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The President's Definition of "Voluntary"

As you can tell, I spent most of yesterday and today poking around the edges of President Obama's plan to solve the mortgage financing crisis; bear with me for one more post about it, because I think I just figured something out. And when I did, I laughed myself absolutely silly. You may hate this. Most of you will probably love it.

From the White House blog, I found a link to a (PDF) document on the Treasury Department website, credited to Jacob Leibenluft, "Support Under the Homeowner Affordability and Stability Plan: Three Cases," (treas.gov, 2/18/09). The first two cases are uninteresting. Let's look at example 3, in the author's own words:

Family C: Eligible for Homeowner Stability Initiative
  • In 2006: Family C took out a 30-year subprime mortgage of $220,000, on a house worth $230,000 at the time (they put less than 5% down). Their mortgage broker – Mom & Pop Mortgage – sold their loan to Investment Bank. The interest rate on their mortgage is 7.5%.
  • Today: Family C has $214,016 remaining on their mortgage but their home value has fallen -18% to $189,000. Also, in November, one parent in Family C was moved from full-time to part-time work, causing a significant negative shock to their income.
    • Their loan is now 113% the value of their home, making them “underwater” and unable to sell their house.
    • Meanwhile, their monthly mortgage payment is $1,538 and their monthly income has fallen to $3,650, meaning the ratio of their monthly mortgage debt to income is 42%.
  • Under the Homeowner Stability Initiative: Family C can get a government sponsored modification that – for five years – will reduce their mortgage payment by $406 a month. After those five years, Family C’s mortgage payment will adjust upward at a moderate, phased-in level.
Existing MortgageLoan Modification
Remaining Years2727
Interest Rate7.50%4.42%
Monthly Payment$1,538$1,132
Savings:$406 per month, $4,870 per year

Homeowner Stability Initiative: How the Program Works for the Lender, Government and Borrower
  • First, Investment Bank (working through a mortgage servicer) reduces the interest rate so that the Family C’s monthly debt-to-income ratio drops from 42% to 38%. This means that Investment Bank must reduce the interest rate from 7.50% to 6.38%, bringing down Family C’s monthly payment from $1,538 to $1,387.
  • Second, the government and Investment Bank share the cost of further reducing the interest rate so that the Family C’s monthly debt-to-income level is lowered to 31%. Any dollar the bank spends is matched by the government. At this stage, Family C’s interest rate is reduced from 6.41% to 4.43%. In total, Family C’s monthly payment has fallen from $1,538 to $1,132.
  • If Family C remains current on their payments, they will receive incentive payments up to $1,000 a year, or $5,000 over five years, that would go towards reducing the principal they owe. Additionally, the mortgage servicer can earn an up-front incentive fee of $1,000, plus up to $1,000 per year in “Pay for Success” fees for three years, so long as Family C remains current.

Now, let's add some annotations to that: how does this actually work? Well, first the bank that's servicing their loan, Investment Bank, "voluntarily" lowers their interest payment from 7.5% to 6.38%, the maximum that this program allows them to charge and still "voluntarily" participate in this program. Because there's a 6.38% interest cap? No, because there's a 38% of income cap, and that's what interest rate would have to be if they were paying off a $213,431 loan over 30 years at a fixed rate and only paying 38% of their current monthly income.

Now, immediately a problem crops up. Investment Bank didn't issue Family C's mortgage, remember? They're only servicing it for some mortgage investment pool that Mom & Pop Mortgage sold the loan to. And because they were planning on selling it to a mortgage investment pool, there's a clause in Family C's contract that says that the interest rate on this loan cannot be legally lowered. Period. At the very least, not without a court order. Nevertheless, Investment Bank will "voluntarily" do so. So, what do they do, dare any of the shareholders in that mortgage pool to sue them for violating the contract? Probably not. If not, they have only one choice: "voluntarily" pay off Family C's mortgage themselves and issue them a brand new 27-year mortgage for the same amount at 6.38%. Since they paid off a 7.5% loan and issued a loan that only pays them 6.38%, they take a substantial loss on the deal. Why are they willing to do that? Because they're doing it "voluntarily." And because they did so "voluntarily," the government will pay Investment Bank $255/month towards Family C's mortgage payment, so that Family C can more easily afford the loan, bringing their payment down to 31% of their income from 38%. What do the taxpayers get for their $255 a month? Nothing. We're doing it "voluntarily."

What does "voluntarily" mean to Investment Bank, in this example? It means that Investment Bank is under no legal obligation to do so. On the other hand, President Obama has just pointedly and explicitly reminded them, there's nothing in the law that says he has to bail them out if their capital asset ratio is out of whack. Which, I guarantee you, Investment Bank's is. So, yes, sure, certainly Investment Bank can decide that even with the government paying $255/month of it, Family C is a bad bet for a $1,387/month mortgage for 30 years, and they are absolutely free to turn them. Yes, they can. They are also legally entitled to decide that the house is a bad bet at $213,431, and turn them down. They are also completely and fully allowed to refuse to take the loss from paying off their old loan. Yes, they are. And President Obama absolutely can say, oh so casually, "Nice banking license you have there. It'd be a shame if anything were to ... happen ... to it." Like, say, him wiping his ass with it, which he absolutely can do any time he wants, now. Not only can he do it, if mark-to-market rules were being strictly enforced, he'd be legally obligated to do so. And there isn't a damned thing Congress can do about it. Nor would they want to. The way the voters feel about banks right now, Congress knows which side their bread is buttered on. Nor do they even have to stick their necks out to give him permission to do so; they already did. The original TARP authorization includes enough weasely language that the President and the Treasury Secretary can do just about anything they want to or about the banks, it's as loosely and sloppily worded as the 2001 war powers resolution was. He absolutely can do this. And there really isn't any way anybody can stop him.

Hey, what do you know? Obama did learn something about negotiation while he was in Chicago, after all! I laughed myself silly when I figured this out. Heck, it's hours later, and I'm still giggling when I think about it. If nothing else, somewhere the ghost of Inigo Montoya is saying, "You keep using that word, 'voluntary.' I do not think it means what you think it means."

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