Truth About the Mortgage Mess Up Will Set You Free (Commentary)

James A. Garfield, the last of the log-cabin presidents and the 20th President of the United States, among others, said “The truth will set you free…” You know what the “…” means at the end of that quote? The ellipsis means there was more. The entire quote was “The truth will set you free, but first it will make you miserable.”

Hang on to your wallets, because here comes some truth. Congressman Barney Frank, Chairman of the House Financial Services committee, is proposing to throw around $11 billion dollars at the mortgage lending market to help insure up to $400 billion in mortgages.

One problem in his proposal, among many, is that the underwriting standards for this bailout will be enumerated at some later date. According to a recent Wall Street Journal article, the idea is that any loan originated between 2005 and mid-2007 would be renegotiable between borrower and lender.

Lenders would have to write down the value of the mortgage to no more than 85 percent of the current appraised value of the property. The borrower gets a low fixed interest rate and a new principal balance equal to a new, presumably lower, appraised value. Instant equity.

This proposal will also bail out the lenders too because they would get a federal guarantee of the debt. What would you do if you were a lender? Why, you would “renegotiate” all your worst loans and essentially “put” them to the government. Well really not the government, but the taxpayers — me and you.

According to the WSJ, mortgage fraud has gone up 1,200 percent (that’s not a misprint) since 2000. What’s a rational lender to do?

According to the article “a new study from the Boston Federal Reserve destroys the myth of the victimized subprime borrower. Boston Fed economists examined 1.5 million homeownerships over nearly 20 years and found that the overwhelming reason for subprime foreclosures is not unsustainable debt foisted on ignorant borrowers or even financial setbacks. People walk out on subprime mortgages when the value of their home declines.”

According to the Fed study “homeowners who’ve suffered a 20 percent decline in home prices are 14 times as likely to default as those who have enjoyed a 20 percent gain.

“Subprime lending played a role but that role was in creating a class of homeowners who were particularly sensitive to declining house price appreciation, rather than, as is commonly believed, by placing people in inherently problematic mortgages.” Do you think that borrowers will not continue to “stiff” the taxpayers just like they have been their lenders already? There’s the truth — cold, hard and unvarnished.

Current Federal Housing Administration guidelines from the WSJ indicate borrowers “should not have debt payments amounting to more than 43 percent of monthly income.” Mr. Frank’s bill would allow this figure to rise to an astonishing 55 percent.

You have got to be kidding me.

His proposal further calls for “flexible underwriting” standards in which borrowers “can’t be denied FHA insurance due to a low credit score” and that a “delinquency on existing mortgages also can’t be the sole reason to deny FHA insurance.”

Unbelievable.

Are there going to be any underwriting standards at all? I’m not a rocket scientist, but it seems to me that “flexible underwriting” standards got us into this problem in the first place. According to the Mortgage Bankers Association, 42 million of the 46 million (91 percent) mortgages they track are currently paying and paying on time.

I’m not sure that this problem is as bad as Mr. Frank says it is.

Only time will tell.

(Glenn E. Atkins, CFA, is executive vice president and fixed income portfolio manager at Garrison Asset Management Co., a registered investment adviser in Fayetteville. He may be reached at [email protected].)