Changes to TARP

November 17, 2008 – 4:05 pm

BY RICHARD RUSSELL

November 14, 2008 — A week light on economic data didn’t lack for activity. Stock markets continue to rage about, bond yields continue to bounce around, and our newly-activist government is engaged yet again.

This week, Treasury Secretary Paulson all but abandoned the original troubled Asset Relief Program (TARP), which was intended to pull bad mortgage-related assets off of lender books in an effort to clear their balance sheets. The $700 billion program was supposed to shift bad debts to the government’s books at some market clearing price, but not a single transaction occurred. The process of culling rotten loans and securities turned out to be more cumbersome and slow than expected, and our guess is that lenders simply failed to show much interest in the program, which would have exposed those assets to some pretty harsh market valuations. If conditions stabilized or improve over time, those assets could prove to be more valuable than today’s market can bear.

Mortgage rates eased a little this week. Like expanding ripples on a pond, the wide swings in rates seem to be diminishing after a series of near half-point moves. Settling down is a welcome sign for the market, and they are settling lower is to the benefit of the borrowers.

The average for traditional conforming 30 year FRMs (up to $417,000) declined by another 17 basis points this week.

Aside from the sudden shift in the TARP roiling markets (the price of some mortgage assets which might have been offloaded under the program nosedived, according to a chart in The Wall Street Journal), this week was all about new loan modification for troubled borrowers. The Federal Housing Finance Agency announced plans to identify and modify more Fannie and Freddie-backed or owned mortgage loans. While admitting that GSE-backed loans represent perhaps only 20% of at-risk mortgages, FHFA Director James Lockhart expressed optimism that by setting a series of standards for “streamlined” modifications, others might follow the lead of the agency and improve the number of mortgages changed. Servicers can earn $800 for each loan adjusted closely to match the borrower’s capabilities: they’ll use a 38% housing ratio for determining monthly mortgage payments, among other factors. Although the FHFA offered only a vague estimate of how many borrowers can be served by the program, “thousands” will probably benefit. To be eligible, a borrower should have missed at least three payments and not filed for bankruptcy. Borrowers will need to contact their servicer and provide supporting documentation and a hardship statement.

Not to be outdone, the FDIC offered its own plan for loan modifications on Friday, but specifically for non-GSE backed loans, so this program would include jumbo, subprime and other non-conforming loans. While offering servicers a $1000 bounty for each loan mod, the program here goes a step further in providing some offset to the investor should the newly-modified loan again fail. The FDIC estimates that originally some 2.2 million mortgages could be eligible by the end of 2009, but expects that perhaps a full third of them will re-fail over time. In such a case, the FDIC will cover up to 50% of the loss to the investor. How it will all work out wasn’t especially clear, and details on the FDIC website were rather thin, but the program could have an expected ultimate cost of about $24 billion while serving to keep perhaps 1.5 million homes out of foreclosure.

Mortgage rates dipped this week, pulled back by a sour economy and fast-declining inflation concerns. Unfortunately, more of the same is likely to come next week. Measures of housing activity, producer and consumer prices, industrial production and more are due out, and while we’ll be looking for silver linings we’re not expecting to find many among the dark clouds. A few more weeks of this and we just might see conforming mortgage rates dip into the 5’s and that would lend a bit of cheer for sure