Analysis Of “The McCain Housing Plan”

I will start off by saying that I think that McCain is on the right track with this one.  This is the best proposal I have heard thus far (other than what the Fed is doing currently with commercial paper) to solve the economic crisis America faces.

First, a bit of an explanation of the root problem…  and I am going to simplify as much as possible, talking about the major themes (and ignore important but smaller ones…)

The fundamental cause of the problems with the banks and the economy as a whole originate in the housing crisis.

The housing bubble led to greater and greater numbers of risky loans and exploded when Fannie Mae and Freddie Mac started acting much like a hedge fund and invested in the very paper they were insuring.  This led to an explosion in the market and decreasing underwriting standards, especially when Fannie Mae and Freddie Mac made the “Alt A” programs available. 

The banks began to group these loans (aka bank debt) together into packages and sell them off to other banks.  The bank that bought them took these packages of loans  and divided them into “risk tiers” and sold those tiers as derivatives.  These banks then grouped the derivatives together and divided them further, until the original group was chopped into so many loans it was impossible to tell what was where.

This, in theory, should have minimized the risk associated with the loans.

Because of the grouping and dividing and selling and grouping and dividing and selling, virtually all the banks were heavily invested in these MBSs (mortgage backed security) and CDO’s (collateralized debt obligation.)

Then the economy slowed…  and housing was the one beacon of light in a dimming economy, so the banks, hedge funds, investors, and consumers invested even more heavily in real estate.

As time went on, the banks began to discover that a much larger than expected percentage of the loans were given to people that should not have gotten them.  The bulk of these “bad loans” were found in the Alt A realm that banks would not have normally invested as heavily in, but for the actions and rules of Fannie and Freddie.

With the economy continuing to slow, eventually the housing sector peaked and the dam broke. 

Foreclosures began to happen at an epidemic rate because the people that should not have been in the loans they were given couldn’t pay.

So the banks/hedge funds and especially Fannie/Freddie realized that they should not have been offering all these loans tightened up their lending standards because they couldn’t continue to offer the crap loans they had been offering, which would have made the hole they were in that much deeper.

The side effect of this was that, especially in a slowing economy, fewer and fewer people could qualify for new loans to buy all the houses that were pouring on to the market from new construction projects (at an all time high) and from massive foreclosures.

The housing market glutted, the banks began to dump the foreclosures for next to nothing and all the other houses sat on the market for a year or more. 

With only the foreclosures selling, they were the only sales to peg the prices of houses against and property values started dropping like crazy, especially in places where the bubble was biggest…  CA, FL, NV.

This has caused the secondary crisis…  there are millions upon millions of people upside down on their houses right now.  Millions.

So because of the problems with 10-15% of the loans, and the foreclosures they led to, the values of the houses with credit worthy people now had problematic loans because their property was worth less than the mortgage was for.

Essentially, the banks no longer knew what any of their loans were worth, because the assets tied to the loan weren’t worth enough to cover the outstanding debts, increasing the balance sheet debts of the banks by billions and billions and billions of dollars.

This made the banks “uncreditworthy” and so they stopped loaning money to eachother, leading to near of total collapse of a huge number of banks.

So, in order to solve the valuation problem, keep people in their homes and prevent more foreclosures, and to prop up the prices of homes as much as possible, earlier this year, the Congress approved a program called the “FHA Secure.” 

This program basically works like this…  if you have a $300,000 loan and your house is only worth $225,000 now, if the bank will lower the balance to the $225,000 then the FHA will insure the loan, making the loan more immediately marketable.

The bill and the program went into effect October 1. 

Not a single bank has implemented this plan to date.

The problem is two fold; 

First, it is voluntary…  the banks don’t have to do it.

Second, it requires that the banks take HUGE writedowns and though it may help even out the bottom line in the long run, in the short term those HUGE writedowns would probably kill them at this point…  especially perceptually.

Nobody wants that.

Ok, so now that we are caught up to present times, we can talk about McCain’s housing plan.

John McCain has basically taken the FHA Secure program, and instead of making the banks take the writedowns and essentially forfeit hundreds of billions of dollars…  McCain wants to re-allocate the “Bailout” money to buy out the negative equity on these people’s houses.

Why is this great?

1.  The estimated cost, about $300 Billion…  A number that is less than half of the “Bailout” which only helps banks/Wall Street and does nothing directly for mainstreet.

2.  It keeps people in their homes, reducing their balances and their payments.

3.  It helps prop up housing prices, or at least stabilize them, because it will lead to fewer foreclosures.

4.  It bails out the consumer and the banks in one fell swoop. 

Helps the folks, helps the banks.  Bingo.  I think he has something right there!

Read more here

Brilliant.

As I said, this is the best idea to solve the crisis I have heard so far (other than the fed buying commercial paper… also brilliant.)

 

(and yes, it’s basically Hillary Clinton’s plan, but don’t tell the Republicans LOL)