Last week U.S. Treasury Secretary Timothy Geithner and HUD Secretary Shaun Donovan sent a forceful letter to mortgage servicers that essentially stated that they were not pleased with the amount of loan modifications taking place. Now I find it hard to believe that our U.S. Treasury with its brotherhood with the Federal Reserve has a hard time advocating such a simple policy. They have the power to circumvent the mortgage industry and Wall Street given that they have bailed out these sectors of the economy. Did they conveniently forget that we nationalized (whoops, put into conservatorship) Fannie Mae and Freddie Mac which now is the U.S. mortgage industry?

Yet in this bread and circus show we get another example of who is really running the show. The U.S. Treasury and Federal Reserve are working for Wall Street and the banking industry, not the American public. One of the baffling items in the Making Homes Affordable initiative is the desire to help out with second lien mortgages. After reading the details of the program, I couldn’t help but have the Jack in the Box commercial theme running in the background, “…mini option ARMs!” First lien, second lien, and what else? The solution apparently is to make these loan mods into Alt-A or option ARM products. By the way, those Alt-A loans are now imploding at a higher rate than subprime with bigger balances. Who would have figured giving out toxic nuclear waste mortgages would cause so much pain?

The irony must be clear to others because people take out second liens on their homes to make them more unaffordable. That is, they increase the overall debt they owe. In the real world people are still doubtful of the future of housing:

Now I have stated in a few examples, like a home Culver City and another in Palms how people used their homes like equity ATMs. There is no basis for bailing out second liens. It is incredible that we are now moving down the path of bailing out loans in which people took vacations, added Jacuzzis to their homes, or even bought a luxury vehicle. Their idea of fixing this problem is making you pay for your 60″ flat screen 30 years into the future. What does that have to do with making homes more affordable? The tragic consequence of this housing bubble bursting is that in fact with prices falling, homes are indeed becoming more affordable. If the goal is for homes to be affordable then trying to prop home prices up is a bad decision. Yet aiding second liens or as I like to call them, mini option ARMs, is a very bad financial decision. Let us examine two scenarios presented to us from the U.S. Treasury:

My first argument would be what in the world was “Family A” doing taking out a $45,000 second on their home? Heck, I’ve bought homes that are cheaper than $45,000! But let us set aside those tidbits for a moment because the government here is lowering the monthly payment down to $154 a month for a $45,000 note! How many of you would like to get $45,000 for $154 a month? This is insanity. What is being implicitly stated here by the U.S. Treasury is they don’t expect this family to ever pay this mortgage back. Their idea is that by giving someone a mini option ARM that they’ll be able to sell the home in 5 years for a higher price and the new buyer will simply roll the 1st and 2nd into one note and all will be well. I am amazed that our idea of fixing the mortgage crisis is by modifying loans to become option ARMs. And what will the rate be in 5 years? It will certainly be higher than the 1 percent teaser rate. In 5 years (2014) the balance will be $37,000 yet who is paying for that low interest rate? If the government is backing this up it is pure highway robbery.

Let us look at another family example:

If you thought the first case was insane just look at “Family B” who took out an interest-only second mortgage to the tune of $60,000. Maybe they needed a new pool with a water fountain (hey, if we’re going to be in a recession you might as well stay cool). Interest-only loans are absolutely toxic junk and many Alt-A loans went this way yet here we are looking to modify this crap. You really have to be careful here because the devil is in the details. First, the initial term was over 12 years at 4.4%. Let us run those numbers first:

The data above is for a 12 year note that includes both principal and interest. So if this is an interest only mortgage, the payment is not $537 (P + I) a month but is set at $220 (I only) a month. This is the same backward logic that has now setup the Alt-A and option ARM tsunami yet our solution is to just increase the term. They make this example play out so well. Their solution? Increase the term to 27 years and drop the rate to 2 percent. One tiny question? Who is making up the payment? Now from the perspective of a lender, why in the world would you want to give someone a 1 percent note? This is like the government forcing a landlord to push rents down to $400 yet he is paying $700 on the mortgage. Any investor is going to want to recoup that additional loss. If the government is making up that shortfall, this would be simply another crony idea to help the housing industry. And the underlying theme is what is even more disturbing. What is being said is that no one has the intention of ever paying this money back. Is anyone concerned about taking a 12 year second and taking it to a 27 year term? This is a second mortgage by the way, not a first mortgage which is even more baffling. Time to create millions of renters not only on real estate but on televisions, pools, vacations, cars, upgrades, etc. Because when you only pay the interest, you are basically paying rent.

This kind of thinking is financially irresponsible. As a general rule, any money you can get your hands on for less than 3 percent is usually a good take. That is why these 1 and 2 percent mortgage refinances are flat out giving money away and not doing anything to adjust the principal. I mean think about it. If I had access to $1,000,000 in cash right now at 1 percent with a 30 year term, I’d take it in a second. After all, the intent is never to pay it back at an accelerated pace. Just more logic from the banking and housing industry.

And if you think the crony banking system is going to shoulder that additional gap think again:

“(Bloomberg) It is well understood that the four major banks would likely need an additional capital injection should they be forced to mark the second-lien mortgages on their balance sheets to a realistic value,” Greenwich Financial’s Frey said.

While under the Home Affordable program, servicers must offer the Hope for Homeowners aid to eligible borrowers, the plan otherwise doesn’t call for first-mortgage balance reductions, focusing instead on reducing housing payments to 31 percent of borrowers’ pay. Lawmakers authorized the FHA program last year, and then revised rules in May after limited use.”

This is such absolute nonsense. They’ll need additional capital injections? Screw them. Seriously, are we now going to bailout second mortgages on top of all the trillions committed to the utterly corrupt banking sector? The fact that you might have some lenders taking capital injections to reduce 2nd liens while leaving 1st mortgages intact is simply backward beyond any sensible financial policy. My gut feelings when the private-public investment program was announced are being sadly confirmed. That is, the government is going to stretch these toxic mortgages out long enough until they can figure out a way to dump these into the taxpayer’s wallet. And keep in mind, lowering rates does have a cost. How so? With all the capital injections and debt you will be paying through this from loss in savings (since rates are artificially low) and also through the annihilation of the US dollar. This was done with the S&L crisis and will be done again. Here is a chart with a very subtle trend:

I think the next prudent step to take is to jump on some interest-only seconds and load up on wheelbarrows since that is probably how we are going to be paying for groceries in the next decade. The fact that a plan for second mortgages is even on the table is pure lunacy.

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