How Do You Spell Relief?

Okay, time to dig into this foreclosure relief plan - something I had meant to do earlier in the week, but wanted to tackle the address to Congress while it was still fresh. So I'll cover this today, and hopefully get to the new budget next.

But first, a brief rant on a somewhat related topic. After selling off Monday, the market rallied back Tuesday - in spite of bad economic data - on a comment during Helicopter Ben Bernanke's Congressional testimony that the economy might start to recover this year. Of course, he hedged his statement mightily, noting that such a scenario assumes the banking sector can be stabilized by then.

Seriously, why would anyone listen to this guy at this point? Isn't this the same Ben Bernanke that about a year ago said the subprime contagion could be contained, and appeared unlikely to spill over to the broader economy? If Ben couldn't see this coming, he can't see five inches in front of his nose. So let's not place too much stock in his prognostications regarding where the economy's headed next.

On to Jim Cramer, Bubblevision's blowhard-in-chief. After fawning over Sheila Bair last night, he commented that the government has to force banks to make loans, because if a bank offers credit cards, and its model says not to issue them if unemployment hits 10%, then it won’t issue them when unemployment hits 10%, which it’s close to doing.

To which I respond, "Duh."

Likewise, he said no bank would want to make a home equity loan in this environment, which is also true. So he says the government HAS to force the banks to do so.

Okay, let’s follow that to its conclusion: the government forces the bank to make the loan. Because of high unemployment and still-falling house prices, the loans default. The bank loses money, but presumably a condition of the government forcing it to make the loans is a backstop from the government – if not, the government will just bail them out once the losses threaten to make them insolvent.

So why doesn’t the government just eliminate all banks and start issuing credit cards and HELOCs itself, to the people who can’t afford to pay them back, funded by those of us who can (for now)? And this clown has a TV show, while you and I have to work for a living.

Rant over.

The $75 billion mortgage relief plan unveiled in Mesa, Arizona last week is supposed to help up to 9 million homeowners avoid foreclosure. (There's that "up to" qualifier again, which means that if one homeowner is helped, the plan worked.) Wait - that's $8,333 per homeowner. Is that really going to stave off foreclosure? Looking at another order of magnitude, the US housing market has lost over $6 trillion in value since the bubble burst, and most estimates indicate that the bleeding is just half-done. So throwing 1.25% of that loss at the problem will produce a fix?

The plan is supposed to help two broad groups of homeowners. The first - "up to" 5 million homeowners - are people whose home value has fallen to the point that they can't qualify for a conforming refi. So the plan would basically relax the Fannie/Freddie conforming qualifications so they can, providing low-cost mortgages - the rate being subsidized by those of us who responsibly bought no more house than they could afford, with a large enough down payment to insulate ourselves from falling prices - which will reduce their monthly payment.

The trouble with this notion is that the problem with those folks isn't the monthly payment, it's the home value, and I'll dig into that momentarily. Studies have shown that up to 80% of homeowners will simply walk away from the home if its value falls 20% below the mortgage balance, even if they can comfortably make the monthly payment on the current mortgage. Why?

Because the bubble led people to believe that the home is just another investment, and people tend to bail out of investments when their losses reach a critical point. Whereas the rest of us see the house as a place to live, and recognize that, just as it was folly to think real estate values would rise forever, it's folly to think they won't eventually - in the long run - recover. So we simply plan to stay put and not sell until they do.

So what those people need - absent discipline and fiscal responsibility, which apparently are only useful in speeches these days - is principal reduction, not payment reduction. And that's not part of the plan.

The second group the plan is supposed to help - "up to" 4 million homeowners - are those facing foreclosure because of job loss or other recession-related impacts, or because of resets on ARMs.

You know, foreclosures as a result of job loss are tragic, but they happen. Always have, always will. I remember, as an S&L examiner in the Rust Belt in the late '70s, entire communities where people left "jingle mail" in the mailbox and moved to where the jobs were, after they lost theirs. It's a fact of life, and those people didn't get bailed out.

Moreover, if you get an ARM, you should know the rate can go up. If you can't afford the higher payment - or if you assumed real estate values would go up forever and interest rates wouldn't, and you could refi at a lower fixed rate later - then I'm sorry to say, you're at risk of losing your house.

President Obama was adamant that none of the money would go to speculators, or to people who "knowingly bought more house than they could afford." Let's see how this works in practice:

Lender: "Okay, first question: are you going to live in this house, or are you a speculator looking to flip it?"

Well, what do you think the answer's going to be? I know of at least one individual who bought a second home during the bubble as an investment, and told the lender he was going to live in it, to get a lower rate. Is the government going to verify this information? If so, how?

Lender: "Second question: did you knowingly buy more house than you could afford?"

Again, guess what the answer will be? "Uh, gee, no, I had no idea that my income as a fry cook at Wendy's (which I lied about on the application) wasn't sufficient to afford a 5,000 square foot McMansion with Italian marble floors, five bedrooms, a media room, and a swimming pool."

At least Bair and others have since acknowledged that some of the money will wind up in the hands of the wrongdoers. But she took it a step further down the path toward communism (we're getting past socialization now), saying that was okay - necessary, in fact: we need to just bail out everybody facing foreclosure, moral hazard be damned.

Not on my dime, sister.

President Obama's justification for the plan was that foreclosures hurt everybody; when half the people on your street get booted out of their homes, and those homes stand vacant and neglected, it hurts everybody's property values. True - temporarily. But not everybody is irresponsible enough to walk when that happens. The vast majority of us pay our mortgage bills on time, and plan to stay in our houses until the value recovers, at least.

The notion is that preventing foreclosures can "put a floor under housing prices," a concept that I've been ranting about since it became part of the new-speak of the new Amerika.

Let me put it simply: a house is an asset. Asset prices are predominantly governed by the laws of supply and demand. The supply of available new homes for sale just hit a record 13.3 months, thanks to rampant over-building that was slow to be corrected (the norm is about 5 months). And the supply of existing homes, while off its recent record, did tick up in January, to 9.6 months, or about double the norm for resales.

Until there is sufficient demand to meet the supply, housing prices will fall. At equilibrium, there will be enough truly qualified buyers to arrest the free-fall. It is impossible to put a floor under prices; they have to reach their natural floor.

Another problem with the plan is that it's only intended for those not yet delinquent on their loans. Yet the current default rate continues to escalate. And the plan won't apply to jumbo loans, on which the default rate is also beginning to climb rapidly.

Meanwhile, Fannie and Freddie are raising fees and down payment requirements for purchase mortgages, and upping points for below-prime FICO scores. That'll help.

Also - as I predicted - the bond market has begun to react to Washington's spending spree, with yields rising this week as issuance ramps up, and also in response to the $1.7 trillion deficit projected this year after the release of the President's new budget, which calls for spending pell-mell on health care reform, clean energy (a black hole for investment dollars), and green stuff (ecologically speaking). That will keep mortgage rates from coming down, because the mortgages will have to be packaged and sold to investors in order to have the liquidity to underwrite them, and investors demand a spread to Treasury yields to buy mortgage-backed securities.

I like what Weiss Research had to say about the plan:

"Foreclosures are actually resulting in overpriced homes burdened with too much debt being moved into the hands of new buyers, who are paying drastically reduced prices. They can therefore purchase using a traditional mortgage ... Delaying and dragging out the downturn ... will arguably work against the market healing."

But of course, we can't afford to let the market heal. We must act swiftly and boldly.