Inspired by Bonddad's Rate Cuts Won't Do Jack
So, after reading Bonddad's diary and some of the comments I was inspired by Bonddad's final point "This is an issue of confidence.". I thought that statement was profound enough it deserved an explanation all on its own because monetarily things are just not that bad.
Consider the types of loans that are being complained about:
1)0% Down or Low Down payment Loans.
2)Adjustable Rate Loans
Then, add on the decline in the housing market, and lenders going under. And, for some reason Congress wants to bail out the lenders.
The thing is the lenders will be fine and here is why.
The issue with adjustable rate loans is defaults and foreclosure when the rates adjust. If the ARM had 20% down payment then the lender will get their money because it is improbable that the house has lost 20%, so only a very small fraction of defaults would fall in this category. The other category is low down loans which would be two fold.
1)100% loans with Private Mortgage Insurance (PMI)
2)First and Second (sometimes a third) to get to 100% of the purchase price.
The lender comes out OK with #1 because the insurance pays the lender the difference between the foreclosure sale price and the amount left on the loan. #2 is a little tricky but, the first lender probably comes out all right because they only loaned 80% and get first dibs at the foreclosure proceeds. The second lender is in trouble as they will likely not get back what they lent.
So, when I look at it this way in terms of lost principal the only lenders that are going to lose principal are those fronting the seconds and thirds to get to 100% Loan to Value. And, they were getting paid 10%+ interest, so will have that going for them. All the others will get their money back eventually.
Which brings us back to The Issue of Confidence. What is happening is that the buyers of mortgage securities don't know how what to value them at because the ratings agencies cannot be trusted, nor the investment banks that created the securities. The securities are a mix of relatively safe (principal-wise) first mortgages with unsafe seconds and thirds. And, unless the investors can accurately gauge the true risk of the security they will not be willing to buy them. But, in the end the vast majority of the principal is going to be paid back. In the mean time, I am sure investors and lenders are madly trying to come up with a system for accurately valuing the mortgage debt currently out there, so the market can start back up and those who want out can unload and those who want in at the new valuations can pick up those securities. Until that happens it is going to be painful.
Note: I did not get into the impact on the borrowers because that is a whole different scenario in it won right. The short version is move as many into loans they can afford, prevent judgments for the difference between foreclosure sale and principal amount, and defray moving costs.