Thursday, February 19, 2009

Cutting through the clutter: Will the housing bailout work?

BTW - I'm on twitter now at Grindstone_Fin - I'm not sure I'm ever going to understand their business model of what the appeal of twitter is, but it seems to be what all the kids are doing....

Onto the news of the day....

I'll start with the premise that home prices are still too high to support. It's like putting a bowling ball on your kid's toothpick bridge - it might hold for awhile, but eventually the laws of physics will win out.

If you look at regions of the US where the housing market is showing some signs of life, it includes Florida and California where prices have plummeted 50% and foreclosures are up. People will step up and buy houses when the prices are right. Unfortunately, in most parts of the country (including most of NNY) prices remain inflated and the market can not find balance with artificial price supports.

Who will the new $75 billion plan help?

1) If your mortgage debt is 80%-105% of your home's value you may be eligible to refinance. A refinance could help cut your payment 5-10%.

My observations -
a) If you have no home equity or up to 5% negative equity you really can't afford your home. No money down mortgages were part of the problem that created the housing bubble. If you're home is only worth the debt owed - you and the bank should suffer the consequences.

b) Who is going to make the determination of loan to value? I think most home debtors think their home is still worth X while the bank might think the home is worth 50% of X. This is the great debate that will determine how many people will participate within this program.

2) The bill creates incentives for lenders to modify the terms of subprime and other loans. Participating lenders will reduce payments to no more than 38% of borrower's income, with the government matching further reductions down to 31%.

I think I've addressed this before - If you can't afford 38% of your pre-tax income going to service your debt, changing that threshold to 31% is not likely to make a material difference. After-tax, the bulk of your income is still going to be servicing debt (plus your real estate taxes are climbing).

Again, this plan seems designed to hold up prices that were never real to begin with. Consider for example, the price of an F1 Ferrari Coupe - MSRP $312k. Well, if you have to pay 20-40% down and finance the balance over 5 years, that limits the market and keeps prices in a natural balance. However, if Countrywide Ferrari Finance suddenly says they will finance up to 120% of the value with an interest only loan over 15 years and balloon payment at the end, guess what happens?

DEMAND SOARS and people that used to buy Hyundai's are lining up to buy Ferrari's. The going price jumps from $312k to $1.1 million because of demand and cheap financing. If the market changes and the price suddenly falls to $850k should we intervene to prevent millions of Americans from losing their Ferrari's? Of course not. They made a flawed financial decision based on poor judgement and loose lending terms.

Now insert a 4 bdrm ranch in Phoenix for Ferrari's in the paragraph above. Hopefully, it's clear why this bailout can't work. The Ferrari is still only worth $312k - propping it up at $850k is only delaying the inevitable.


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