As disappointed global stock markets plummet in response to the Federal Reserve's latest stimulus initiative, few investors are paying attention to what may be the Fed's real intention behind this new plan: mortgage refinancing.
For the longest time, I have been convinced that the housing market holds the key to economic growth (or lack of it) in the U.S. As such, I have been hoping against hope that one or more of a long line of presidential candidates would actually have the courage and intellect to recognize and address our main problem.
Instead, I hear how "we need to get America back to work" or "we need to roll back all these regulations that are preventing businesses from investing." While all of those jingoistic slogans sound good, none of them address the main issue: how to deal with the trillions of dollars in underwater mortgages and the people who hold them.
The Fed, through QE II, attempted to push interest rates low enough so that borrowers could stave off foreclosure by refinancing their mortgages. The problem is that lenders insist that the market value of homes to be refinanced must be no lower than 25 percent of the mortgage they carry. That's a real "Catch-22" for most borrowers, thanks to the decline in housing values over the last three years.
Their houses are now worth a lot less than that. So mortgageholders are in a bind. They can't sell their property because they won't get back enough to pay off the loan. They can't refinance because the house is worth less than the mortgage and they can't afford the monthly mortgage payments. As the situation drags on, more and more Americans slip into bankruptcy or walk away from their home/mortgage leaving and already weakened financial system to pick up the pieces.
Right now this is just my guess of what the Obama administration may be planning. Over the past week a number of governmental trial balloons have been floated in the media concerning refinancing of up to $1 trillion of mortgage loans on easier terms. It won't be a giveaway, if it occurs, in the sense that to qualify for re-financing, you must be current on your mortgage payments and the loans must have been guaranteed by Fannie Mae, Freddie Mac or the FHA. How would it work?
Homeowners who qualify would get a new 30-year loan at say 4 percent and payoff 100 percent of the old mortgage (presumably carrying a much higher rate of interest). This is called prepaying your loan in the mortgage business. Your bank receives the proceeds and pays off the old loan to Fannie and Freddie. These two government mortgage entities would receive these billions in prepaid mortgages and dispense them to the ultimate mortgage holders in the mortgage-backed securities market.
Now, guess who holds the lion's share of mortgage backed securities in this country? You guessed it, the Fed.
That still leaves Fannie and Freddie with a problem. They need to refinance all these new 30-year, 4 percent mortgages. They are also assuming a lot of risk since lending now, when interest rates are at historical lows, is a dicey business. Who will buy them and how can they protect these new mortgage loans from future losses when interest rates begin to rise? The answer was revealed in Wednesday's Fed announcement.
The Federal Reserve announced that it intends to drive long-term interest rates lower by purchasing long term U.S. Treasury bonds. The Fed said it will also juggle its $2.65 trillion securities holdings by using its enormous cash flow to buy more mortgage debt. In other words, since it will be on the receiving end of all these billions in prepaid mortgage money, it will just turn around and use that cash to buy up billions in these new refinanced mortgages. At the same time, by driving long rates lower through their purchase of long dated Treasury bonds, they effectively remove the risk of rates rising anytime in the near future. The Fed becomes both buyer and seller of this entire refinancing operation.
The beauty of this move, in my opinion, is that the White House will be able to launch a new refinancing program/stimulus plan without going through Congress for approval. Nor will it add to the deficit, since all of these transactions will be run through the Federal Reserve. The Republicans may have gotten wind of this, thus the letter to the Federal Reserve Board just prior to their meeting, warning the Fed members not to do anything further to stimulate the economy.
Well, boys, the Fed just blew you off and you can't do a thing about it.
Is this all a hair-brained scheme of mine born of too much work and too little vacation? Time will tell. But if I'm right, I would expect an announcement fairly soon. I have to hand it to the Obama administration if it is true and they can pull this off. The scope of refinancing they are planning will put $2,000 or more a year into borrower's pockets, which will amount to a huge stimulus program that bypasses Congress and goes straight to the people. I hope I'm right.
Bill Schmick is an independent investor with Berkshire Money Management. (See "About" for more information.) None of the information presented in any of these articles is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at (toll free) or e-mail him at email@example.com . Visit www.afewdollarsmore.com for more of Bill's insights.
This week one of my clients asked me to explain the ongoing foreclosure debacle in "plain English" as she put it. It dawned on me that there may be a lot of readers out there who would benefit from the same thing, so here goes.
The first point to understand is that homeowners can only be foreclosed and evicted by the person or institution that actually holds the mortgage loan note. That noteholder is the only entity that has the legal authority to ask the courts to foreclose and evict the mortgageholder. That note is what you sign and give to the original lender, promising to pay the loan back over 10-20-30 years. It is that note (not the mortgage) that is the important legal document.
Back in the day, before mortgage-backed securities and loan securitization, most mortgage loans were issued by your local S&L or bank. The note stayed with the local financial institution who serviced the loan, just like in the movie "It's a Wonderful Life."
Then some Wall Street rocket scientists decided to modernize that business. Since all mortgageholders are not the same and some are riskier than others, these Gordon Gekko-lookalikes decided there was a buck to be made in wholesaling mortgage loans to investors hungry for higher-yield securities. Wall Street bought these mortgage loans off the banks and bundled them into huge pools called Real Estate Mortgage Investment Conduits (REMICs). At that point, these mortgages were spliced and diced into tranches according to their risk, (among other variables). The REMICS never owned the mortgage notes, but were simply re-packaging the mortgage loans, taking a fee and selling them to others.
Investors bought these loans, which were separated into a whole range of tranches according to how much risk the investor wanted to take on. What is important to understand is that each tranche holder owned a portion of the same mortgage, rather than investor A owning my mortgage and investor B holding yours. If my mortgage defaulted and you owned a junior (riskier) tranche of my mortgage (times many, many more) then you would be hit with that loss first. If there was still some loss left over, the more senior (safer) tranche holder would take a hit as well. It was physically impossible, even if the sellers owned the notes, to divide them fractionally between thousands if not millions of buyers. So once again these mortgages (tranches) were sold but not the notes.
Imagine the complexity of keeping track of what mortgages were defaulting versus those that were not and how much loss to assign each individual trancheholder? Enter the Mortgage Electronic Registration System (MERS), which became the repository for millions of digitized mortgage notes that all the financial institutions originated from the actual mortgage loans signed by you and me. These digitalized mortgage notes were sliced and diced and rearranged once again and came out the other end as mortgage-backed securities. The problem was that MERS didn't actually hold the mortgage notes either. And therein lies the rub. Legally, the chain of title for these mortgage loans has been broken a couple of times.
As I've explained, the key document in taking out a mortgage is the note. In order for that note to be sold or transferred to someone else (for example, transformed into a mortgage-backed security), the note has to be physically endorsed over to the next person. If it isn't, the chain of title is broken. If the chain is broken than legally the mortgage note is no longer valid. The person who took out the mortgage no longer owes the loan, because he no longer knows who to pay. In my opinion, I still believe that everyone has an obligation to repay money they have borrowed, otherwise, the entire system of credit will disintegrate.
Of course, with the number of foreclosures that have hit the nation, this issue was bound to be discovered as homeowners began to contest eviction. The banks, realizing their error, hired foreclosure mills, (legal firms that specialized in foreclosures), to remedy the problem. Accusations that these foreclosure mills actually went back and falsified documents in order to repair the broken chain of titles caught the attention of attorneys-general throughout the nation as did stories of robo-signers who were signing their names to foreclosure documents that attested that they had reviewed the loan documents when they hadn't.
In an election year, this issue has disrupted everything to do with the mortgage markets from foreclosure to new home sales. Everyone from the White House, the Justice Department, the U.S. Treasury and the Housing Departments are announcing task forces to dig deeply into this mess. In my opinion, the digger they deep the worse the true story will become so stay tuned.
Bill Schmick is registered as an investment advisor representative and portfolio manager with Berkshire Money Management (BMM), managing over $200 million for investors in the Berkshires. Bill’s forecasts and opinions are purely his own and do not necessarily represent the views of BMM. None of his commentary is or should be considered investment advice. Anyone seeking individualized investment advice should contact a qualified investment adviser. None of the information presented in this article is intended to be and should not be construed as an endorsement of BMM or a solicitation to become a client of BMM. The reader should not assume that any strategies, or specific investments discussed are employed, bought, sold or held by BMM. Direct your inquiries to Bill at 1-888-232-6072 (toll free) or email him at Bill@afewdollarsmore.com Visit www.afewdollarsmore.com for more of Bill’s insights.