I had some harsh
words last week for Peter Schiff, which prompted a comment from Jack:
Taking on Schiff? Get ready for a barrage of hate mail from him and his lackeys!
In fact, I got no hate mail at all, just a polite email from Peter’s brother
Andrew, saying that I should talk through my ideas with Peter. I did, and the
following Q&A is the result. I hope you find it interesting. As always with
these things, my interlocutor gets the last word.
Felix Salmon: You write that "Without question,
the Bush administration’s mortgage rescue plan will exacerbate, not alleviate,
the problems in the housing market," and that "there is no question
that as lenders factor in the added risk of having their contracts re-written
or of being held liable for defaulting borrowers, lending standards for new
loans will become increasingly severe". If these things are really so certain,
why do you think that the Bush administration and the American Securitization
Forum were so happy to sign on to this plan?
Peter Schiff: In the short run the plan will keep
some homes out of foreclosure and appease voters, who will be able to continue
the delusions that they
still have home equity. Also, the plan might create some false hope,
thereby slowing down the adjustment. However, over the long run, which
may happen sooner then many politicians naively believe, the plan will
make mortgages even harder to get, and ultimately lead to even lower
home prices and more foreclosures than might have been the case without
the plan.
The best thing is for the government to stay out and let the lenders
work this out with the borrowers without any outside interference. In
many cases foreclosure is better then keeping people in homes they can
not afford that are worth less then their mortgages. Let investors buy
these properties, put up real cash, have some equity, and rent them out.
FS: Surely though we’ve seen quite clearly that the
loan servicers simply don’t have the capacity to work out every delinquent or
soon-to-be-delinquent loan on a case-by-case basis.
And when you say that foreclosure is "better" in many cases if it
comes sooner rather than later, presumably you don’t mean for the borrower but
rather for the lender. Given that lenders can be trusted to act in their own
self-interest, do you really think that they will put off foreclosures in such
situations just because Hank Paulson had a press conference?
PS: I did not say it would be easy for the lenders
but they should be allowed to work it own without government interference. For
most subprime borrowers, their houses are liabilities not assets. How does it
serve their interests to keep them in huge mortgages they can not afford on
homes that are worth less than the mortgages. Losing these homes means getting
out of debt and a chance at a new start. They can rent something they can afford
or save up to buy a house once they are actually in a position to afford one.
This will be a lot easier in a few years anyway when houses are much cheaper.
FS: Do you have any evidence that the lenders resent
the government "interference" which I consider to be little more than
allowing the lenders to get around a table and work something out without risk
of being accused of illegal collusion? It seems to me that the lenders are actually
quite happy about having been able to work out this deal, and would be happy
whether the government chivvied them along or not.
As for the homeowners, of course their houses are assets: it’s their mortgages
which are liabilities. Losing their houses only means getting out of debt in
certain limited circumstances: (a) when the loan is non-recourse — which is
rare in the subprime world, especially since most subprime mortgages were refinances;
(b) when the servicer accepts a short sale; (c) when the homeowner declares
bankruptcy as part of the foreclosure process. If they do declare bankruptcy,
then their ability to even rent a smaller house in the near term, let along
buy a new one in the long term, is definitely diminished.
And in all of these cases, the homeowner is still better off staying
in their own home if the frozen teaser mortgage payments are lower than the
amount the homeowner is going to have to pay in rent. Since the mortgage-freeze
plan is explicitly targeted only at those subprime borrowers who have been making
their teaser-rate mortgage payments in full so far, does it not make sense for
both homeowner and lender to continue that state of affairs? You might be right
that home prices are going to fall a lot in the coming years, in which case
it would make sense for any homeowner — not just subprime borrowers
— to sell their house right now and rent. But I don’t see that anybody’s speculation
about the future direction of housing prices should be enough to start turfing
people out of their homes.
PS: Lenders do not need any help from government
to negotiate deals that are
in their best interests. This plan amounts to coercion, where lenders
are being "asked" to make concession that absent government intervention
that might not otherwise be willing to make. It is possible that in
some cases freezing teaser rates might make sense, but such decisions
should be left to the lenders. It is also possible that in many cases
foreclosure would be a better option for the lender then a freeze, yet
this plan may prevent such an outcome to the detriment of lenders.
Apart from moral and legal issues, such actions are bound to have a
chilling effect on the willingness of lenders to continue extending
credit to American borrowers or cause future rates and terms by which
such credit is extended to be less favorable.
Sure a house is an asset (though despite conventional wisdom a depreciating
one) but you can not separate it from a mortgage that encumbers it. They must
be viewed together, and if the mortgage exceeds the value of the house, then
together they amount to a liability. Most subprime borrowers either put none
of their own money into these properties, or if they did, they extracted any
original down-payments though refinancing. As such they have no right to occupy
properties that rightfully belong to the lenders who actually paid for them.
If a teaser rate is so low that it amounts to less then what "owners"
might otherwise pay in rent, why should lenders be required to provide such
subsidies — especially since these "owner/renters" have no equity
in the properties and will likely not maintain them at all during the period
of the freeze? Therefore not only will lenders suffer below market interest
payments during the freeze, but the houses will be that much less valuable when
they are ultimately sold in foreclosure when the freezes expire.
Why not let lenders foreclose now, cut their losses, and put these homes
in the hands of responsible owners with financial incentives to maintain
their investments? Let current occupants either rent back their houses
from investors, or move elsewhere. There is nothing wrong with being a
renter, I should know as I am one myself. If these overstretched
subprime borrowers actually want to be home owners one day and not
simply real estate speculators with other peoples money, they can save
up a 20% down payment and buy a less expensive house they can actually
afford.
For those subprime borrowers with other assets and good incomes let them
negotiate new mortgages with the banks for lesser amounts but where the
borrower kicks in some new cash back to the lender. This way the owners
will actually have an asset (a house worth more then the mortgage
against it) and a financial incentive to take care of it.
This approach will allow for a far more rapid decline in real estate prices
and therefore a return to a normal housing/mortgage market. However as politicians
would rather voters continue to harbor delusions of phantom home equity, this
market based approach is being resisted by those seeking re-election. However,
in the long run this plan will actually cause real estate prices to fall even
further then what might have been the case without it.
Peter Schiff’s first book is “Crash Proof“.