently. seconds are primarily based upon the prime rate. One can argue that many sub-prime first mortgages on their own were not a problem for the borrowers but the added burden of the second put on the property many times after-the-fact was too much for the borrower.

The mortgage mess illustrates the fundamental problem with a dishonest, inflationary monetary system: it’s impossible to tell just one lie. Once you tell a single lie, additional lies are inevitably required to try and cover up or obfuscate the original one. In the end, what might have seemed like a harmless and expedient half-truth turns into a fragile web of lies that collapses under its own weight.

This entry was posted on Sunday, December 9th, 2007 at 12:23 pm and is filed under banking, free market, inflation, monetary reform. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.