Macro Economic Trends and Risks
Sub-Prime Bailout Ineffective?

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December 6, 2007

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It will be really interesting to see how the target audience: "sub-prime borrowers" gets defined this afternoon.

A layperson might think that the sub-prime subset of all mortgage borrowers would be small. However, if that is the case then why would their defaulting be such a cause for concern?

My guess is that "sub-prime borrower" does not get defined. This way the program could be applied to wherever needed, even to mask the true nature of the crisis.

For....if the sub-prime borrower is defined and gets to freeze their ARM rate for 5 years, what then becomes of the prime borrower who also has an ARM and also is endangered by rising rates? Are they so few in number that the system can take their defaults?

It will also be interesting to see how the credit reporting will be done on these "frozen rate" loans. Obviously the borrower is not paying as originally agreed. If the borrower still gets hammered on credit, then why pay a note against a house that isn't worth what's owed on it? These borrowers are "sub-prime" presumably because their credit history was bad to start with which may just indicate that they don't have very good foresight nor the best paying habits nor the highest savings rates nor the ability to be paying for a huge asset that isn't now worth what they owe on it.

IMO the real danger to the system is from the HELOCs (Home Equity Lines Of Credit) that were used to 1). come up with the difference between 80% LTV and whatever was borrowed to purchase the house; and 2). given out virtually at will to anyone who applied who were using their home as an ATM. Both of these situations allowed up to 100% of the equity to be borrowed. In the case of default and foreclosure, 100% of these loans will be lost in today's declined real estate values. Will the HELOCs be frozen as well? Will all HELOCs (or any) be defined as being "sub-prime"?

I've seen the arguments that either the homeowners should be made to pay the folly of their bad decisions or they should be bailed out because they were victimized by unscrupulous purveyors of mortgage money operating under an Administration too lax in oversight. I think these positions both oversimplify the issues. One has to look past the rhetoric to the reality and try to determine the root causes of this latest fiasco and try to address those so that future generations don't experience the same thing. Indeed that kind of probing may happen down the road, but doesn't address the immediate problem of foreclosures.

If the problem is so great that this one issue has the power to bring the Republicans to the table in a constructive fashion with the Democrats in this era of polarity, to bring the big money people to the table with the peons, how truly massive must this issue be? Is it, perhaps bigger than we think? Or is all of this just political posturing in the campaign cycle?

I'm of the school that the problem is immense. I also am a cynical old redneck who believes that all politicians are using the issue to promote their own self-image. I'm also cynical enough to believe that the monied are not doing anything for any other motive but enlightened self-interest.

So....having said all of that, I'm left with the question: "Is this plan anything but a bromide?" I don't think it will work as intended, if I read the intentions correctly and that being to seriously stem the wave of defaults and bankruptcies now beginning to build up for the cresting on the American economy. I don't think it will work in large measure because the issue isn't only monthly affordability of mortgage payments. The issue is overall affordability of owning houses whose expense is too great for the income, in an economy driven in SUVs powered by gasoline whose price is skyrocketing to grocery stores whose costs are also skyrocketing. It is fueled by these expenses outpacing the rate of income growth. It is fueled by too little insurance for which the costs are way too high, and this group is lead by health insurance. In short, the squeeze on the American household is coming from many directions at once. The big one is the house mortgage and, if that expense is eliminated by defaulting at the same time that rentals are plentiful, the result on an individual basis may be for the household to be able survive all the other demands. The declining house values will probably be the factor that tips the equation in favor of continued increasing defaults and foreclosures.

To make a long story finally come to a conclusion: I believe the "cure" being promoted today will apply to more than just the "sub-prime" borrower, and that it will turn out to be no more effective than the WIN (Whip Inflation Now) buttons were decades ago.