If you haven’t read Monday at the Treasury: an overlong exegesis, Steve Waldman’s review of his meeting at Treasury with Tim Geithner, do so. It’s a great piece. Steve’s piece certainly showed how Tim Geithner and I agree on public policy. Seriously.
Here’s the money quote for me:
On HAMP, officials were surprisingly candid. The program has got a lot of bad press in terms of its Kafka-esque qualification process and its limited success in generating mortgage modifications under which families become able and willing to pay their debt. Officials pointed out that what may have been an agonizing process for individuals was a useful palliative for the system as a whole. Even if most HAMP applicants ultimately default, the program prevented an outbreak of foreclosures exactly when the system could have handled it least. There were murmurs among the bloggers of “extend and pretend”, but I don’t think that’s quite right. This was extend-and-don’t-even-bother-to-pretend. The program was successful in the sense that it kept the patient alive until it had begun to heal. And the patient of this metaphor was not a struggling homeowner, but the financial system, a.k.a. the banks. Policymakers openly judged HAMP to be a qualified success because it helped banks muddle through what might have been a fatal shock. I believe these policymakers conflate, in full sincerity, incumbent financial institutions with “the system”, “the economy”, and “ordinary Americans”. Treasury officials are not cruel people. I’m sure they would have preferred if the program had worked out better for homeowners as well. But they have larger concerns, and from their perspective, HAMP has helped to address those.
If I understand Steve correctly, he’s saying the government’s mortgage loan modification efforts are not designed to help borrowers per se. They are designed to help extend the life of banks’ existing loan books so they can pretend these loans are more valuable than they will eventually prove to be. Extend and pretend helps banks, not borrowers.
I am glad that Treasury was candid because they were saying to Steve what I have been saying to you all along. Just two weeks ago, I wrote Hiding Bank Losses to tell you this charade is still ongoing. Propping up underwater mortgages is a bad idea that only helps the incumbent institutions, by the way.
Here are a few examples from late last year as a reminder of how banks are playing this game.
- Extend and pretend and the growing divide between delinquencies and foreclosures, Oct 2009
The Annaly data and graph above suggest that lenders are actually modifying a decent number of mortgages that fall delinquent – so much so that foreclosure statistics understate the overall distress in the housing market. So, this is a little bit of damned if you do, damned if you don’t as far as banks are concerned. On the one hand, they are getting pilloried for not modifying loans. Yet, on the other hand, in modifying loans they can be accused of “delay and pray” tactics in order to avoid writedowns. Both accusations seem fair given the enormous increase in foreclosures. Nevertheless, you can understand the dilemma.
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Short Sales in North County: “Feeding Frenzy” as banks pretend and extend, Oct 2009
The guy in the house has been on the foreclosure roles for a long time. Apparently, he ran up loans 15% over the original amount, which suggests he may have been using the house price as an ATM when prices were going up. But now he is making partial payments to avoid being foreclosed. The interesting thing is that by making a partial payment, the owner can get off the foreclosure roles and stay in his home.. until he misses another payment, which in this case has happened several times.
This is called “extend and pretend” otherwise known as “delay and pray.” Banks love this because they don’t have to write down the value of the loan immediately and the owner is looking for an exit strategy that doesn’t put him out on the street. It’s all good, right?
- More evidence of extend and pretend, Dec 2009
Internet maven and San Diego North County real estate guru “Jim the Realtor” has another post showing us that extend and pretend is alive and well in the wonderful world of housing.
The HAMP programs fit into this by giving banks a government vehicle to extend the life of loans. But we have known for months that these were just delaying tactics. These loans eventually go bad at fantastic rates. See Stat of the Day: Home loan delinquencies going bad faster than fixes from March. The hope is that banks will earn enough from the steep yield curve to steel themselves against this and ease in to their losses rather than taking them all at once and precipitating a panic and liquidity crisis. Two impediments I see:
- Strategic defaults: if borrowers get wise to the fact that they are throwing good money after bad and that they will eventually default anyway, they could opt to strategically default. See Strategic default: In come the waves again.
- Second mortgages: the big four commercial banks have shed loads of second mortgage and home equity liens on houses. The recovery rate for these is abysmal. If default rates pick up, that’s going to be a problem. See The coming wave of second mortgage writedowns and The fake stress tests and the coming wave of second mortgage writedowns.
On the whole, I think the government programs – the stress tests, the HAMP program, all of that – has been designed to extend and pretend in the hopes of a multiyear recovery.
From what Steve says, Secretary Geithner and his crew are a savvy bunch with their eyes wide shut. They are fully aware of the pitfalls here and are working to overcome them within the current system. That necessarily means turning a blind eye to some of the more dire downside scenarios like a double dip.
I would go as far as to say that Tim Geithner and I have the same view of the situation. Take the stress tests, for example. In March, I said:
"The only difference between what Geithner says and what I have been saying has to do with the hidden losses [obscured by the stress tests and regulatory forbearance] and their likely impact."
The key is that Geithner believes both that we have had a liquidity crisis and that it was necessary to do "deeply unpopular, deeply hard to understand" things to re-capitalize banks in order to save the system. I don’t believe either of those things.
Does that mean the banking system will collapse? No, especially if we can avoid a double dip. Banks have earned and raised a lot of money since the crisis began. If they get another year or two to earn even more in a multiyear recovery, most are going to be home free.
Some will show weakness again, however, as we saw in Japan in the 1990s. If we double dip, the solvency problems will re-appear en masse.
In either scenario, what I object to is the concept that saving incumbent institutions is equivalent to saving the system. The incumbent banks are not the system. This reveals a deeply ingrained ideological bias toward the status quo, manifested in our laissez-faire culture in what I have termed de-regulation as crony capitalism.
I see ideology as very dangerous. It produces cookie cutter responses to complicated economic questions that can have catastrophic results. For example: does a lax regulatory environment lead to freer markets? For the past generation the answer to this question has been yes. But I see deregulation as practiced more of what I call ‘corporatism’ i.e. the favouritism of incumbent well-connected large organizations at the expense of individuals and smaller enterprises. As an aside, note that Ron Paul sees the Obama Administration as another corporatist administration favouring incumbents. Also see Obama should be pro-market, not pro-business by Jim Pethoukoukis.
Those of you who are buying the big business propaganda about Obama calling him a socialist fail to understand that large corporations want a free hand to continue run roughshod over individuals and small business. Rhetorically, this is a good approach by corporations because people buy into this.
–On ideology and economics and the apathy of the American public
I made many of the same points last year in my post on Obama and the Fat Cat bankers.
Why the charade? Why the deeply unpopular, deeply hard to understand policies?
Let me use my favourite Tim Geithner equals Jack Nicholson clip to demonstrate:
I want the truth!
You can’t handle the truth!
I have a greater responsibility than you can possibly fathom. You weep for the homeowner, you curse the U.S. Government. You have that luxury. You have the luxury of not knowing what I know – that the homeowner’s demise, while tragic, probably saved lives. And, my existence, while grotesque and incomprehensible to you, saves lives.
I have neither the time nor the inclination to explain myself to a man who rises and sleeps under the blanket of the very freedom that I provide and then questions the manner in which I provide it.
Did you order the Code Red on homeowners?
You’re goddamn right I did.
Government diktat (including the zero interest rate policy) has effectively been a looting of savers and the American public to bail out a few large incumbent corporations. The ends do not justify the means and never will.