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The Fed's Plan - Rumors of News
Go back a week to an article in the NY Times (Link). The guts of this story is that the Administration is working on a plan to Re-Fi residential mortgages on a massive scale.
When I first read this, I ignored it. The scope of the proposal was too large. There was also (IMHO) a fatal flaw. The thinking was that the jumbo ReFi would be made available to only those who had a mortgage that ended up with either Fannie or Freddie. I ask the question, "What about those poor odds and sods who have a mortgage with a community bank?” Do they get nothing while those who owe F/F big bucks get a break? Where is the fairness in that result?
But every day since the NYT story, I have heard the rumblings about some deal being done. It has already impacted MBS spreads. It's back in the news today with an article in the WSJ. (Link) I have to believe that where there is smoke, there is probably some fire.
I went back to the NYT piece. There are some clues. First is that Louise Story wrote the article. She is a fine reporter. Anything that she says has been supported by “real” sources. "Who were these sources?" is a question to ask. Some words from the piece:
Administration officials said on Wednesday that they were weighing a range of proposals.
Read this to mean that people in the Administration deliberately planted this story. This was a “trail balloon” approach. This is very typical for this administration. They leak their intentions in advance. More from the NYT:
But refinancing could have far greater breadth, saving homeowners, by one estimate, $85 billion a year.
The following chart was included in the NYTs article.
The information in the chart and the very precise estimate of “85 billion a year” can only have come from one source. It has to be the FHFA that is doing the talking to the NYT. It had to come from the most senior level. That HAS to mean that it came from the Acting Director, Edward DeMarco.
The NYT functionally confirmed the source of the article as DeMarco with this written quote from him:
“F.H.F.A. remains open to all ideas that provide needed assistance to borrowers” while minimizing the cost to taxpayers, Mr. DeMarco said in a written statement.
Now consider some of the wording in the WSJ article today. Note: This article was written, in part, by Jon Hilsenrath. Jon is well known to be a mouthpiece for the Fed. He gets his thinking directly from Bernanke. Some quotes:
There are several reasons why refinancing has been weak, say Fed officials.
Some Fed officials say that it would be in Fannie and Freddie's financial interest to allow borrowers who are current on their mortgages to refinance at lower rates because it would increase the likelihood that they won't default.
Officials at the Federal Reserve are frustrated that they've pushed interest rates to the lowest levels in decades and yet many borrowers haven't been able to take advantage.
You can take these quotes to the bank. They are from Bernanke. It is Bernanke that is frustrated that his low interest rate policy has not resulted in more ReFi’s. You can also take as a fact that Bernanke wants something done on mortgage relief.
One other fact in the picture. The new IMF head, Christine Lagarde, spoke on the phone to Obama before her speech at Jackson Hole. She must have told the Big O that a program to clear up America’s mortgage mess was her top priority. She made that very clear in her speech the following day.
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Okay. Put these pieces together. What do you have? Assume for the sake of discussion that the President does announce a major new initiative to ReFi F/F mortgages. Assume further that the cost of the millions of ReFi’s would come from existing sources (the $35b of already issued and funded Hope Now Bonds), or better yet, the costs would be crammed down the neck of the banks who are servicing the loans (necessary to get DeMarco to go along). Say, for the sake of discussion, that the targeted mortgages are those who have not yet defaulted, but are desperately in need of a break. That amount would come to about $1.4 Trillion. This is a very big amount. Assume finally that the new mortgage rate would be about 4%. This (if accomplished) would be a very big shot in the arm for the economy as a whole.
Now do a flow of funds for this mega transaction.
I) Homeowners get a new loan at 4% and payoff 100% of the old mortgage.
II) The servicing banks get the proceeds and pay off the old loan.
III) The money is paid to F/F. This money is used to redeem existing mortgage pools of Agency MBS.
IV) Fannie/Freddie have the same asset mix at the end of the day. They still need to finance the new 4% mortgages they are writing.
V) Fannie and Freddie are taking on substantial new risk as they now have a book of 4% mortgages and are much more at risk to rising interest rates.
VI) It takes 90 days for a new mortgage to become a new Agency MBS. During this period F/F warehouse these loans. They finance the warehouse with short-term debt. They take action to reduce their risk by entering into new swap transactions or by buying derivatives to neutralize the market risk.
VII) As the process goes on huge chunks of EXISTING higher coupon MBS are prepaid. Investors in those MBS securities will be forced to re-invest the proceeds.
So who is going to be the biggest recipient of the cash pre-pays? That’s easy to answer. It’s the Federal Reserve. They currently own 1.0 Trillion of Agency MBS. A very substantial portion of the total prepayments of F/F MBS will be paid to the Fed. The Fed’s balance sheet will shrink very rapidly as a result.
The Fed has already established what will happen when principal is prepaid on their holdings of MBS. The have said they will reinvest any proceeds back into new purchases of US Treasury securities. As this chart of the Fed’s holdings show, this has already happened to the tune of $250 billion. The new proposal for the mega ReFi will dramatically reduce the MBS holdings. It will force the Fed back into the market to purchase big amounts of Treasury bonds. This process will take at least a year. But the total amounts could easily exceed $600 billion (QE2 size).
There is a flaw in this logic. On a macro basis, total mortgages loans remain the same. This is only a re-pricing. Not a reduction of total debt. The reality is that the Fed will be buying more treasury bonds, but F/F will have to be selling new bonds to protect themselves against interest rate risk. What will be happening is that the Fed is buying to reduce interest rates while at the same time F/F will be buying protection in the form of swaps, options and new term funding. So the real consequence to the credit markets will be a wash.
There is one solution to this dilemma that achieves the desired outcome. The Fed could easily enter into the swaps/options with F/F to eliminate their basis risk. Think of this as a different version of “Operation Twist”. The Fed wants to reduce long-term interest rates. It does not matter to them if they do it with direct purchase of bonds or if they absorb future interest rate risk by writing derivatives that would neutralize the market impact.
The Fed can’t write $1 trillion of interest rate swaps to the street in order to achieve this objective. There would be far too much counter-party risk for the Fed to do this. But they have no counter party risk with F/F. At the end of the day F/F is the government, so the Fed can say they have no counter-party concerns. The bulk of this would be financed by F/F in short-term markets. The swaps and options with the Fed would alleviate the market risk they would face from the ReFi’s.
Who would be AGAINST this plan? No one that I can think of. DeMarco would be able to say that the plan protects the taxpayers from future losses. Obama would say that he has created a new stimulus of $85 billion a year. Bernanke would love this plan. He would be “Forced” into buying a new big amount of Treasuries. He would have his excuse for QE3 handed to him. That the Fed would be forced to absorb new risk of loss to rising interest rates is of no concern to the Fed. They are in so deep today, another $1 trillion of notional risk would not change the picture. Keep in mind that the Fed is very anxious to pull the next trigger.
Who would be the sources of SUPPORT for a plan like this? Everyone but some Republicans is the answer. DeMarco (FHFA) would get what he wants. Obama would get what he wants (10,000,000 homeowners would love him). The economy WOULD benefit from this as consumers would have new cash in their pockets. Bernanke would get everything he wants (a new QE), and would have the political cover for his efforts.
The only voice of dissent will come from Republicans in the House. But it is very likely that this could all happen without a vote. From the NYT piece:
The idea is appealing because it would not necessarily require Congressional action.
There are too many pieces of this pie to ignore. This is a solution to problems that are both political and economic. I see no significant opposition. Republicans will scream “foul”, but who cares. This can happen over their objections.
I'm looking for something along these lines to be announced soon. It will come in the President’s upcoming speech. None other than Ben Bernanke will be the biggest supporter. That makes it a very feasible outcome.
Will this work? I’m not convinced. I think this is the ultimate "kick the can down the road". But that is the only strategy that is in place today. Delay the inevitable; win the next election. That is the only thing that matters in D.C.
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Rumors, rumors and more rumors
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Do a Quiet Title and you could own your home without needing to make another payment. If the paperwork is 'broken' you can file ownership of your home and be done with payments. You DO NOT need a lawyer as your town/city clerk can help you.
A few key questions to ask your lawyer: Who holds my mortgage, exactly? Is my house recorded under the MERS system? Can my house be foreclosed or is the documentation fouled up?
Another key question to ask: if the bank forecloses and sells my house for less than I owe, am I liable for the difference under my existing loan? under new loan?
Excellent point. Talk with a lawyer before refinancing your house.
No need for lawyer, common sense applies. DO NOT SIGN ANYTHING until you file for a Quiet Title and if the bank comes screaming, DEMAND to see the wet document and ALL title transfers, being sure they adhere to the law in your State.
My wet document has MERS listed originally, and the state AG does not care, so there is no title transfer issue as far as they are concerned. I also live in a non-judicial state, so it's even less of a concern.
As George Carlin famously said, "They've got a club and you ain't in it!"
Common sense applies to your mortgage contract and the legal process? WTF? Have you been paying attention? None of it makes the slightest bit of sense. Even the professional people at MERS have fucked it up royally.
You NEED a lawyer (an aggressive one with experience specifically in foreclosures and quiet title) unless
(i) your house is has a modest value (say, less than $35,000) in which case the fees might outweigh your gain, or
(ii) you consider yourself an expert in property law, the real estate contracting process, and the litigation legal process, and even then, maybe.
Quiet title is not a bad idea, if it makes sense in your state.
If you can own your home outright, or stay in your home with substantially smaller payments when it otherwise would have been foreclosed, legal fees are a small price to pay.
Why would someone who has been living mortgage free (not paying their mortgage) sign up for this? By the time a new loan is made, with all the associated fees, the new loan balance will be higher than the old loan balance (in all likelihood). Plus, reducing a payment a few hundred bucks a month is not likely to help someone who is unemployed. Does anyone get a haircut in this deal? I'm not disputing the analysis...just asking.
Would only apply to those who are not currently in default.
What a donkey show... So in a "secret backdoor" way the rest of us are getting secretly backdoored... and everyone is paying for the dumbshits that bought houses that were too expesive for them... And 99% of Americans will have no idea... BRILLIANT! Should be a Guiness commercial...
Let me see if I get this right.
There is about ~$1T of MBS/Agency on the Fed balance sheet. (I could be off, been a while since I checked).
As these get repaid/replaced, the Fed shifts its balance sheet mix towards Treasuries, perhaps keeping the total size of the Fed's balance sheet constant.
F/F actually ADD $1T to their balance sheet as they become the holders of the new, refinance-driven securities.
F/F's revenue actually grows (due to larger collection of assets) even as their interest rate (gross) margin declines (these securities have lower interest rates)
F/F and the Fed enter into an interest rate swap or some other derivative, which can be cleverly buried in either balance sheet to suit any purpose.
It is back door QE because the Fed/government balance sheet is growing (just not the Fed's).
Great way around the debt ceiling too! Come to think of it -- this is literal 3 card monte writ large!
Do I understand this correctly Bruce?
Understand that I am speculating on what is coming. I did that yesterday with Solyndra. That worked out pretty well.
http://www.bloomberg.com/news/2011-08-31/solyndra-to-file-for-bankruptcy...
On your points, I think you have just one thing wrong. The Fed would not buy the new MBS, they would buy Treasury bonds.
Wait, so F/F continues to hold these on the books because the Fed offers to backstop the interest rate risk with a long-term swap that looks like Operation Twist 2?
That's what I meant re: Fed purchases -- MBS/Agencies matured, and they are replaced by Treasuries.
But F/F balance sheet does grow significantly under this scenario, right? (And somebody, somewhere has to buy agency debt to support the increase in F/F's balance sheets.)
That's where politicians would squawk loudest I think.
I only half-see what you're saying. I like the idea of re-fi, .. details, I'm far away from, but the jist is F/F is left with better quality, longer term debt, which they re-fi inhouse? and what, there's a transfer to the Fed? That transfer is already mandated for Treasury take-up. It's nice, the boat has become a bit slicker, but it hasn't really changed course. It's easier to tack though.
The presumption that longer term monetary stability is well-impacted is sensitive to deflationary forces: anywhere the FED suggests pulling Stimulus is deflation-isitic. However, perhaps monetary stability isn't the goal at this particular moment. That's the trick in announcing UST purchases...I'd go one step further in F/F re-fi, subordinate the new loans on a state basis.
It's the Federal Budget that sticks out here, and that's exacerbated by the strange euro paradyne - on the one hand, domestic price levels require heavy deflation, which requires a strong dollar, which requires the FED sit back from serious intervention; perhaps they should simply revoke Primary Dealer status till Basel III comes into effect and take up the slack themselves? Once Domestic costs start to move narrower, there should be a strong influx of Investment. At that point the States become fiscally-righted. On the other hand, the Federal Government spends such a substantial sum, it is very awkward to re-distribute the spending: the ideal system would be to shift the organization of those finances from trickle-down, to 'intermediate'. Thankfully, the US is fairly underdeveloped in parts; if they wanted to do this they'd just need to contact ARPA, the DOD and the local Community colleges. Nudge the boat a different direction as well as make it more nimble.
But Wall St.. the efficient use of capital.. what if they sell what's left of their interest in mortgages for Transfer out of their long-term deriviatives positions...politically feasible?
"Not a reduction of total debt"
The process of refi is not free, the costs are rolled into the new loan so the total debt will increase. Especially if points will be required to differentiate the risk.
Then there is the whole issue of mark to market and loan to value.
Plus, the whole need for this is because those who cannot currently refi should really be identified as "subprime" because of their sub par FICA score and overall C+ credit rating.
They may be current and able to pay their mortgage, but they are less than credit worthy having done more than fail to send in a utility payment on time. A score below 650 indicates a troubled credit history.
Fanny and Freddy are themselves already bankrupt.
So a borrower at 6.5% with a FICA of 650 and a $150k mortgage appraised at $120k with $20k of equity is going to payoff the existing loan and create a new loan at 4%? 4% of what? $150k? $130k? 120k? Presumably a new 30 year fixed that rolls in all the fees of refi, presumably at a base cost of 2 points or $3k, etc.
The same scamsters who pushed those who cannot read the fine print back in the original subprime days are lining up on the sidelines for this one to go through.
For this proposal then is to re-establish the very thing that got us into trouble in the first place, sub prime MBS, and should be dead on arrival.
Spot on! Every "No Loss" to the Borrower, or Lender turns out to be a loss to the Taxpayer!
Its FICO, with an O, like in Obama
For those not in currently in default (but underwater) the old principal would be rolled over at 4%. There will be no cost to the borrower. That will be paid by Uncle Sam. It costs ~$3000 to close a loan. Say there are 10mm mortgages that qualify. That comes to $30b. Obama has that in his pocket with the $35b of funded Hope Bonds.
It is possible that this is a simple as getting a letter in the mail that says:
"You have a new 30 year at 4%. Your new monthly is X dollars less! Just sign here and then go shopping!!"
bk
Wouldn't they require an appraisal before sending that letter?
How does a second mortgage fit into this? I'm one of those slightly underwater homeowners with a 5 3/8% 30 yr fixed taken in '05 plus the not so nice variable second taken in '07 (80k balance with 1% due each month as payment or approx $800/mo). I'm current on payments and have an 800+ credit score and would benefit by $400 +/- on a program like this (moral views about the plan aside).
Think of it from F/Fs perspective. They are not trying to make a buck, They are trying to avoid a loss.
Who is more likely to default? A couple with a 200k mortgage at 6%? Or a couple with a $200,000 mortgage at 4%?
That's easy. The 6% defaults more. So by doing this F/F have improved their overall risk profile.
Seconds are toast in this deal.
Are the banks going to perform the appraisals on the underwater props? And, what is fair market value in a manipulated interest rate environment anyway? Its called "financial management" peeps.
it would be nice to see some data on what that current average rate is for those who would then qualify for the Obamarate™
Which instrument at the end of the day reflects the increased interest rate risk at the Fed with this plan? Bucky. The dollar would get crushed. Gold, Oil, and commodities love the plan. Grandma on social security gets squeezed even harder.
<nt>
Great post. My initial take: if this plan comes to fruition, and you are invested in mreits, sell now. Correct my thinking, but, how can mreits continue to offer their big leveraged yields when the long tail (which generates their profits) is squashed by this plan?
Also, there is no free lunch. What does this do to home prices? Inflation? The dollar? So many goddamned moving parts, it is impossible for investors to make rational decisions in this fucking rigged and gamed market.
it reduces the supply of fresh meat for the foreclosure market
but the overhang and shadow inv is so big along with those undewater any direct upside will be a couple of years from when/if and to what extent the program is implemented IMO
Well thought out and very plausible, Bruce.
"Investors in those MBS securities will be forced to re-invest the proceeds."
I would call this a sticking point. Can the gov force people to reinvest their money in MBS? I see long court battles holding this up for years.
The world is yield hungry. Yes, there will be demand. These are, after all, Government backed bonds that pay 75BP more.
No they can't force anyone. I think what he meant was: as a portfolio manager you HAVE to reinvest in something--there's NO SUCH THING AS CASH at that level.
But, if you have the option, do you buy 4% or lower MBS securities when you can buy other things?
And, how does this effect the banks - the FED now flattens the yield curve even further making the bank loan portfolio even lower margin going forward and banks are supposed to make money how? Raising more fees? CHARGING you to deposit/safekeep your money? Frank-Dodd made them divest much or their profitable trading business - do banks become utilities? Does financial engineering die?
Isn't this also positive for the $US over the longer run if it works? No more printing needed with the MBS refi money for the FED, but Europe is still sitting on a massive problem. Do the the currency guys who are betting on FED action that devalues the $US further change their mind and consider the EURO$ a greater risk? Does Europe/ECB come to the realization that the carry trade is killing their exports and rasing commodity costs cut short rates? Does it matter in the mdst of their liquidity crisis?
What about the dumb bastards like me who have a jumbo that isn't held by F/F and will continue to get no relief? Maybe I sould stop paying...,I guess I'll wait for the telemprompter to speak and see what the deal is.
"No more printing needed with the MBS refi money for the FED"
Isn't buying Treasuries with proceeds from the Fe'ral Reserve's MBS holdings effectively printing? Or was the first go round (when the MBSes were bought) printing, and this is just shuffling things around? Or is it a bit of both? (Genuine questions: this stuff makes my head hurt even when it's explained as well & as simply as BK somehow manages.)
All good questions.
On the matter of the dumb bastards with jumbos, well they're fucked. Sorry.
bk
dup...
Does this plan also reduce liability for fraudulently documented mortgages?
I'm sure it will. If you got this offer you would sign a loan loan document. In that document would be a waiver for any past sins or irregularities in the deed.
Excellent point....but, when you go to eventually re-sell the home to another person, would the title be insurable? You might be willing to waive it, but wouldn't the person buying it from you (perhaps years down the road) want to know that the actual note holder had been paid and that he was getting a clear, unencumbered title?
Thanks for your great work, by the way.
Which makes me wonder if one might be better off refusing it, and see what happens afterwards.
The "plan" is clear.
The predators-that-be intend to cause so much inflation so quickly, that even as home prices continue to fall in real value (measured against gold or silver), their prices will start rising in so-called "nominal terms" (fiat dollars). The population of royally bummed-out, pissed-off and STUPID home owners will then look hopefully upon the predators continuing this insane destructive smoke-and-mirrors plan, and less hopefully for honest solutions ala RonPaul.
This is all about the 2012 election. The time has come to feed the banksters again while pretending they are feeding "the people". The vast majority of the population will not notice their homes are still losing value in real terms, or that their salaries are falling like a rock in real terms.
The "two day" meeting of the fed next month will unleash a torrent of new cash upon the market, and kick inflation upward dramatically at exactly the moment it is already starting to surge anyway.
Look out above.
"The population of royally bummed-out, pissed-off and STUPID home owners will then look hopefully upon the predators continuing this insane destructive smoke-and-mirrors plan..."
...provided that these folks do not have to buy food, clothing, or gasoline....
I think you hit the nail on the head with this one Bruce. Your theory ties in nicely with an article I read a while back. Here's the link and a quick quote...
http://www.financeandeconomics.org/Articles%20archive/2011.08.17%20Bank%20Credit%20Repo.htm
"We cannot be certain the Fed will use the repo market in this way, but the problems with a new round of quantitative easing, the studies of the repo market admitted in FOMC minutes, and the recent entry of Fannie Mae and Freddie Mac to the Reverse Repo Counterparty List are strong evidence they will."
I find the scenario Bruce Krasting describes here very convincing as one part of the strategy the Federal Reserve will initiate in its next FOMC meeting.
The only problem with the logic is that a lot of what the Fed owns is Fannie 4% MBS. These are not the loans likely to be refinanced since the underlying mortgages already have a 4% handle. Instead the prepays will go to other investors, who will lose interest margin if they end up reinvesting in new lower rate MBS.
Not correct. The list of Fed holdings is posted.
Great stuff.
bruce nails it again. you rock, dude.
But WHERE THE FUCK IS MY CHECK?!!! I paid cash for my home and it's down almost 50%. Ooops, I forgot, if you pay your taxes and stay out of debt and save for the future, they pay you .2% on a CD and you get to watch others bailed out of their poor decisions. Don't send me a check, I'll take gold coins instead. (That's why they won't send me the check-they know where it will go)
Wow, I can't even imagine paying cash for a house, when you can pay it off over time with worthless BennieBux. My condolences.
Why don't you take a note out on it now, and use the money to buy PMs? It's the only way your ever going to come out ahead on the deal.
Wait, are you rich? You don't need fu cking help, you need to pay more taxes.
Those of us that did the right thing can now stop feeling like we have been sh*t on, to check off the " sacrifice for all America " box, and prepare for the next snafu !