"The Mother of all Bad Ideas"

 

Without question, the Bush administration's mortgage rescue plan will exacerbate, not alleviate, the problems in the housing market. As the plan will sharply reduce the ability of new buyers to make purchases, it really amounts to a stay of execution and not a pardon.

Although there are mountains of uncertainty as to how the plan will be structured and implemented, there is no question that as lenders factor in the added risk of having their contracts re-written or of being held liable for defaulting borrowers, lending standards for new loans will become increasingly severe (higher down payments, mortgage rates, and required Fico scores, lower loan to income ratios, and perhaps the death of adjustable rate loans altogether). The result will be additional downward pressure on home prices, despite the fact that in the short term fewer homes will be sold in foreclosure than what might have been without the rescue plan.

Most homes temporarily saved from foreclosure will continue to depreciate as new buyers fail to qualify for loans. As a result, lenders will be on the hook for more losses than had the foreclosures taken place sooner. Of course, as these chickens will likely come home to roost after the next election, that's a trade-off incumbent politicians will happily make.

Compounding the problem is that subprime borrowers with frozen payments on loans that exceed the values of their homes will likely choose not to pay property taxes, condo or homeowners fees, or maintain the condition of their properties. Were these properties to be sold in foreclosure now, at least their new owners would have financial incentives to maintain the value of their investments. Upside-down subprime borrowers will have no incentive to throw money down a rat hole: why make additional payments on properties in which they have no equity and which they will likely lose to foreclosure anyway? When these homes do go into foreclosure, back taxes and other fees on dilapidated properties will inflict even greater losses on lenders.

Also, subprime borrowers with frozen resets will be unable to either borrow additional money against their homes or sell them. As rising credit card payments, higher food and energy bills, and stagnating wage growth or unemployment make even paying the frozen rates increasingly more difficult, this lack of flexibility will prove fatal. Also, the moral hazard inherent in offering help to only those who can demonstrate an inability to afford the reset rates, or restricting the bailout to borrowers with low credit scores, guarantees that borrowers will alter their circumstances to qualify for the aid. Therefore more loans will be frozen than are currently forecast, and the financial circumstances of the borrowers will be that much more impaired as they endeavor to pile on added debt or reduce their incomes to conform to the requirements of the bailout.

Lost in current discussion is the fact that few subprime borrowers have any skin in the game in the first place. Having put nothing down or having extracted equity in previous refinances, most subprime borrowers will lose nothing if their homes go into foreclosure. In some cases the teaser rates were so low that borrowers actually paid less than what they might otherwise have paid in rent. In fact, those who have already extracted equity have received huge windfalls from their homes and will leave their lenders holding the bag.

Also missing from the dialogue is the fact that those individuals and companies that sold these homes to subprime borrowers in the first place pocketed large sums of money they never would have received if these exotic loans were not available. Is anyone going to ask them to give some of that money back in order to compensate the lenders for their losses?

Finally, it's the camel's nose under the tent that is the most troubling. Delinquencies on auto loans are now at record highs, and with no home equity left to extract and a weakening economy, this problem can only get worse. What is next, a moratorium on car payments? Of course if the government can "require" private parties to rewrite contracts, what about the government's obligations to re-pay its debts? After all, the Federal government is the biggest subprime borrower of all and it has committed the American taxpayer to the mother of all adjustable rate mortgages. With the majority of our near 10 trillion dollar national debt financed with short-term paper, what happens when interest rates rise? Will the government extend the maturities of one-year treasury bills, tuning them into 10-year treasury bonds, forcing holders of government debt to accept below market returns for extended time periods? These are real risks that will not go unnoticed by a world already saturated with depreciating U.S. dollar denominated debt.

Ostensibly, this plan is being offered in an attempt to stem the tide of foreclosures that might otherwise cause further weakness in home prices. The reality of course is that current home prices are still too high, having been a function of the lax lending standards and rampant real estate speculation that got us into this mess in the first place. A return to prudence in lending also means a return to prudence in pricing. Everyone seems to agree that a return to traditional lending standards is a good idea, but no one seems willing to accept a return to rational prices as a consequence. The government's attempt to orchestrate such an outcome is doomed to failure, as it is impossible to maintain bubble prices after the bubble has burst!

The final absurdity is the Government's attempt to portray their plan as voluntary. Of course the authorities point out that if their "suggestions" are not adopted by lenders, much more draconian legislation will surely follow. Let freedom ring.

For a more in depth analysis of the tenuous position of the Americana economy and U.S. dollar denominated investments, read my new book "Crash Proof: How to Profit from the Coming Economic Collapse."

 

 

"If the dollar loses value too quickly, it could wreak havoc on the economy and financial markets - driving up interest rates and inflation and slashing Americans' purchasing power" -Peter Schiff 

 

 

"People keep talking about a Fed bailouts as if there is no cost. All the Fed can do is create new dollars. What that does is diminish the value of all the dollars everybody already has. They try to socialize the losses among all the holders of dollars" -Peter Schiff

 

 

Dec. 7 -  There is not all that much difficulty in steering a modern economy when it is faced with one main danger. If that is inflation, the need is clearly to rein back on the growth of demand. If the central bank overdoes the restraint it is not all that difficult to correct its error by loosening its policy. If its first measures prove inadequate, it can step up the dose. .......

 

"The housing bubble has burst. Prices are going to collapse and sales are going to fall through the floor." -Peter Schiff 

 

 

"With the Federal Funds Rate cut, the Fed revealed that it has no interest in defending the dollar or containing inflation. This kind of irresponsibility is all gold needs to move higher from its current levels unless the Fed somehow finds its backbone within a year or two, then gold has a good chance to take out its inflation-adjusted high of nearly $2,000 per ounce within this decade." -Peter Schiff

 

" Gold Bounces Around the Range " - USA Gold Daily
 

"It's going to soon hit $90 and go north of $100 next year. We should see $150 to $200 oil in the next two to three years because of the drop in the dollar. Once Asian countries allow their currencies to appreciate, demand will explode there.'' -Peter Schiff