Federal Reserve Chairman Bernanke presented a harsh message in his speech Tuesday before the Independent Bankers of America (Orlando). Prodding both mortgage investors and the government, Bernanke came just short of demanding that they trade principal write downs for government guarantees. Bernanke’s real audience was the Congress, the White House, large commercial and investment banks, mortgage servicers, and structured product investors.
The message: “For the lender or servicer, working out a loan makes economic sense if the net present value (NPV) of the payments under a loss-mitigation strategy exceeds the NPV of payments that would be received in foreclosure.” Put the “do the math” message together with Bernanke’s pushing for Fannie (FNM), Freddie (FRE), and FHA to guarantee refinancing; and his message cannot be any clearer.
Adding to his argument for principal write downs, Bernanke reiterates the obvious: A homeowner with negative equity has “less financial incentive to try to remain in the home.” Bernanke acknowledged that structured product investors have conflicting interests, and that servicers are restricted by the trusts. Lenders have been reluctant to write down principal because that could lead to additional principal write downs if home prices continue to fall.
Bernanke counters with two points. A principal write down could lead to the borrower refinancing, relieving the original lender of the bad investment. (Bernanke acknowledges that second lien holders would have to re-subordinate to the new mortgage.) Bernanke then cites a proposal by the Office of Thrift Supervision that would allow original lenders to participate in future appreciation.
When Bernanke concludes with “Ultimately, though, real relief for the mortgage market requires stabilization, and then recovery, in the nation's housing sector”; he loses my support. This conclusion says Bernanke’s ultimate goal is to restart housing appreciation. Bob Toll, Toll Brothers’ (TOL) CEO, first said this during his most recent conference call. Just as the NASDAQ never fully recovered, neither will house prices. Bernanke should be saying “go through the wrenching adjustment, and then the housing market will provide the necessary liquidity.”
Bernanke also needs to acknowledge that the cost of operating a house has increased substantially in recent years, leaving less money available for mortgage payments. Consider food, energy, insurance and real estate taxes. This leaves far less money available for the house itself. Housing prices cannot increase unless incomes increase or operating costs go down.
Disclosures: Author is long FNM and FRE.
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The message: “For the lender or servicer, working out a loan makes economic sense if the net present value (NPV) of the payments under a loss-mitigation strategy exceeds the NPV of payments that would be received in foreclosure.” Put the “do the math” message together with Bernanke’s pushing for Fannie (FNM), Freddie (FRE), and FHA to guarantee refinancing; and his message cannot be any clearer.
Adding to his argument for principal write downs, Bernanke reiterates the obvious: A homeowner with negative equity has “less financial incentive to try to remain in the home.” Bernanke acknowledged that structured product investors have conflicting interests, and that servicers are restricted by the trusts. Lenders have been reluctant to write down principal because that could lead to additional principal write downs if home prices continue to fall.
Bernanke counters with two points. A principal write down could lead to the borrower refinancing, relieving the original lender of the bad investment. (Bernanke acknowledges that second lien holders would have to re-subordinate to the new mortgage.) Bernanke then cites a proposal by the Office of Thrift Supervision that would allow original lenders to participate in future appreciation.
When Bernanke concludes with “Ultimately, though, real relief for the mortgage market requires stabilization, and then recovery, in the nation's housing sector”; he loses my support. This conclusion says Bernanke’s ultimate goal is to restart housing appreciation. Bob Toll, Toll Brothers’ (TOL) CEO, first said this during his most recent conference call. Just as the NASDAQ never fully recovered, neither will house prices. Bernanke should be saying “go through the wrenching adjustment, and then the housing market will provide the necessary liquidity.”
Bernanke also needs to acknowledge that the cost of operating a house has increased substantially in recent years, leaving less money available for mortgage payments. Consider food, energy, insurance and real estate taxes. This leaves far less money available for the house itself. Housing prices cannot increase unless incomes increase or operating costs go down.
Disclosures: Author is long FNM and FRE.
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