Credit Crunch

A post I saw at CL&P Blog, which mentioned that Minnesota is seriously considering a moratorium on foreclosures, got me thinking.

Isn’t a simple moratorium just a postponing of the inevitable?   After all, unless something else happens, in all likelihood many of the potential “foreclosees” will be unlikely to catch up with their payments, the potential resale value of the potentially-foreclosed property dwindles due to lack of debtor incentive to maintain the property, and the lenders suffer a certain amount of balance sheet pain from having to keep bad debt on the books for that much longer.

I can empathize with the sentiment that something needs to be done to stop a flood of foreclosures.   Yes, I am a little disgruntled with the sentiment — my wife and I accepted a higher interest rate and bought less of a house than some of our peers, because we saw the potential downside of going with an ARM; therefore it’s tough accepting the apparent unfairness of folks being bailed out of their bad bets while those of us who made more responsible decisions are left to indirectly pick up the slack.  But I accept that a hard crash of the real estate market is not a good thing for the country, and I can definitely empathize with how life can suck when luck goes against you.

As part of bankruptcy reform a couple of years ago, Congress sought to make it tougher for individuals to seek bankruptcy protection, or to limit such protection, under the premise that there were too many folks abusing the system.  The pros and cons of the changes can be a subject of debate, but the fact remains — our leaders thought bankruptcy should be a measure of last resort, and therefore put a couple of extra hoops in the process, to attempt to get others to perceive it as a last choice and to be aware of potential, less extreme alternatives.

I wonder if those states and localities that are pushing for moratoria shouldn’t adopt a similar stance.

Rather than simply stop foreclosure actions for a time, perhaps legislators and regulators should be attempting to introduce new hoops, with an eye towards making sure that every other alternative has been exhausted.

For example, I could imagine lenders being obliged to seek to work out some form of alternative financing arrangements, or facilitating access to third-party counselors to provide guidance to delinquent homeowners.  

I could also imagine a rejiggering of laws or regulations to facilitate real estate transactions whereby a delinquent homeowner can sell a property to a qualified buyer, who would assume the outstanding mortgage as part of the deal.

Heck, I could also tolerate new laws/regs adopted to incent banks to flip foreclosed as quickly as possible, even if the house sells at a low price.   (A 900% property tax surcharge on foreclosed properties not reoccupied within 6 months, anybody?)  Structured properly, such measures should alter the banks’ side of the foreclosure equation enough to provided added incentive to seek alternative, less drastic solutions…as well as providing municipalities extra revenue to support the strain on services arising from having a large number of vacant properties.

I realize that several lenders already have become rather proactive about helping their clients avoid foreclosure, and that those lenders also routinely face challenges of customer avoidance, confusion, or unwillingness to seek to save themselves.   But I do question whether such practices are the exception rather than the rule, or that consumers are adequately aware of such alternatives.

However, if consumers have to go through extra hoops to seek any sort of relief from debt issues, why shouldn’t the lenders be similarly constrained?

Seen in the Wall Street Journal (subscriber link):

SLM Corp. swung to a first-quarter loss and warned it can’t make profitable loans at this time, prompting the nation’s largest student lender to assess its operation and call for a “system-wide liquidity solution.”

The credit crunch and recent cuts in federal subsidies have led some lenders to stop making federal student loans and tighten their credit standards on private student loans.

“Today’s environment is the most difficult we have seen in our 35-year history of student lending,” Chief Executive Albert Lord wrote. “It has become obvious that we can only meet the enormous student credit demands we are seeing at Sallie Mae if there is a near-term, system-wide liquidity solution.”

In Senate testimony Tuesday, Senate Banking Committee Chairman Chris Dodd said he would send a letter to Treasury Secretary Henry Paulson to direct the Federal Financing Bank to purchase participation interest in pools of new student loans backed by the government.

Hmmmm…. student loan providers pulling out of the market, interest rates on loans high, and the echo of the baby boom graduating high school, all at the same time.

This can’t be good, can it?

Seen in the Australian Financial Standard:

Actuaries will play a more central part of the banking and financial services sector as a result of the US sub-prime mortgage crisis, according to Greg Martin, Institute of Actuaries of Australia president.

“We are seeing enterprise risk management (ERM) roles proliferate across the financial services sector particularly where recent volatility and repricing has highlighted the need for ERM related skills and disciplines. Actuaries are playing an increasing role in this trend,” said Martin.

I realize that from my vantage point in the P&C side of the American insurance industry, it was tempting to question the SOA’s creation of the Chartered Enterprise Risk Analyst (CERA) designation last year.

However, it is interesting to see an Aussie grasp on such an expansion of / shift in actuarial focus as a way to expand the profession into other industries.

Also, the quote above conjured the image of Superactuary, traveling faster than a speeding bullet to save mild-mannered economists from the dungeon of Evil Credit Crunch Guy….an image which amuses me far more than it should.

In case you were looking for some tangible evidence of how tight the credit market has become…well, apparently all you need to do is attempt to apply for a mortgage. Seen in Zacks Commentary:

Typically, a minimum credit score of 680 has been required to get favorable rates on mortgages. This score has been perceived as the dividing line between good credit and mediocre or bad credit. Now, lenders are asking for scores of 720 or higher - a sign of significantly tighter standards.

To put these numbers in perspective, Experian’s National Score Index currently stands at 692. According to CreditReport.com, not a single state has an average credit score of 720 or better. (South Dakota had the highest average score at 710; Texas was the lowest at 651, followed by Nevada at 655.)

In other words, the average American has a credit score below the minimum currently required by mortgage lenders. At a time when many homeowners are looking to refinance adjustable rate mortgages and homebuilders need more buyers, this is not good news.

I’ve been doing work around the house in recent months, with an eye toward eventually selling and moving someplace warmer (and cheaper), taking advantage of the miracles of telecommuting. With mortgage lending as tight as it is now…well, it looks like I’ll have several months in which to make preparations.

The Secretary of the Treasury, Henry Paulson, held a press conference Monday that discussed….well, it’s probably a bit much to call it a plan. Perhaps it’s best described as a focusing of effort. Quoting his prepared remarks:

While the reality is a bit more complex, in the interest of simplicity, there are four categories of subprime borrowers. There are those who can afford their adjusted interest rate; these homeowners need no assistance. There are also a substantial number of homeowners who haven’t been making payments at the starter rate on their subprime loan and may not have the financial wherewithal to sustain home ownership; some of these homeowners will become renters again. A third category of homeowners might choose to refinance their mortgage - putting them in a sustainable mortgage while keeping investors whole. This is the first, best option. Servicers should move quickly to assist those who can refinance.

And the fourth category is those with steady incomes and relatively clean payment histories who could afford the lower introductory mortgage rate but cannot afford the higher adjusted rate. We are focusing on this group, determining who they are and what steps may appropriately assist them.

The dividing lines between the groups apparently isn’t fully fleshed out. However, already some folks are noticing that it may be more advantageous to be in one group than another. For example, consider this thought from WiseBread:

Perhaps even better than being in category three, though, would be to find yourself in category four.

At this stage, there are no rules written to establish who falls into this fourth category. However, it occurs to me that one of the reasons that someone might be able to afford a mortgage at a teaser rate, and yet not be able to afford it after a reset, is if someone has too much other debt. If that’s the case, it might be awfully tempting for such someones to take on a big chunk of extra debt and thereby move themselves out of category one and into category four.

It seems clear that if you just blow all that money on high living (or, you know, medical bills), that you’d find yourself in category four. (Don’t borrow too much and put yourself into category two. That’d suck.) But maybe there’d be some way to borrow the money and then spend it not on high living, but rather something of lasting value. Depending on exactly how the rules end up getting written, it might be something as simple as savings bonds; it might have to be something risky like land or a long-term, interest-free loan to your brother-in-law. Then, once you’d kept your loan from resetting, you could probably get your money back—if whatever you bought really was a thing of lasting value—and pay off that extra loan that put you into category four.

While I applaud the notion that a fix to the mess could provide the opportunity for some to turn a bad situation into a more advantageous one, I am miffed that such a benefit will likely come as an expense to the rest of us somehow, in the form of an additional burden on government expenditures (to the extent there’s federal financing or insurance provided).

And there is the whole “if we had known about this coming down the pike, we might have gone with an ARM mortgage…” syndrome.

However, I suppose that I should take some comfort in the concept that government action to cushion this crunch will hopefully head off additional economic instability if foreclosures were to spike, etc.

And, on the seeming unfairness front…well, we do have the premise underlying parts of capitalism that with taking greater risk, there is a chance of greater reward (as well as greater loss). By taking the safe, responsible route, my family won’t reap the benefits of the bailout, but at least we haven’t had to worry about a massive interest rate reset impacting our budget.