Here’s my opinion on the new Bush’ plan to freeze ARM rates for subprime borrowers. First of all I’m not against this plan at all, maybe I will even support it if I see that it is not falling apart, which is very likely.
What I definitely like is that budget money (what I’ve paid in taxes, and I’m paying quite a lot of taxes) are not involved. Second I like that the investors are supposed to pay the bill, not the communities, homeowners or whatever little people there are around. If investors invested money I suppose they don’t really need those money and we can plunder this wallet a little bit.
The only problem with the plan is that it may turn out that investors may try to refuse to be plundered. The whole idea of tranched CDOs is that they have multiple layers of protection. First layer is that mezzanine slices of CDO are protecting the senior debt. Second layer is that every slice is protected by CDS. The first protection is for the loan life, the second protection is for the first 5 years.
If the loan is modified the way that the default is artificially delayed by 5 years the CDS protection will expire and thus the tranche must be downgraded to reflect this elimination of protection. Bondholders will not like this and they will try to sue everybody and everyone to declare every modified loan default and to trigger the immediate insurance payment. Insurance holders will counter-sue to declare the loan current and not subject for insurance event. Counterparties will spend a lot of money on lawyers and then some money will change hands. We’ll see what happens.
Update: Looks like I was incorrect about lawsuits
December 9, 2007 at 1:15 am
[...] not all investors are exactly thrilled with the plan The only problem with the plan is that it may turn out that investors may try to refuse to be [...]
December 10, 2007 at 9:02 pm
I believe this plan is as useful as the Super SIV program. It doesn’t address any the problems and is doomed to fail:
1. Housing prices will continue to fall. As the prices fall, more and more homeowners owing more than thier property is worth will opt to walk away. Why would some one with poor credit, no equity continue to pay a loan? The risk is that as prices fall, those that qualify for the Freeze will simply walk away. Of course by the time these folks start walking away, home prices will be even in worse shape, and the bond holders will lose an even greater sum of money.
2. Lenders and investors are tighting their belts and increasing lending standards, and not just for home loans. This includes credit cards, auto loans, student loans and even business loans (both big and small). This is going to continue to drag on home prices and pending homeowners will find it difficult to purchase a home.
3. It only addresses a very tiny amount of loans that are in trouble. It does address borrowers with higher FICO scores, or Alt-A\Prime borrowers who are also over thier heads. A few drops in the bucket.
4. It risks aliening investors and possibly forcing investors and banks to liquidate, before this policy is forced on them. For instance Lets suppose you’re one of the investors holding on to this debt. Do wait and bet that housing prices will be higher, or do you opt to liquidate before the policy blocks your ability to liquidate for the next several years? Historically, the early investors that bail out fair much better that take a wait and see approach, when it comes to addressing bad debt.
Read this and tell me if you think the Freeze has a prayer:
http://blogs.marketwatch.com/greenberg/2007/12/straight-talk-on-the-mortgage-mess-from-an-insider/
To summorize, no one is looking at the huge problem of second loans on properties.
theroxylandr wrote:
“Bondholders will not like this and they will try to sue everybody and everyone to declare every modified loan default and to trigger the immediate insurance payment. Insurance holders will counter-sue to declare the loan current and not subject for insurance event.”
I can’t locate the article I read on Friday, but it discussed a Federal bill to indemnify lenders and mortgage brokers from being sued by bondholders and investors over freezed rates on mortgages. If I find it I will post a link.
OT: I find it odd that none of the bond insurers have pushed back on all the loans that are defaulting. For instance, If I was the manager of a bond insurance company I would be demanding the originator/servicer provide me documentation on all of the loans included in the bond. Then I would search to locate any loans inproperly documented. As soon as I found one bad documented loan, I wouldn’t pay a cent until the all of the proper documentation is submitted. I also deduce payment on any loans with false information (ie no prove of income, failure to properly assess the property’s value, etc).