Criticism of the Bush/Paulson Mortgage Plan

In Economics 101 students learn that markets are driven by demand and not supply. The Bush/Paulson plan addresses supply and assuming that the plan gets off the ground it will only address supply at the margin. This is not anyone’s fault. The pill that is required to fix the housing market will have to be swallowed in parts over time. The market is not willing to admit at this point how severe the problems are.

Back to demand. The demand for housing is broken up into parts:

1. subprime demand, once estimated to be about 20% of the market, basically no longer exists. They can’t get the financing.

2. The Alt. A group may also want to buy a home, but they can no longer obtain financing.

3. There are a few investors, but they have to have their own sources of financing.

4. That leaves only the prime borrower, defined as someone with the credit history, income, and down payment necessary to get a mortgage that can be sold to Fannie Mae and Freddie Mac (agency paper in the language of the “biz”).

These people fall into two groups: a) those that are will buy a home at or near current market prices. This is where most of the housing demand is coming from at this point. I call this group the “oblivious” group, because they are oblivious to the current market conditions and just want a home. People have a variety of legitimate reasons for buying a home, but in these times a “romantic” notion of home ownership based on thinking of the early and mid 20th century just may be obsolete.

The second group of prime buyers b) is very cognizant of the market conditions and are sitting on the sidelines waiting for the price of homes to fall more. My guess is, this second group of prime buyers is slowly growing larger at the expense of the “oblivious” group.

With all that said the housing market goes no where until demand increases. Demand will not increase until the price of existing homes decreases (forget new homes it is only 15% of the housing market) and the second group of buyers believes that we have hit the bottom. They will not believe that we have hit bottom until the housing inventory number starts to decline. If you will notice there are no comments about interest rates, they are not material.

I have talked long enough. Text in bold is my emphasis. From Bloomberg:

U.S. Treasury Secretary Henry Paulson's plan to prevent as many as 1.2 million people from losing their homes by freezing interest rates on subprime adjustable-rate mortgages will bring no benefit to the depreciating housing market.

``At best, it may stop some of the hemorrhaging of the housing market, but it doesn't necessarily turn things around,'' said Nicolas Retsinas, director of Harvard University's Joint Center for Housing Studies in Cambridge, Massachusetts. ``The fundamental problem with housing is oversupply.''

Existing home prices may fall as much as 15 percent by 2009 from their peak last year, even if interest rates are frozen on one fifth of 2006 subprime loans resetting next year, said Mark Zandi, chief economist at Moody's Economy.com, a unit of New York-based Moody's Corp. About 2.8 million mortgage loan defaults will occur in 2008 and 2009, Zandi said in Dec. 5 testimony before the U.S. Senate Judiciary Committee. . . .

. . . . ``It's long overdue that someone puts something on the table that's enforceable and real and not just a press release,'' said Prentiss Cox, a former assistant Minnesota attorney general who prosecuted predatory lending cases. He's now an associate professor of clinical law at the University of Minnesota in Minneapolis.

Paulson's plan is being introduced as the number of Americans who fell behind on their mortgage payments rose to a 20-year high in the third quarter, the Washington-based Mortgage Bankers Association said in a report yesterday.

Analysts at Credit Suisse Group estimate more than 30 percent of borrowers with subprime adjustable-rate mortgages are behind on their payments before their loans reset higher and 775,000 homes with $143 billion of mortgage debt will go into foreclosure through the middle of 2009. The forecast was made before Paulson's plan was disclosed.

``It'll be the biggest housing recession we've known,'' said Allen Sinai, chief global economist at New York-based Decision Economics Inc. ``Even if we figure this part of it out, we are not through it.''

The government-led initiative may ``reduce the severity of the decline,'' said Robert Shiller, chief economist at MacroMarkets LLC and a professor at Yale University in New Haven, Connecticut. Still, ``if past cycles are a guide, we could have weak or declining markets for five to 10 years,'' Shiller said.

Sixty-one economists said in a letter to Congress yesterday that they oppose the Paulson plan and urged ``against excessive new regulations or federal interventions as a response to current trends in the housing market.'' The economists sent the letter with FreedomWorks, a non-profit group that supports less government and lower taxes. Its chairman is Dick Armey, a former Republican representative from Texas and House majority leader.

``Right now I think it takes a brave soul to buy a home because there's so much chatter about housing prices dropping,'' Toll said. ``As soon as that fear leaves the market and we have some kind of equilibrium, we'll be back on top.''

Homebuyer confidence may be helped ``at the margin'' by the Paulson plan, said James Paulsen, the Minneapolis-based chief investment strategist at Wells Capital Management who helps oversee about $200 billion.

``Rather than real impact, it may cause people to settle down and free up capital flow,'' Paulsen said. ``It could have that kind of benefit. I'm not sure the real fallout will be that much different.''
Zandi estimates new and existing home sales will bottom at an annualized rate of 5.25 million units in early 2008 from a peak of 8.5 million homes in mid-2005. New home sales are projected to fall 13 percent in 2008, according to estimates from the National Association of Realtors in Chicago.

U.S. home prices declined for the first time since 1994 in the third quarter as foreclosures increased and lenders tightened mortgage requirements, the Office of Federal Housing Enterprise Oversight reported on Nov. 29.

Part of the success of the Paulson plan may hinge on loan- servicing companies' ability to handle the workload of modifying terms of existing mortgages, Zandi said. Mortgage service companies are authorized to negotiate with borrowers, though so far only about 1 percent of loans surveyed by Moody's Investors Service have been changed.

``It's only recently that Washington has focused on the fact that the critical players in making this kind of remedial program succeed are the investors as opposed to the banks,'' said H. Peter Haveles Jr., a New York-based partner at the law firm Arnold & Porter LLP, who represents investment banks and mortgage companies in regulatory investigations and civil litigation.