Monday, December 3, 2007

Hillary Clinton Decides to Mix Chemicals in a Lab Vis a Vis Mortgages

If anyone wants to know how dangerous it is for uninformed politicians to make policy suggestions that have political goals, they need to look no further than this proposal by Hillary Clinton in response to the mortgage crisis.

Democratic presidential candidate Hillary Clinton called for a 90-day moratorium on foreclosures for homeowners who default on subprime mortgages.

The New York senator, is also seeking a five-year freeze on the monthly rate for subprime adjustable mortgages and a requirement that the industry report how many mortgages have been modified. In a letter to Treasury Secretary Hank Paulson, Clinton said she may consider legislation to protect lenders from lawsuits and let them convert certain mortgages into ``stable, affordable loans.''


Clinton also proposed a fund of as much as $5 billion to help communities suffering from high rates of foreclosures. The moratorium on foreclosures would be at least 90 days and only apply to owner-occupied homes.

I have already pointed out Hillary Clinton's disastrous mortgage bailout plan. This is frankly more of the same.

It seems that Hillary Clinton has forgotten several simple business rules. The first rule is that contracts have stipulations and each party must meet their end of the contract or face consequences (no matter how sympathetic each party is). A mortgage is a contract and there are certain stipulations. For instance, the bank stipulated that they would shell out the entire sum of the original mortgage amount, almost always six figures and more, up front. They stipulated that the borrower would pay that mortgage back one month at a time. It also stipulated that if said borrower failed to repay then the home would be taken from them. The borrower signed that mortgage and thus agreed to that contract.

Despite what Hillary Clinton believes, changing any contract in a wholesale manner, as she wants with mortgages, is neither good policy, nor good for the economy. Banks paid out hundreds of thousands of dollars up front with the intention of receiving that money back one month at a time. If that money wasn't received, the banks would take the collateral, the property. That is how banks expected to make that transaction profitable for themselves. Hillary Clinton wants to take away the entire profit structure away from the banks and she thinks there are no unintended consequences to it.

There are. If banks happen to lose a lot of money in a wholesale manner as Hillary Clinton intends, they will pass those losses onto us, in the form of higher interest rates on future mortgages.

Finally, and here is the worst part, the people that Hillary wants to save from foreclosure, for 90 days at least, are almost entirely in over their heads. They bought property they simply can't afford. I don't care if her moratorium is 900 days, this dynamic isn't going to change. If you can only afford a home that is 200K and you buy one for 250k, no moratorium is going to save you from yourself.

Second, Hillary Clinton wants to freeze ARM's (Adjustable Rate Mortgages). This is ludicrous. The reason that any loan has the rate that it has is ALL the factors that went into that loan, including the fact that the rate on that loan would move later. (In other words an ARM almost always has a lower rate than a fixed rate everything else being equal) Hillary Clinton wants to freeze rates even though banks offered a lower rate with the intention of having that rate move in a future period.

The manner in which banks determined the rate that borrowers received is extremely sophisticated and far past the grasp of Hillary Clinton, with all due respect. Yet, that, to her, matters not. She wants to, in a wholesale manner, freeze rates when the banks intended to have them move (and in exchange offered an initially lower rate). This of course totally disrupts the models that banks used in order to determine that rate. This means that banks will lose millions of dollars. That means that future rates will be that much higher to make up the difference.

Furthermore, there are people currently holding onto mortgages with fixed rates with each of these banks that Hillary Clinton wants to freeze the ARM's of. If I were holding onto a fixed rate (one that stayed the same over the life of the loan), I would be screaming bloody murder. I took a higher rate so that I wouldn't risk a future rate even higher, and now all those that didn't take the precaution I did get to have their rates frozen. I would be saying screw that and demand that my rate be lowered to their level since I only took the higher rate because I wanted my rate fixed for life. If Hillary Clinton is fixing their lower rates, then I would want my rate lowered and fixed as well. This is what is referred to as a moral hazard. Hillary Clinton is rewarding those that took on a risk they shouldn't have with an artificially fixed rate. By doing so she invites more people to take on ARM's when they shouldn't in hopes of getting the same doeal. I wonder if Hillary Clinton has a solution to that.

The worst thing about this is that Hillary Clinton is doing this strictly for political reasons. In sales, I always look to find my way on the same perverbial side of the table with my client against a chosen villain. Usually, I choose the bank (though not always), and I make the process me and the borrower against the bank. Hillary Clinton is using the same technique only it isn't to sell a mortgage, but to propose bad policy. She wants to find herself on the same side of the table with the poor borrowers against the bank. This may very well be a good political strategy however it is disastrous policy, and I hope everyone reading my analysis can see why.

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