Why is the nation that came up with the iPod, Prozac and La-Z-Boy so unimaginative when it comes to its biggest product of all--home mortgages?
Halfway through a rather predictable speech before Congress on housing woes in September, Federal Reserve Chairman Ben S. Bernanke suggested something radical for the mortgage industry: Why not show a little creativity in financing home purchases?
He's got a point. It's just possible that variations on the standard 30-year home mortgage might have facilitated homeownership without precipitating the collapse in subprime lending that is now killing borrowers and lenders alike.
Recent years have, to be sure, seen some novelties in mortgages--letting buyers pay interest only, for example, or giving them low teaser rates to start out--but the new terms served more to foment speculation and risk-taking than to dampen it. What if, instead, buyers had been given ways to reduce risk, just as they can easily do with their stock portfolios? Then they would have sacrificed some of the gains in a bull market, but they would have been better equipped to survive the housing bear market.
"The U.S. has been creative in mortgages but only in a very narrow way," says New York University professor Andrew Caplin. "[We have] lost ambition for the large ideas."
Here are five ways banks could reduce the risk of foreclosures.
Share the appreciation. In return for a payment from an investor, the homeowner agrees to share the profit on the home if and when he sells at a profit. This is like buying some stock and then reducing your risk in it by selling call options against your position. The payment could go into an escrow to be tapped in an emergency.
Hedge with a short sale. The idea is that after buying, the homeowner would short a regional index of home prices of the sort traded on the Chicago Mercantile Exchange (nyse: CME - news - people ). If the bank held the futures position in escrow, it could reduce its risk of losing money on a foreclosure; presumably, if the homeowner had to sell in a downturn, he'd make enough on the short sale to cover the decline in his home's value.
Offer puts. The homeowner buys insurance against a decline in regional home prices. In effect, he's buying a put option. The risk reduction is similar to that for the futures short sale. A nonprofit called NeighborWorks America has sold dozens of insurance policies on home-price drops in Syracuse, N.Y., but the idea hasn't caught on elsewhere.
Vary duration, not monthly payment. The risk with an adjustable-rate mortgage is that the monthly payment can shoot way up when it resets. Why not keep payments fixed but translate a higher interest rate into a longer term for the mortgage? Adjustable-length mortgages apparently aren't offered in the U.S.
Make TIP-like mortgages. Treasury inflation-protected bonds have each coupon and the principal tied to the Consumer Price Index. A mortgage version, as proposed by the late Nobel economist Franco Modigliani, would have monthly payments that creep up slowly even in times of tumultuous increases in the inflation rate (and therefore interest rates). Modigliani mortgages never caught on, and in some places (New York, for example), they are prohibited.
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Saturday
Uncreative Destruction
Bush Aims to Prolong Expansion With Subprime Freeze
Dec. 6 (Bloomberg) -- President George W. Bush today announced a freeze on some subprime mortgage rates in an effort to stop a wave of foreclosures from undoing the six-year expansion.
Treasury Secretary Henry Paulson and regulators forged the agreement with lenders that will fix interest rates on some loans for five years. The deal is focused on borrowers who will fall behind once initially low rates reset to higher levels through July 2010.
"We face a difficult problem for which there is no perfect solution," Paulson said at a news conference in Washington. "The current system for working out those problem loans would not be sufficient to handle the anticipated 1.8 million owner-occupied subprime mortgage resets that will occur in 2008 and 2009."
The housing slump, now in its third year, is pushing home values down and restraining economic growth, which economists estimate will be less than 1 percent this quarter. The collapse in the market for securities backed by subprime mortgages cost the chief executive officers of Merrill Lynch & Co. and Citigroup Inc. their jobs, roiled markets from Auckland to New York and forced the Federal Reserve to cut interest rates twice.
The agreement addresses homeowners unable to afford higher interest rates once starter rates increase, and offers help in one of three ways, a White House official said. The options are freezing rates or refinancing into either a new private mortgage or a Federal Housing Administration-backed loan, he said on condition of anonymity.
The measures may help more than 1 million subprime borrowers avoid foreclosure over the next two years, the official said.
"There are a couple of problems with it,'' Frank, a Massachusetts Democrat, said at a hearing on housing today. It's a ``grave error that there's a cutoff at a 660 FICO score," he said. That penalizes those who struggled to maintain good credit profiles, he said. Frank also faulted the plan for failing to address the penalty for prepaying many subprime mortgages.
"My biggest concern is that there are a lot of Americans who are making their mortgage payments, they are current, and the benefit won't go to them," Representative Spencer Bachus of Alabama, the top Republican on the House Financial Services Committee, told reporters after a meeting with Paulson yesterday.
One challenge has been to craft a deal minimizing lawsuits from investors in bonds backed by the mortgages being rewritten, analysts said. The longer that lower rates are extended, the more risk posed to the bonds' values. Republican Representative Mike Castle of Delaware has proposed legislation offering a "safe harbor from legal liability" to mortgage servicers.
'Be Careful'
"The things that make the U.S. mortgage market the capital-market success that it is are property rights and the sanctity of contracts, so they have to be careful to not damage either one of those," said Scott Simon, head of mortgage- and asset-backed bond investing at Pacific Investment Management Co.
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Economists React: Foreclosures Pick Up Speed
December 6, 2007, 3:21 pm
The number of mortgage loans at least 30 days past due reached its highest point since 1986 during the third quarter as foreclosure starts increased across all loan types, according to a Mortgage Bankers Association survey released Thursday. Here are economists’ reactions.
Source: MBA via Lehman Brothers
Foreclosures are likely to continue to surge, particularly for subprime ARMs. According to our mortgage strategists, about 2.8 million subprime mortgages are scheduled to reset in 2008 and 2009 to a mortgage rate about 30% higher. This will ultimately lead to a jump in foreclosures as many of these borrowers cannot afford the higher payment and will have a difficult time refinancing or selling their home. Rising foreclosures add to already-bloated inventory and crowd out regular sales. Since foreclosures typically sell at about a 25-30% discount from market clearing prices, this will put downward pressure on home prices. We look for national home prices to fall at least 15% from peak to trough as the housing recession continues to weigh on the economy. – Michelle Meyers, Lehman Brothers
Not surprisingly, delinquency and foreclosures rates posted their largest rise of the current downturn in 3Q. Subprime loans are naturally much more problematic than prime loans, but prime adjustable-rate loans are showing increasing problems. Meanwhile, started foreclosures have soared, and the foreclosure rate for all mortgages is now considerably greater than at any time in the twenty-eight year history of the series. … Fixed-rate prime and subprime mortgages are performing no worse than they were in the 2001 recession, but adjustable-rate mortgages are considerably worse. – Abiel Reinhart, J.P. Morgan Chase
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Wednesday
Extreme Retirement: Retire in Your 30's!
Could retirement before you're even eligible to join AARP be the quintessential impossible dream? Not if you're consistently disciplined, focused, driven and don't give a hoot about what the Joneses think of that beat-up Chevy in the driveway, say experts.
Whether you work to live or live to work is a question increasingly answered in favor of living by couples who have opted out of the daily grind before the traditional "early" retirement age of 50-something. What's more, they're not going quietly, but instead are springing up on Web sites and in media interviews, telling their stories and encouraging others to follow suit.
Bankrate found two such couples who were eager to share their tales of extreme early retirement: Billy and Akaisha Kaderli, and Sandy Aldridge and partner Dale Lugenbehl. Though their lifestyles are vastly different, they share many traits.Set free to roam the world
The Kaderlis can count themselves as members of a small group of founders of the extreme early retirement trend among baby boomers. Now in their 17th year of retirement, the couple ditched their 9-to-5 jobs when they were 38 years old.
At 55, they say they would have made the same choice again, only investing sooner and with more confidence. The Kaderlis' initial $500,000 nest egg has grown steadily, partly because they hung in the stock market through the '90s boom and the historic bust that followed, and partly because they've lived on an average of just $24,000 a year. Initially, they put all their savings in a low-cost index fund.
Retiring at 38, they say, was an excellent age because they had accumulated life experiences through their careers: He was a former restaurant chef and owner, and at one time, the youngest branch manager at brokerage Dean Witter, while she continued to run the restaurant.
"We retired with youth, vigor and plenty of enthusiasm to venture out into traveling the globe. Retiring earlier, we would not have acquired enough skill or self knowledge about how we are able to interact with the world," the couple wrote from Thailand.
The Kaderlis sold their home when they retired, and remained homeless while they explored the world, spending time in the Caribbean island of Nevis, as well as in Venezuela, Mexico and Thailand. They recently purchased a small home in an Arizona retirement community, and now split their time between Chiang Mai, Thailand, and Mesa, Ariz., when not traveling to other countries.
Their Web site, www.retireearlylifestyle.com/, gives them the opportunity to communicate with other early retirees, as well as educate the younger generation. Their advice to 20-somethings who want to follow the same path is simple: Save everything and stay out of debt.
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