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Minyan Mailbag: The Refi That Won't Refi


But, as we know, these are less than normal times.

Minyan Brent lobbed the following question to Toddo and I thought I'd chime in as well:

"I know you have been quick to point out the structural problems and the massive mortgage resets about to take place. My assumption is that this party does not have to end, because of creative financing (this week alone I have gotten three requests for re-financing and one will give me a fixed rate of 2.5% for 5 years). As a side note, I bought my house in 2001 and still have the original 30 year fixed loan on it. My question is, and maybe you can shed some light on the subject, what happens if, when you go to refinance your house, it is appraised at less than your loan amount? By my estimates houses are selling at January 2005 levels and if you bought or took cash out after January 2005 your house has a good chance of being underwater.

Thanks for all your help.
Minyan Brent"

Dear Minyan Brent - In my humble opinion, how this question is "answered" by the markets/government may well dictate where and/or how hard our economy lands. It is beyond dispute that there are hundreds of thousands of people who have fooled themselves into believing they are "homeowners," and who will soon come to the realization that what they really own is what they paid for: a "monthly payment," a "pile of debt," and aboslutely no piece of the real estate they live in. That rude awakening will be brought about by precisely what you describe, upside-down mortgages. Under "normal" circumstances, the outcome of this scenario would be relatively straight-forward: either the borrower ponies up fresh equity to bring the loan-to-value ratio back in line or there is no refi and the house gets foreclosed on.

But, as we know, these are less than normal times.

I doubt that the same "forces" that facilitated the debt binge (i.e. Elmer and the Feds) will work to worsen the symptoms of the inevitable hangover. Some evidence of that is already emerging in the "subprime mortgage area" where, anecdotally at least, the new OCC guidelines aimed at tightening lending standards appear to be treated like red traffic lights in Naples, Italy, i.e. as an invitation to be deliberately ignored. With the benefit of plausible deniability by the lenders in cohoots with the enforcers, we will likely find out what is really going on with these "new" underwriting standards about the same time that we will see a credible set of financials by Aunt Fannie (FNM).

More insidiously, I can attest first hand that some large private residential developers/lenders are already agitating their lobbyists to stave off a sequel to the 1990 horror movie which starred various bank regulators and the RTC. If you believe these characters, the 1990 debacle was not the result of 150% LTV loans for office buildings in the desert, but rather a consequence of out-of-touch power-hungry regulators who dared demand that S&L's maintain a degree of solvency above some barf-test level. Hence, the solution this time is to ensure that the regulators stay out of the way, and they allow the lenders to decide how to reserve for bad loans and collect on them. I describe this scenario as far more insidious because, if left to perpertuate iteself, it would likely be the beginning of a long torturing journey along the path followed by Japan, which for more than 10 years opted to turn all eyes away from failed lenders and bad loans at the cost of a near depression for the rest of the economy.

Of course the draconian, free-market solution to "the refi that can't refi" would not exactly smell like roses either. People who should never have been allowed to borrow beyond their means would face foreclosure, banks would fail, and on a more macro level, we just may find out how much of its $40 trillions in underwritten derivatives JP Morgan (JPM) is really good for.

Realistically, and perhaps stemming from the apathetic despair I feel for the current level of complacency in the financial system, my sense is that the answer to your question (it took me a while, but I have one) will likely be a random, nonsensical mixed bag of all of the above, with the uniting goal of maintaining our current permanent plateau of debt-induced "prosperity." Two or three years ago I would have convincingly argued that the "refis that can't refi" would have been the trigger for financial armageddon. But sticking to that posture today requires ignoring that equal, if not bigger, imabalances have been buried, at least temporarily, under the ever-growing wordlwide piles of freshly minted fiat- money.

Ultimately, an unforseen and uncontrollable financial accident will ripple through our financial system and wash ashore all the sins of our uber-leveraged asset economy. "However, no one knows the day or hour when these things will happen, not even the angels in heaven or the Son himself.* Only the Father knows." (Matthew 25:36).

See, I knew 15 years of Jesuit education would come in handy at some point.
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