A Level Gaze

A Level Gaze

"What effect must it have on a nation if it learns no foreign languages? Probably much the same as that which a total withdrawal from society has upon an individual."
--G.C. Lichtenberg

Saturday, December 08, 2007

Sucker Trap

I had thought the Paulson Plan rather a poor deal for homeowners:

The basic outline is that loans are put into three segments:

1. Borrower appears (from fairly superficial analysis of the data, not any deep digging) to be eligible for a refinance. These borrowers are to be encouraged to refinance.
2. Borrower appears able to make payment at current rate, but appears (again, from fairly superficial analysis) to be unlikely to be able to refinance (generally because LTV is too high with FICO too low). These borrowers are eligible for the “fast-tracked” mod (the rate freeze) if they meet some FICO and payment increase tests.
3. Borrower appears unable to make payment even at current rate; these borrowers are presumed to be unable to refinance. They are not eligible for the “fast track” rate freeze mod; they may be eligible for some kind of work out, but it would have to be handled the old-fashioned fully-analyzed case-by-case way.

Which the inimitable Tanta further boils down to:

1. Not in default and default not imminent
2. Not in default and default reasonably foreseeable
3. In default or default imminent

As I mentioned in the previous post, the plan was specifically targeted to freeze the rates of only those homeowners who were at the very limit of their financial wherewithal, to squeeze the absolute last nickel out of them. As Tanta explained, there is a good reason for this: the securitization contracts specify that the terms of only those loans in imminent danger of default may be modified without (complex, expensive) renegotiation.

In an environment of decreasing prices, spiking inventory, and tighter credit, a provision that makes it barely possible for homeowners who bought at the top of the market to stay current on their mortgages is at best dubiously advantageous. Against the ability to stay in their homes would have to be weighed the fact that they would be overpaying for the privilege with the last of their financial resources. Unless their incomes increase significantly during the five years the Plan covers, they would be in much the same position in which they find themselves today: facing a significant payment increase they can't to afford. In the then-likely event of foreclosure, they would be left with nothing. If, instead, they just mailed the keys to their servicers now and walked away, they could then rent essentially the same houses for much less money, save the difference, and be in a position to make downpayments on rationally-priced homes when their credit ratings reset.

This looked like a bad enough deal considering what many thought to be the Plan's other major stipulation: that the loan-to-value ratio (LTV) of the first mortgage could be no less than 97%. As such, mortgagees facing hopeless levels of debt on their homes would be excluded from participation, and wouldn't be thereby tempted to prolong their impossible situations. However, as Mike Shedlock pointed out yesterday afternoon, that provision had been widely misread: the Plan covers only those with LTVs of more than 97%. That is, only those in the worst shape, many of them already owing more than the value of their homes, would "benefit".

In light of this clarifcation, the Plan can no longer be construed as possibly a good deal for certain people in very specific circumstances. It is, in Mish's very apt characterization, nothing more than a "sucker trap" that will ultimately ruin nearly every homeowner who participates in it.

posted by David at 12/08/2007 11:09:00 AM ::

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