Whether or not the recently announced $275 billion Homeowner Affordability and Stability Plan helps you largely depends on where you live and your particular situation. For starters the property MUST BE YOUR PRIMARY RESIDENCE; and your EXISTING loan MUST be a conforming loan, which among other things, means it MUST be LESS than $417,000. In some expensive metro areas, however, the limit was recently increased to $729,750. Keep in mind, however, these higher limits were, for the most part, introduced in 2008; so, if you bought your home more than 1 year ago, these higher limits will not apply to you. On the flip side, any loan that is not conforming is a non-conforming (also called jumbo) loan. To simplify, conforming = $417,000 or less and non-conforming/jumbo = greater than $417,000.
This week’s release was fairly general, but a more detailed plan is expected on March 4, 2009. The three phases of the plans are as follows:
1. Refinance Plan ($0 estimated cost to taxpayer): This plan is for people who are paying on their mortgage, but their home has lost too much value to qualify for refinancing. Conforming loans require 20% of equity in the home and many people have fallen below this threshold. To qualify under the plan, you MUST have a conforming loan, you must NOT be behind on your payments, and your mortgage must fall between 80% and 105% of your home’s current market value. To illustrate: if you have a $400,000 mortgage, your current value must fall between $320,000 and $420,000. The trick here is that your CURRENT LOAN must be a conforming loan. Good luck in high cost areas like LA, SF, DC, and NY where conforming loans used in new home purchases are rare. To put this in some perspective, in 2006, 60% of loans used to purchase a home (not refinance) in the SF Bay Area were non-conforming.
A second mortgage on your property will not disqualify you from this program. As long as the amount owed on the first mortgage is less than 105% of the value of property and the second mortgage lender agrees to remain in the second position, you may still qualify. Ultimately, the lender will want to see your ability to meet the payments on the new first mortgage.
The hope with this plan is that it will provide an opportunity for millions of families stuck in higher rate loans, to refinance into lower rate loans with zero cost to the taxpayer.
2. Loan Modification ($75 billion estimated cost to taxpayer): This plan is intended to help people whose mortgage payment is too high for their income. This could be due to an increased mortgage payment, loss of income, or both. This plan is open to people who are BOTH CURRENT and BEHIND on their mortgage. Just like the Refinance Plan, above, you MUST have a conforming loan. Lenders will be encouraged to cut monthly payments for troubled borrowers to 31% of monthly income, which most experts believe is a reasonable level. The goal is to reduce payments to manageable levels for borrowers whose income is not sufficient to make their monthly payments. The reduced payment is achieved through government provided lender incentives. Lenders are likely to lower payments mainly by reducing interest rates and the government will share partially in the cost of reducing the interest rates of these borrowers. Banks receiving TARP funds are strongly encouraged to work with borrowers, reducing principal if necessary, though that decision is ultimately left to the lender. The added risk to the lender is that, if the borrower files for bankruptcy, pending legislation may allow a judge to reduce the principal anyway.
3. The final part of the plan doubles the size of cash outlay to Fannie Mae and Freddie Mac, which the government hopes will restore confidence in those entities and help to keep interest rates low. The government will cover $200 billion in losses from Fannie Mae and Freddie Mac, which own or guarantee more than 60% of U.S. mortgage debt. They perform a very important part of the mortgage cycle because they purchase loans (conforming only) from banks, allowing the banks to receive money today (instead of 30 years from now), which in turn allows them to make more loans today. In other words, Fannie Mae and Freddie Mac inject liquidity into the mortgage market.
What is not covered by the plan:
1. Mortgages greater than $417,000 (limit is up to $729,250 in some high cost areas in ’08 and ’09)
2. Vacation property
3. Rental property, unless it is 2-4 units and you live in one of the units.
4. Second mortgages
Monday, February 23, 2009
Monday, February 16, 2009
Why You Should Care About the Bank Bailout
Americans do not have a lot of love for the banks these days. Most Americans do not understand the complexities of the credit markets (neither do many people working in the credit markets). Most people feel that the bailout is rewarding bad behavior. Managers that took ignorant risks and led their companies into the ground are receiving huge sums of public money. Whether or not the big banks DESERVE to receive capital injections from our tax payer dollars is certainly debatable, but this article will discuss the question I’ve heard quite a bit lately, which is, “why do they need it?”
The short answer is they need it because they are suffering historic losses, resulting in an erosion of their capital base, leaving them undercapitalized. Regulators require banks to meet certain minimum capital requirements. The big National Banks (i.e BofA, Wells Fargo, Citibank, JPMorgan Chase, etc…) are governed by the Office of the Comptroller of the Currency, or OCC for short, whose primary mission is “to ensure the safety and soundness of the national banking system.” If the letters N.A. or NT&SA follow your bank’s name on your checks, your bank falls into this category. These National Banks hold approximately 70% of the banking assets in the U.S., so it is easy to see their importance to our financial system.
The OCC requires banks to stash some of their cash (or create reserves) as an important cushion against unexpected losses from today’s loans that may go bad in future years. It is impossible to know today exactly which specific loans will go bad, otherwise the bank wouldn’t make them, and so they just make an estimate (say 2% - 5%) on total loan volume for the year. When loans actually go bad, they are written off against this stash. When the bank’s estimate is wrong and more loans go bad than their original estimate, the losses exceed the stash, meaning the bank becomes undercapitalized and requires more capital to remain in business. In theory, this rule should create a strong incentive to manage a bank in a prudent manner because the bank owners’ equity is at risk in the event of failure. The OCC requires the stash to be risk weighted, meaning that the bank must set aside more capital for risky assets (loan to flaky friend) than for safe ones (loan to best friend), which leads us to why they are asking for more capital.
As individuals default on home loans and as consumers stop shopping, as they have, repayment on those mortgages and business loans slows, requiring the banks to down grade some of the remaining loans in their portfolios. In some case, regulators call for multi-notch downgrades (i.e. from “top notch” to “junk” status), requiring the bank to make significant additions to the stash. Junk rated debt carries an especially punitive risk weighting, as banks must set aside five times more capital than they have to for top notch debt. A larger stash leaves a bank with less capital to lend, which leads to less credit available to consumers to buy homes, cars, TVs and clothes. Without government intervention, the vicious cycle would continue to recur until the whole system ultimately grinds to a halt.
Under the Treasury Department’s new bank bailout program, proposed this week, banks will be required to undergo a “stress test” to determine if they: 1) can keep lending and 2) can stay in business if the downturn worsens. Some think this requirement was strategically placed by the Obama Administration as a non-ideological way to prove to the public that individual banks need to be nationalized, or taken over by the government.
While most Americans are frustrated with how the funds to date have been used, the problems resulting from non-action could cause the entire system to crash. Approximately 40% of lending in the U.S. flows through the secondary credit markets, which makes lending possible, and right now that market is frozen. The banks need more capital to make new loans. Let’s only hope they actually make more loans.
The short answer is they need it because they are suffering historic losses, resulting in an erosion of their capital base, leaving them undercapitalized. Regulators require banks to meet certain minimum capital requirements. The big National Banks (i.e BofA, Wells Fargo, Citibank, JPMorgan Chase, etc…) are governed by the Office of the Comptroller of the Currency, or OCC for short, whose primary mission is “to ensure the safety and soundness of the national banking system.” If the letters N.A. or NT&SA follow your bank’s name on your checks, your bank falls into this category. These National Banks hold approximately 70% of the banking assets in the U.S., so it is easy to see their importance to our financial system.
The OCC requires banks to stash some of their cash (or create reserves) as an important cushion against unexpected losses from today’s loans that may go bad in future years. It is impossible to know today exactly which specific loans will go bad, otherwise the bank wouldn’t make them, and so they just make an estimate (say 2% - 5%) on total loan volume for the year. When loans actually go bad, they are written off against this stash. When the bank’s estimate is wrong and more loans go bad than their original estimate, the losses exceed the stash, meaning the bank becomes undercapitalized and requires more capital to remain in business. In theory, this rule should create a strong incentive to manage a bank in a prudent manner because the bank owners’ equity is at risk in the event of failure. The OCC requires the stash to be risk weighted, meaning that the bank must set aside more capital for risky assets (loan to flaky friend) than for safe ones (loan to best friend), which leads us to why they are asking for more capital.
As individuals default on home loans and as consumers stop shopping, as they have, repayment on those mortgages and business loans slows, requiring the banks to down grade some of the remaining loans in their portfolios. In some case, regulators call for multi-notch downgrades (i.e. from “top notch” to “junk” status), requiring the bank to make significant additions to the stash. Junk rated debt carries an especially punitive risk weighting, as banks must set aside five times more capital than they have to for top notch debt. A larger stash leaves a bank with less capital to lend, which leads to less credit available to consumers to buy homes, cars, TVs and clothes. Without government intervention, the vicious cycle would continue to recur until the whole system ultimately grinds to a halt.
Under the Treasury Department’s new bank bailout program, proposed this week, banks will be required to undergo a “stress test” to determine if they: 1) can keep lending and 2) can stay in business if the downturn worsens. Some think this requirement was strategically placed by the Obama Administration as a non-ideological way to prove to the public that individual banks need to be nationalized, or taken over by the government.
While most Americans are frustrated with how the funds to date have been used, the problems resulting from non-action could cause the entire system to crash. Approximately 40% of lending in the U.S. flows through the secondary credit markets, which makes lending possible, and right now that market is frozen. The banks need more capital to make new loans. Let’s only hope they actually make more loans.
Sunday, February 8, 2009
“STIMULESS” To Pass Senate This Week
Three moderate Republican senators (Arlen Specter – PA, Olympia Snowe – ME, and Susan Collins – ME) broke ranks this weekend with their party and joined moderate Democrats to reduce the price tag of the “2009 Economic and Recovery Reinvestment Act,” better known as the “Stimulus” by approximately $100 billion or about $500 per every American adult, ending 5 days of partisan gridlock and making passage likely. The revisions only impact the spending components of the bill and reshape the make-up of the package to be 60% spending / 40% tax cuts, approximately the split between Democrats and Republicans in the U.S. Senate, which is no coincidence. Before you run out and spend your $500, here is what is no longer in the bill:
· $2.0 billion to expand high speed Internet networks
· $5.8 billion for public health programs
· $16.0 billion for school improvements
· $40.0 billion in direct aid to states
The $40.0 billion in state aid was intended to help states fill their budget gaps and reduce public sector workforce reductions in areas like education and public safety (i.e. keep teachers, firefighters and cops working). Stimulus opponents identified this as wasteful spending (better known as “pork”) and prefer that tax cuts, rather than spending, be the center piece of the program although most independent economic analysis shows government spending to have a much larger positive multiplying effect on the economy than tax cuts (analysis performed by Moody’s Economy.com and the Center for Economic and Policy Research). For example an increase in federal infrastructure spending (the median proposed spending program) returns $1.59 in economic activity for every dollar spent. In other words, $100 billion spent on infrastructure projects generates another $159 billion in additional economic activity and a little more than 1 million jobs. The MOST stimulative tax-cut, a payroll tax holiday, would add $1.28 in additional economic activity ($128 billion for every $100 billion of tax cuts), approximately 20% less than infrastructure spending. Making the Bush tax-cuts permanent, would have only a $0.31 stimulative effect ($31 billion of increased economic activity for every $100 billion of tax cuts) on the economy primarily, because they are skewed towards investors and wealthy individuals who would save the money, rather than workers who would buy stuff, thus re-circulating those dollars back into the economy, resulting in more jobs. The LEAST stimulative spending proposal is 8% better than the MOST stimulative tax cut.
While government spending can be much more efficient and less wasteful, for sure, the point of a stimulus is to help drive demand in the absence of it. The government can and should become the consumer of last resort when the public is not. While lunching at a local mall yesterday, I was struck by the seemingly full parking lot versus the sight of empty handed shoppers.
Notably missing from the package is anything addressing the home foreclosure problem, which still looms large. Administration officials indicate that issue will be addressed in the request for the second $350 billion of TARP funds expected this week.
· $2.0 billion to expand high speed Internet networks
· $5.8 billion for public health programs
· $16.0 billion for school improvements
· $40.0 billion in direct aid to states
The $40.0 billion in state aid was intended to help states fill their budget gaps and reduce public sector workforce reductions in areas like education and public safety (i.e. keep teachers, firefighters and cops working). Stimulus opponents identified this as wasteful spending (better known as “pork”) and prefer that tax cuts, rather than spending, be the center piece of the program although most independent economic analysis shows government spending to have a much larger positive multiplying effect on the economy than tax cuts (analysis performed by Moody’s Economy.com and the Center for Economic and Policy Research). For example an increase in federal infrastructure spending (the median proposed spending program) returns $1.59 in economic activity for every dollar spent. In other words, $100 billion spent on infrastructure projects generates another $159 billion in additional economic activity and a little more than 1 million jobs. The MOST stimulative tax-cut, a payroll tax holiday, would add $1.28 in additional economic activity ($128 billion for every $100 billion of tax cuts), approximately 20% less than infrastructure spending. Making the Bush tax-cuts permanent, would have only a $0.31 stimulative effect ($31 billion of increased economic activity for every $100 billion of tax cuts) on the economy primarily, because they are skewed towards investors and wealthy individuals who would save the money, rather than workers who would buy stuff, thus re-circulating those dollars back into the economy, resulting in more jobs. The LEAST stimulative spending proposal is 8% better than the MOST stimulative tax cut.
While government spending can be much more efficient and less wasteful, for sure, the point of a stimulus is to help drive demand in the absence of it. The government can and should become the consumer of last resort when the public is not. While lunching at a local mall yesterday, I was struck by the seemingly full parking lot versus the sight of empty handed shoppers.
Notably missing from the package is anything addressing the home foreclosure problem, which still looms large. Administration officials indicate that issue will be addressed in the request for the second $350 billion of TARP funds expected this week.
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