Mortgage Banking
January 2009
Federal regulators have been aggressive, persistent and determined to contain the financial crisis that erupted into a global liquidity freeze in September. A key goal is to bring about recovery in the housing sector to stop the bleeding at financial institutions and mitigate the economic fallout.
By Robert Stowe England
Last September, federal regulators faced their greatest challenge yet in finding solutions to the intensifying global financial crisis that began almost two years ago and virtually overnight ignited a financial panic.
Over the weekend of Sept. 13-14, regulators worked feverishly to rescue Wall Street giants Merrill Lynch & Co. and Lehman Brothers, both based in New York, to avoid Monday morning financial market fallout. They also searched for a way to rescue the world's largest insurance company, New York-based American International Group Inc. (AIG), which grappled with a severe cash crunch that was pushing it toward imminent bankruptcy.
When the dust had settled Sunday night, federal regulators had arranged for Bank of America, Charlotte, North Carolina, to acquire Merrill Lynch, and the Federal Reserve was prepared to take control of AIG in return for an $85 billion loan, saving the firm from bankruptcy.
For Lehman Brothers, however, there was neither a buyer nor a federal rescue, and the venerable firm declared bankruptcy on Monday, Sept. 15 on $613 billion in debt. It was the largest bankruptcy in U.S. history, and the end of the line for a firm that was created before the Civil War and had survived the Great Depression. While its brokerage business and its headquarters were sold off to London-based Barclays Bank plc, Lehman's failure both sharply accelerated and greatly deepened the liquidity and credit crisis that had taken hold of global financial markets.
Only a week earlier, the newly created Federal Housing Finance Agency (FHFA) had placed Fannie Mae and Freddie Mac into conservatorship, while the Treasury Department pledged to keep the two government-sponsored enterprises (GSEs) solvent and provide loans as needed, and make modest purchases of mortgage-backed securities (MBS). That effort was done, according to Treasury Secretary Henry Paulson, to ensure there was sufficient credit to finance home purchases and, thus, to help the housing market find a bottom.
Both Paulson and Federal Reserve Chairman Ben Bernanke have said a turnaround in the housing sector that brings an end to falling house prices is the key prerequisite to restoring the financial sector and bringing about a rebound in the economy. The drop in mortgage rates that came on the news of the government takeover of the GSEs the week before was quickly reversed with Lehman Brothers' collapse.
A turnaround in housing is dependent, at a minimum, on the availability and pricing of mortgages, according to Lyle Gramley, former Fed governor and senior economic adviser at the Stanford Group, Washington, D.C. "Lower mortgage rates would help a great deal. But until we get financial markets convinced that the economy is on the mend and we begin to see risk aversion melt way, it will be hard to generate a strong increase in housing activity," he maintains.
Few tears were shed over the demise of Lehman when it fell. There was a strong sense in some circles that it was a victim of its own risk-taking. The Wall Street firm was brought down by its "huge holdings of illiq- uid mortgage-related assets accumulated mainly through greed and efforts to achieve high fees on ever-more [complicated] structured finance, all of which was financed by excessive leverage and short-term borrowings," says David Jones, chairman of Investor Security Trust Co., Fort Myers, Florida, and president and chief executive officer of DNJ Advisors LLC, Denver.
Yet, the fall of Lehman Brothers brought with it devastating consequences. "Your real moment of truth for financial markets was the Sept. 15 bankruptcy of Lehman Brothers," says Jones. "Clearly it was a huge mistake" to let Lehman fail, he maintains.
Alex J. Pollock, resident scholar at the American Enterprise Institute (AEI), Washington, D.C, and the former chief executive officer at the Federal Home Loan Bank of Chicago, agrees. "They tried to stop [the bailouts] with Lehman Brothers. I think everyone now agrees, and history will agree, that was a major mistake," Pollock says. "They said, 'We're going to draw the line at Lehman Brothers.' When they did, they inadvertently created a run on money market funds. They had to bail out the money market funds and everyone else," he adds.
Federal officials paint a different picture. The failure to rescue Lehman was unavoidable, they say, given the limited powers that Treasury and the Fed possessed at the time. "A public-sector solution for Lehman proved infeasible," Bernanke told the Economic Club of New York on Oct. 15, "as the firm could not post sufficient collateral to provide reasonable assurance that a loan from the Federal Reserve would be repaid, and the Treasury did not have the authority to absorb billions of dollars of expected losses to facilitate Lehman's acquisition by another firm."
Little could be done, Bernanke said, "except to ameliorate the effects of Lehman's failure on the financial system."
Even if one conceded that the hands of Treasury and the Fed were tied by law and they could not save Lehman, the aftermath has been far worse than probably either Paulson or Bernanke expected.Among other things, Lehman's failure prompted runs on money market funds and deposits at weaker banks and thrifts, while lending between banks and by banks froze up, driving up the spread between the three-month London interbank offered rate (LIBOR) and Treasuries-the so-called TED spread. (TED is an acronym derived from T-BiIl and ED, the ticker symbol for the Eurodollar futures contract.)
When the TED spread rises, it is a sign that lenders believe the risk of default on interbank loans is increasing. While the long-term average of the TED spread is around 30 basis points, the TED spread rose above 300 basis points on Sept. 17, 2008, breaking the record for the Black Monday crash of 1987. On Oct. 10, the TED spread set a new record of 465 basis points. (The progress that has been made in reducing the TED spread since Oct. 10 is widely seen as a sign of recovering liquidity and improving trust among banks.)
The differing treatment of Bear Stearns & Co. Inc., New York, in March (where a buyer, JP Morgan Chase, New York, was found) and Lehman in September points to an underlying problem at the Fed-and the cause of the panic that ensued, according to Alan Meltzer, professor of political economy at Carnegie Mellon University's Tepper School of Business. Pittsburgh.
"The Fed's failure is that in its 95 years of history, they have never announced what their lender-of-last-resort policy will be," Meltzer says. "It may bail them out, let them fail, or something in between; [further, not knowing what the policy response will be] produces uncertainty-which was amplified by the differing treatments for Bear Stearns and Lehman," Meltzer says.
"If you're a portfolio manager with a couple of hundred million dollars under your control, you're uncertain, so you rush for cash," he says. In the future, the Fed should make it clear when it will allow banks to fail-and it should be prepared to let some institutions fail, according to Meltzer. "Capitalism without failure is like religion without sin," Meltzer says. Unfortunately, however, the Fed's policy still is unclear and is likely to remain unclear, which is a problem for the financial markets, Meltzer says.
The $700 billion rescue package
The rapidly worsening financial crisis in September quickly became a political drama that riveted the public as Paulson and Bernanke called on Congress to pass emergency legislation to provide up to $700 billion to buy troubled assetsmost of them toxic mortgage derivatives-from banks in order to inspire more confidence in banks. The "bailout," as it came to be called rightly or wrongly, was distinctly unpopular. Congress, however, was warned in private sessions that with credit lines being terminated or frozen, failure to approve the $700 billion request posed a danger for a sharp contraction in the economy.
With some warning of another Great Depression if nothing was done, on Oct. 3 Congress passed the Emergency Economic Stabilization Act (EESA) of 2008 and President Bush signed it into law. It provided $350 billion immediately to implement the Troubled Asset Relief Program (TARP), but required Treasury to come back to request the second $350 billion of TARP funds. Among other things, EESA temporarily raised the limit on federal deposit insurance from $100,000 to $250,000, effective immediately upon passage until the end of 2009.
The passage of EESA boosted the options available to the President's Working Group on Financial Markets, which stepped up its review of emergency initiatives that could have immediate effects in improving liquidi- ty and credit while also working to programs to quickly address more fundamental systemic issues. Notably, it gave federal officials the authority to rescue a firm like Lehman Brothers by allowing Treasury to inject capital.
The dollar value of the myriad federal rescue and bailout efforts that have followed from EESA and new initiatives from the Fed and the Federal Deposit Insurance Corporation (FDIC) were well past $4 trillion by December. They are expected to grow even more as federal officials continue to try to unclog financial arteries and mitigate the damage done by bad mortgage assets and credit default swaps (CDS) on the balance sheets of banks and other financial companies.
Notably, federal regulators want to find a way to hasten the end of the bottoming process in the housing sector by reducing foreclosures to limit a further buildup in housing supply, and provide sufficient credit and lower interest rates to boost demand.
$1.9 trillion in guarantees by FDIC
With the passage of EESA, Washington's efforts were greatly expanded. The following actions were taken and have been seen by many to have been beneficial in lowering a range of rates, providing credit and improving trust in financial institutions:
* Oct. 7, 2008: The Federal Reserve Board announced creation of the Commercial Paper Funding Facility to purchase three-month unsecured and asset-backed commercial paper directly from issuers.
* Oct. 8, 2008: Central banks in the United States, Canada, England, the European Union, Sweden and Switzerland announced coordinated interest-rate reductions. The Federal Reserve lowered the Federal Funds Rate 50 basis points to 1.5 percent.
* Oct. 14, 2008: The FDIC announced a program to guarantee bank debt and to also fully insure non-interest-bearing transaction accounts, such as money market mutual funds for accounts up to $250,000. According to the Associated Press, the guarantees could cover up to $1.4 trillion in bank debt and $500 billion in transaction accounts, for a total of $1.9 trillion.
* Oct. 21, 2008: The Federal Reserve announced creation of the Money Market Investor Funding Facility to provide senior secured funding to facilitate an industry-supported private-sector initiative to finance the purchase of certificates of deposit and commercial paper issued by highly rated financial institutions.
Troubled assets
It quickly became clear that the policy of breaking the logjam in credit by buying up troubled assets was itself in trouble, and Treasury Secretary Paulson began to talk about the potential for capital injections to help stabilize and strengthen the banking system. Critics began to point out practical obstacles to a program to buy up toxic assets. For one thing, there are so many derivatives of the original residential mortgage-backed securities that untangling the whole mess would require the assembly of a team of experts working around the clock, according to Kenneth Scott, professor of law and business at Stanford Law School, Palo Alto, California.
"If you're going to bring it into being, it's going to be a formidable task and it isn't going to be done quickly," he says. It would require complicated models that contained detailed data on individual loans in the original MBS pools and be able to trace back from collateralized debt obligations (CDO) squared (CDO2) to CDOs to MBS to the underlying loans, Scott says. While time-consuming, this effort would eventually pay off, given sufficient resources, according to Scott.
There were also tactical objections to the purchase of toxic assets. "In my opinion, the original idea [of] trying to buy mortgages and distressed mortgage securities at some prices nobody knows did not address the core problem, [which is] the fear of insolvency," says AEI's Pollock. A program of capital injections to banks, in contrast, does address the fear of insolvency and, thus, "gets at the root of the problem," he says.
"Think about it this way: The reason markets freeze up is that everybody's afraid that [the other fellow] is broke," says Pollock. At firms with high leverage, "you don't have to burn through much until you are insolvent," he says. The natural response is to hoard cash, Pollock says.
Finally, there were worries about the impact of the pricing of purchased toxic assets. "I'm surprised Paulson didn't recognize mortgages are being sold, and at a discount," Meltzer says. "Any [future] buyer [of mortgage assets] wants to discount those problems quite a bit, and that keeps prices low. If he bought mortgages at those prices, he would bankrupt the sellers. If he paid more than that, he would be stiffing taxpayers. That's one of the reasons I opposed the plan," he says.
Perhaps the final nail in the coffin for the program to purchase toxic assets was that the price tag kept rising. Thomas Ferguson, a professor of political science at the University of Massachusetts, Boston, captured the dilemma in a Sept. 22 article in The Nation when he wrote, "the Paulson plan [under TARP] is akin to trying to fill the Pacific Ocean with basketballs." By mid-November, Paulson had concluded that it would have a more immediate effect to implement a Capital Purchase Program to inject $250 billion into eligible financial institutions. Not surprisingly, many in Congress were fuming at Paulson's change of heart, seeing it as something akin to a bait-and-switch.
Paulson tried to persuade Congress and the public that it was right to change the strategy for how the government would use TARP funds. "We recognized that a troubled asset purchase program, to be effective, would require a massive commitment of TARP funds," he stated. "It became clear that, while in mid-September, before economic conditions worsened, $700 billion in troubled asset purchases would have had a significant impact. Half of that sum, in a worse economy, simply isn't enough firepower."
Paulson also sought to gain some understanding for the difficulty that federal officials faced. "There is no playbook for responding to turmoil we have never faced," he said Nov. 18 in testimony before the House Committee on Financial Institutions. "We adjusted our strategy to reflect the facts of a severe market crisis, always keeping focused on Congress' goal and our goal - to stabilize the financial system that is integral to the everyday lives of Americans."
Capital purchase plan
Treasury announced Oct. 14 its plan to purchase up to $250 billion in preferred stock in federally regulated banks and thrifts. By Oct. 26, $115 billion had been injected into eight large institutions. Citigroup Inc., New York; JP Morgan Chase & Co.; and Wells Fargo & Co., San Francisco, each received $25 billion, with Bank of America coming in fourth at $15 billion. "In Washington, that is a land-speed record from announcing a program and getting funds out the door," Paulson told Congress. By Nov. 25, the Capital Purchase Program had invested $161.5 billion in 53 banks and thrifts, from $9 million for the Broadway Financial Corporation, Los Angeles, to $6.6 billion for the U.S. Bancorp, Minneapolis.
Have the capital injections helped? Pollock, for one, thinks it was the right thing to do. "TARP is a way to make temporary equity investments in order to get us over the time of the panic, and it addresses the core of the problem," he says.
Because the private markets are not going to invest in banks in a time of panic, that leaves the government as the only available party to do the investing, he says. "From what we can tell from some uncrunching of the money markets, it seems to be helping," he adds. Pollock says the benefits can also be seen in improvements in the commercial paper markets, a decline in the TED spread and in an improvement in the availability of corporate financing. "It brings back a sufficient amount of willingness to operate in the markets, which, if not yet normal, are less abnormal," Pollock says.
Second rescue for AIG and Citigroup
On Nov. 26, Treasury and the Fed took steps to further strengthen AIG, including a capital injection of $40 billion for preferred equity - an approach that could have saved Lehman. The Fed reduced the size of AIG's loan from $85 billion to $60 billion and reduced the rate from LIBOR plus 8.5 percent to LIBOR plus 3 percent.
AIG agreed to transfer an unstated amount of residential mortgage-backed securities (RMBS) to a new financing entity to be capitalized with $1 billion from AIG and funding of up to $22.5 billion from the Federal Reserve Bank of New York. AIG and the New York Fed will share in any recoveries in the market prices of these assets.
Further, AIG and the New York Fed agreed to create a second financing entity to purchase up to $70 billion of multi-sector credit default swap exposure on which AIG has written CDS contracts. AIG will provide $5 billion in funding and the New York Fed will provide up to $30 billion to the second financing entity. As with the RMBS entity, AIG and the New York Fed will share in any recoveries in market prices of the assets.
As Citigroup shares fell below $5 and it became unlikely the bank could raise additional private capital, Treasury and FDIC teamed up in yet another bailout of this systemically important institution on Nov. 23. Treasury injected another $20 billion into Citigroup from the Capital Purchase Program for preferred stock with an 8 percent dividend.
The FDIC agreed to provide protection against the possibility of unusually large losses on an asset pool of $306 billion of loans and securities backed by residential and commercial real estate that will remain on Citigroup's balance sheet. Citigroup will take the first $29 billion in losses. After that, the remaining losses will be split between Citigroup and the federal government, with the Treasury taking up to $5 billion in losses from the TARP, and the FDIC taking the next $10 billion in losses. Any additional losses are guaranteed by the Fed. Citigroup will issue preferred shares to Treasury and the FDIC for the protection against losses.
With the AIG and Citigroup investments, the capital purchase plan had reached $226.5 billion. Further, with these actions, Treasury, the Fed and the FDIC were able to put a limit on the ultimate losses the two firms could suffer on $408 billion or more of toxic assets.
A trillion here, a trillion there
Will $250 billion of capital injections be enough to get banks back on their feet and ready to lend again? Absolutely not, says Paul Miller, an analyst with Friedman, Billings, Ramsey & Co. Inc., Arlington, Virginia. "The system needs at least $1 trillion," he argues. Furthermore, the U.S. financial system needs tangible common equity and not additional preferred equity injections like those from Treasury "to restore confidence and improve liquidity in the credit markets," Miller says.
So far, regulators and policymakers in Washington have not recognized the need for more common equity and, for this, reason, have stumbled from crisis to crisis, according to Miller. "I think over the last year a lot of what [federal regulators have done] is put Band-Aids® on the problem," says Miller. "But the problem is the cuts were too big for the BandAid to hold. They tried to fix it piecemeal and failed to see the real crisis coming," he adds.
A fundamental mistake was made by regulators and banks when they began to count preferred equity as core capital-when instead they should have view preferred equity as debt, Miller maintains. As a result, banks assumed they had more core capital to support lending than they really had, when push came to shove. The failure to see the need for more tangible common equity is why, as the Fed, the FDIC and Treasury faced one crisis after another, the decision to invest in preferred equity did not have the desired beneficial effect it should have hadsuch as with Citigroup, which had to come back after an initial $25 billion injection to be rescued by the federal regulators, Miller argues.
Friedman Billings calculates that the lack of adequate levels of tangible common equity is greatest among the six largest banks-Citigroup, JP Morgan Chase, Bank of America, Morgan Stanley, Goldman Sachs and Wells Fargo (including Wachovia Corporation, Charlotte, North Carolina)- plus AIG and Norwalk, Connecticut-based GE Financial Services. These eight large institutions have roughly $12.2 trillion of assets and only $406 billion in tangible common equity - or just 3.4 percent. This represents a leverage ratio of 29 times capital.
"If this wasn't bad enough, we expect the current tangible common equity will be essentially wiped out by [expected] losses from existing loan and security books," Miller says.
By injecting $1 trillion to $1.2 trillion, these institutions will have 8.5 percent in tangible equity or a leverage ratio of 12 to 1. To get the capital into the system, Miller recommends the declaration of a bank dividend holiday so that institutions can retain internally generated capital. The TARP should be converted into pure tangible common equity, Miller says. Then the government should force banks to raise additional capital above the government's injections. Finally, Friedman Billings supports a centralized CDS clearinghouse that backstops all transactions and eliminates the cross-default problem.
$200 billion for TALF.
With very little of the first tranche of TARP money left by November, Treasury and the Fed took additional steps to jumpstart the asset-backed securities (ABS) market for consumer lending, a market established by the Federal Reserve Bank of New York for auto and student loans, credit cards and small-business loans. While ABS issuance was $240 billion in 2007, it declined sharply in the third quarter of 2008 and came to a halt in October. This, in turn, threatened further deterioration in the economy.
In response, Treasury allocated $20 billion of the TARP funds on Nov. 20 to provide credit protection for a new Term Asset-Backed Securities Loan Facility (TALF). Under the new facility, the New York Fed will lend up to $200 billion to holders of newly issued AAA-rated ABS. Observers, however, continue to worry that banks will cut back sharply on credit-card debt, while underwriting on auto loans had tightened significantly, putting a crimp in auto sales. With this investment, the Capital Purchase Program reached $246.5 billion.
By Dec. 9, Treasury announced an additional capital injection of $3.8 billion into an additional 35 banks, with amounts as small as $1.7 million going into Manhattan Bancorp, El Segundo, California, and just under $1 billion into Popular Inc., San Juan, Puerto Rico, bringing the preferred equity total capital injections (not counting Citi and AIG) to $165.3 billion in 78 institutions. (After auto industry bailout talks failed in the Senate, the White House said it would look into possible use of TARP funds in an auto bailout.)
Another $600 billion for mortgage purchases
In a more targeted effort to help the housing sector find a bottom, the Federal Reserve on Nov. 25 announced it would purchase through competitive auctions up to $100 billion in direct obligations from Fannie Mae, Freddie Mac and the Federal Home Loan Banks. In addition, the Fed said it would purchase another $500 billion of mortgage-backed securities.
The news immediately led to a 50-basis-point drop in mortgage rates. The Mortgage Bankers Association (MBA) reported that for Thanksgiving week - the week of the Fed's announcement - the average contract interest rate for the 30year fixed-rate mortgage (FRM) fell to 5.47 percent from 5.99 percent. MBA's Weekly Mortgage Application Composite Index jumped 112 percent from the prior week. The Refinance Index increased by 203 percent, while the Conventional Purchase Index rose 37 percent and the Government Purchase Index (largely Federal Housing Administration [FHA]) rose 39.2 percent.
4.5 percent Treasury mortgages
While a number of academics as early as October had made proposals suggesting that Treasury offer low interest mortgages directly, there was no response from Treasury until Dec. 4, when The Wall Street Journal reported the department was considering offering 4.5 percent mortgages to the purchasers of new homes and to finance them with 3 percent bonds.
The proposal, the Journal reported, would not cover the purchase of existing homes or refinancings. In developing its own proposal, Treasury reportedly drew on a plan put forth by two academics from Columbia Business School, New York: Christopher Mayer, professor of real estate; and economist Robert Glenn Hubbard, the school's dean. Mayer has estimated the proposal under consideration by Treasury could help 1.5 million to 2.5 million people buy homes.
The Treasury program is aimed specifically at reducing the supply of new homes still on the market, thus reducing the overall inventory of unsold homes. Even though not officially adopted by Treasury as of this writing, the plan was netting praise. However, others believe that even more needs to be done. Meltzer, for example, has a proposal that would do more, he says, to reduce housing inventories. "The way to do that is very simple-just offer a tax credit to anyone who makes a down payment on an existing house in 2009," Meltzer says. "If they don't pay taxes, give them the money."
Such a plan would not only eliminate the excess supply of housing, but also turn around the home building industry, which, in turn would boost the economy, he says.
There are other proposals circulating to address the housing market. Martin Feldstein, professor of economics at Harvard University, Cambridge, Massachusetts, and president and chief executive officer of the National Bureau of Economic Research (NBER), proposes that the federal government offer full-recourse replacement mortgages for 20 percent of the value of homes when lenders agree to reduce the principal in return for a non-recourse loan.
A far more ambitious proposal has been put forward by economist Lawrence Lindsey, a former Fed governor and former director of the National Economic Council at the White House, and currently chief executive officer of the Lindsey Group, Washington, D.C. Lindsey would get rid of the troubled assets that are weighing down the banks, the markets and the global economy by refinancing mortgages to all comers at 4 percent, but with a catch-the new mortgage would have full recourse, including wage garnishment. The program could refinance at estimated $9 trillion in mortgages, according to Lindsey. Under the refinancing option, the problem of being unable to value MBS and CDOs that are clogging up the financial system "goes away," according to Lindsey.
Sheila Bair's proposal
Preventing foreclosures through voluntary loan modifications involving interest-rate reductions is an approach that has been supported by Treasury since September 2007, with some success. However, Treasury resisted so far a foreclosure-prevention proposal by FDIC Chair Sheila Bair that would rely on loan guarantees from Treasury - an approach authorized in EESA - as an incentive to get lenders to modify loans for troubled borrowers. Treasury could compensate lenders for losses in case of a redefault.
The program is based on the FDICs experience with loan modifications at Pasadena, California-based Indymac, which was taken over by the FDIC in July 2008. Under the proposal, interest rates would be lowered or the term of the loan would be extended until monthly payments represent only 31 percent of income. In some cases the principal could also be reduced. The FDIC has estimated the program would cost $24 billion. Bair has said the losses would be shared between the government and lenders on 2.2 million loans (half the 4.4 million troubled loans). With an expected re-default rate of 33 percent, it would thus prevent another 1.5 million homes from coming on the market. Comptroller of the Currency John C. Dugan on Dec. 8 reported, however, that within six months 53 percent of loans modified in the first quarter of 2008 re-defaulted by being more than 30 days' past due, while 58 percent re-defaulted after eight months.
Paulson has called the Bair plan "a subsidy for banks," but Bernanke, who has supported principal reductions for loan modifications, has warmed to the plan. Congressional leaders, such as House Financial Services Committee Chairman Barney Frank (D-Massachusetts) support the Bair plan and believe that TARP funds should be used for it.
Even so, some economists, such as Meltzer, have doubts about the proposal. "Bair's idea seems to me to be fraught with difficulties," Meltzer says. He agrees with the contention in a Dec. 3 Wall Street Journal editorial that said the Bair plan "invites" defaults. "If you miss two payments, we will help you get a reduction in your mortgages. How many people are going to be in line for that?" Meltzer asks.
The proposal may be difficult to implement, he adds. "These are not your ordinary, plain-vanilla mortgages. They are split into pieces, and it's not that everyone knows where the pieces are and can get agreement to put the pieces back together again."
Bernanke proposed other approaches to loan modification in a speech Dec. 4 to the Federal Reserve System Conference on Housing and Mortgage Markets in Washington, D.C. He suggested Congress consider reducing the upfront premium (3 percent) and the annual premium (1.5 percent) on the HOPE for Homeowners program at FHA. Congress might also consider raising the debt ceiling to allow Treasury to purchase Ginnie Mae securities, which would bring down the 8 percent interest rate on the HOPE for Homeowners program, also known as the H4H program. Or Congress could subsidize the rate, he adds.
In his Dec. 4 speech, Bernanke suggested the government could purchase delinquent or at-risk mortgages in bulk and refinance them into the H4H or another FHA program. Buying in bulk could take advantage of depressed values and help avoid adverse selection, he told Congress.
Interim report card
If one were to grade the success of efforts to stabilize the system and help the housing sector find a bottom through the end of 2008, most observers have been saying that the combined efforts of Treasury, the FDIC and the Fed have been effective in diffusing the worst of the panic and in restoring some level of functioning in many debt markets.
Special commendation, however, goes to the Fed, according to a number of observers. "The Fed's overall efforts are monumental," says Gramley. "You have to give the Fed a lot of credit for being very innovative and very, very creative to get this thing turned around."
The approach of the Fed, he says, "reflects Bernanke's understanding of the potential damaging effect on the economy of a severe credit crunch, like the one we are in right now." Gramley points to Bernanke's expertise on the Great Depression as helpful in his understanding of the present situation. "He knows about what happened then and wants to make sure we don't make the same mistakes again."
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Copyright © 2009 Mortgage Bankers Association of America. Reprinted With Permission.
