Another Band-Aid for Housing

Mike Larson examines the housing market slump and takes a closer look at how the Federal Reserve is reacting towards the U.S. facing a possible recession. In this issue of Money and Markets, Mr. Larson explains the different factors that could lead to a recession in the U.S.

Jupiter, Fla. (PRWEB) December 9, 2007 -- Mike Larson examines the housing market slump and takes a closer look at how the Federal Reserve is reacting towards the U.S. facing a possible recession. Mr. Larson explains the different factors that could lead to a recession in the U.S.

Roughly 100,000 subprime adjustable rate mortgages (ARMs) are on track to "reset" every month for the next two years, according to UBS. A reset is when the interest rate and payment on an ARM adjusts higher. The FDIC projects that total resets will amount to roughly $330 billion through next December. Interest rates on many ARMs are expected to rise from a range of 7 percent to 9 percent to 11 percent to 13 percent.

The Mortgage Bankers Association just released awful data on third-quarter mortgage delinquencies and foreclosures. Some 5.59 percent of mortgage borrowers were behind on payments in the three months ended this September. That's up from 4.67 percent a year earlier and the worst reading going all the way back to 1986.

A record 0.78 percent of U.S. mortgages entered foreclosure in the quarter. And the overall foreclosure rate jumped to 1.69 percent from 1.05 percent a year earlier. The mortgage and housing crisis could cost investors and banks as much as $400 billion because of write downs and losses on mortgage-related securities and other investments.

President Bush and Treasury Secretary Henry Paulson outlined their latest bailout plan Thursday, December 6. To understand their plan of action, the Paulson's plan must be explained. There are 4 categories:

1. Those who can afford their mortgages now, and who can afford them post-reset.

2. Those who can't even afford their loans at the current teaser rates.

3. Those who can probably refinance if they want to. Paulson would prefer that these people be refinanced into new mortgages, rather than have their existing loans modified.

4. Those who can handle their mortgages at the current teaser rates, but who couldn't afford them if their rates and payments were to reset higher.

It's the people in category four that are being targeted for relief, provided they have steady incomes and relatively clean payment histories. Specifically, borrowers who are at least 30 days behind on their loans at the time of the potential modification or who have been more than 60 days late within the past year will be excluded.

The program will apply to anyone who took out a subprime ARM between January 1, 2005 and July 31, 2005 and whose rates reset between January 1, 2008 and July 31, 2010. That will theoretically allow these borrowers to stay in their homes, improve their credit, and eventually refinance. It's also designed to prevent even more foreclosures, which could exacerbate the home inventory glut and push home prices even lower.

Another part of Paulson's plan: Allow state and local governments to sell tax-exempt bonds to raise money to refinance borrowers out of subprime loans. Currently, such bonds can only be used to finance things like first-time home buyer purchase loans.

There are three major problems with the Paulson plan.

1. It's going to be extremely difficult to get everyone on the same page. Banks generally don't make 30-year loans to borrowers and hold them on the books forever. They originate those loans, and then unload them into the secondary market. There, those mortgages are bunched together into all types of securities, which in turn are bought by income-seeking investors the world over.

2. Modifications aren't a permanent fix because modified loans frequently go bad anyway. Rates are high; a 1994, study here in the U.S. found that almost 68 percent of prisoners released that year were re-arrested within three years. In other words, modifying loans on a wholesale basis may not be the best deal for lenders or borrowers.

3. Resets aren't the only cause of foreclosure or even the biggest one. Here's a shocking statistic: Borrowers are already behind on roughly 25 percent of subprime loans made in 2006 that don't reset until 2008.

Reason: Because home prices are falling. As a recent Federal Reserve Bank of Boston paper points out, declining home prices play a "dominant role in generating foreclosures." When borrowers owe more than their homes are worth, they have a psychological incentive to give up.

Then there's the financial incentive. The median price of an existing home in this country was $207,800 in October, down $22,400 from its July 2006 peak.

"Housing is being hit by a perfect storm. The latest bailout plan will help, but it's not the perfect solution. Moreover, price declines in many parts of the country are even bigger. Right now, judges can restructure other debts in bankruptcy, but not primary home mortgages," Mr. Larson states.

To read this issue online, please visit:

http://www.moneyandmarkets.com/Issues.aspx?NewsletterEntryId=1251

About MIKE LARSON & MONEY AND MARKETS     

Mike Larson joined the company in 2001, and has more than 10 years of experience researching and writing about personal finance, investing, and the housing and mortgage industry. In 2003, Mr. Larson was named associate editor of the company's monthly Safe Money Report. In this role, he is responsible for writing and editing as well as analyzing trading opportunities for clients. Mr. Larson is also a regular contributor to the company's daily e-letter, Money and Markets.

Mr. Larson holds B.A. and B.S. degrees from Boston University.

Money and Markets (www.moneyandmarkets.com) is a free daily investment newsletter from Dr. Martin Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Weiss Research, Inc. is located in Jupiter, Florida. For more information about our editors, or to set up an interview, please contact Jennifer Moran at 561-627-3300 or visit www.moneyandmarkets.com.

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