My old friend Ramsey Su, foreclosure expert and keen observer of the ongoing mortgage trainwreck, is back with another guest commentary. His latest email missive puts the infamous mortgage freeze in his crosshairs, and he’s agreed to let me reprint it here. Read on, and if you like this you might enjoy Ramsey’s prior commentary here, here, and here (the first of these, a prescient piece on the impact of foreclosures written in February, is one of the most widely read articles ever to appear on the Econo-Almanac).

Ramsey’s piece follows…

The Big Mortgage Bailout — The Big Lie
by Ramsey Su

WARNING: THE CONTENTS OF THIS ARTICLE ARE DEPRESSING. If you take the time to read it, you will realize that I am not kidding. Most of you who have been receiving my emails know that these emails are generally just a way for me to organize my thoughts by writing things down. In this case, I do hope that you will take the time to read it. (All highlights are mine; a friend at the WSJ sent me most of the links).

The mortgage bailout has been capturing news headlines recently. Regurgitated reports have been at best confusing. I have no choice but to dig deeper myself to see what all the hoopla is about. The following are my findings. What surprised me was how easy it was to research this topic if one has some background in real estate and mortgage financing.

This is probably a good place to start. Last Thursday, December 6, George Bush gave a speech on the subject and it is detailed here. I am going to use this as the framework for this email:

Who is this HOPE NOW Alliance? This is their website.

Who is this HOPE NOW Alliance? This is who they really are.

HOPE NOW is nothing more than an industry alliance with the sole intent of getting to the borrowers. I am not passing judgment on HOPE NOW at this point but I think it is important to understand that they are NOT some consumer advocate group but rather an industry dominated group.

We have also heard about this new initiative called FHASecure. Here is a simple website explaining how to qualify for FHASecure loans:

This is the criteria:

To qualify for FHA Secure, eligible homeowners must meet the following five criteria:

• A history of on-time mortgage payments before the borrower’s teaser rates expired and loans reset;
• Interest rates must have or will reset between June 2005 and December 2009;
• Three percent cash or equity in the home;
• A sustained history of employment; and
• Sufficient income to make the mortgage payment.

Aside from adding #2 above, which is really inconsequential, there is no difference between the FHASecure and a normal FHA loan.

The White House claimed:

In just three months, the FHA has received over 120,000 refinancing applications and has already helped more than 35,000 people refinance.  By the end of 2008, the FHA expects this program to help more than 300,000 families.

I wonder how many refinancing applications FHA normally receives in any three months period and what is the normal approval rate.

What captured the most attention recently is of course the Paulson Plan. Naturally, this would be the most logical website to find the details of the plan, right?

As it turned out, I cannot find the plan at the Treasury website but rather at the website of the American Securitization Forum.

What is this American Securitization Forum? I must admit I have never heard of them nor did I hear them mentioned in any of the speeches. Well, this is who they are and what they do.

So this Paulson of the Paulson Plan is not Henry Paulson, Treasury Secretary, it is Henry Paulson, Spokesman for the ASF. Take a look at the members of this group. Do they look familiar?

The ASF/Paulson bail out plan is 34 pages but all you have to do is read the executive summary which is only five pages. I strongly encourage anyone interested to take a few minutes to read through it. I will post the link again: Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans

One short sentence on page 1 and one short paragraph on page 5 pretty much summarized the entire intent of the plan.

On page 1, the scope of the bail out is limited to:

• were originated between January 1, 2005 and July 31, 2007;
• are included in securitized pools; and
• have an initial interest rate reset between January 1, 2008 and July 31, 2010.

Any reasonable person may ask: if the plan is intended to help borrowers avoid foreclosure, why would a government plan be limited only to loans in securitized pools? ASF answered this question on page 5:

The modification maximizes the net present value of recoveries to the securitization trust and is in the best interests of investors in the aggregate,
because refinancing opportunities are likely not available and the borrower is
able and willing to pay under the modified terms.

Now that I have laid out the background, the bailout plan is much easier to understand. Every word in the proposal is intended to maximize the net present value of recoveries, nothing else. If you are looking for the section as to how it will help borrowers, let me know when you find it because I sure can’t.

Here are some of my analysis and opinion of various parts of the bailout plan:

FICO test:

• If the current FICO score is less than 660 and is less than a score 10% higher than the FICO score at origination, the borrower is considered to have met the
“FICO test.” If the borrower meets the FICO test, the servicer will generally
not determine the borrower’s current income.
• If either a) the current FICO score is 660 or higher, or b) the current FICO is at least 10% higher than the FICO score at origination, the borrower is considered to not meet the “FICO test.” If the borrower does not meet the
FICO test, the servicer will use an alternate analysis to determine if the
borrower is eligible for a loan modification.

While the masses may consider this FICO test totally illogical, it makes perfect sense under the profit model. The plan is to make anyone who has ability to pay, pay. The 10% higher rule is to weed out those who had taken steps to improve their credit score and therefore must have some money to pay and make them pay pay. There is no consideration for fairness, moral hazard, or just morals; this is purely about maximizing profits and our government is not only endorsing it, our government is promoting it.

Page 2

• All servicers of second liens to subprime borrowers should cooperate fully with this framework by providing information needed by first lien servicers and by agreeing to subordinate the second lien to any new first lien resulting from a refinance (with no cash out) under this framework.
• If the borrower also has a second lien on the property, this framework contemplates that the borrower is able to refinance the first lien only, on a no cash out basis. In order for the loan to fall into this segment, the second lien does not have to be refinanced; however, any second lien holder will need to agree to subordinate their interest to the refinanced first lien.

My thoughts: There is no doubt that the 2nd lien holder is the biggest benefactor of these bailout plans. Their position improves from total loss to possibly no harm at all. Whether it is a short pay refinance or a 5 year freeze, the 2nd may get something out of nothing. They may be the biggest driver of these plans.

Page 3 – (Segment 2 are the targeted borrowers)

Segment 2 includes current loans where the borrower is unlikely to be able to refinance into any readily available mortgage industry product.

• Current: For purposes of this framework “current” means the loan must be not more than 30 days delinquent, and must not have been more than 1 x 60 days delinquent in
the last 12 months, both under the OTS method. Corresponding tests would apply under the MBA method if the servicer uses that standard.

I wonder how many people, when they heard the word “current”, would define it as ASF does here. In simple terms, you are current if you are not delinquent by 1 payment right now or have not missed more than two consecutive payments in the last 12 months. Why is this “current” an issue? It is sold under the pretense that the bailout is to help responsible borrowers when in fact it is to identify those who can still manage to pay something.

• LTV test: All current loans with an LTV (based on the first lien only) greater than 97% are deemed not to be eligible for refinance into any available product, and thus are within Segment 2. (97% is the maximum LTV allowed under FHA Secure.)
• Not FHA Secure eligible: All current loans that otherwise do not satisfy FHA Secure
requirements, including delinquency history, DTI at origination and loan amount standards for this program, are within Segment 2 unless the servicer can determine whether they may meet eligibility criteria for another product, by reviewing eligibility criteria without performing an underwriting analysis.

This is a brilliant two part scheme. Here is how I believe the scheme is intended to work.

Scheme Part 1: Say the subject property was valued at $100,000 with an 80/20 financing package in place. Now the property is worth $90,000. Using only the 1st lien, the LTV is only 88.9% ($80,000/$90,000), far below the 97% LTV. The idea is to get these suckers (borrowers) to refinance into one of those FHASecure while the 2nd lien holder agrees to subordinate to a new 1st. The old securitized 1st is now home free with a FHA/government bailout while the 2nd, though still in an over-encumbered position, has just received a reprieve. How brilliant.

Scheme Part 2: If the property has dropped to approximately $83,000 or below, then Scheme part 1 is not feasible. So it is best to keep this borrower paying in a 120%+ CLTV property. As you can see, with the property value so low, they know with certainty that a default would be a total wipe of the 2nd and a severe loss to the 1st.

This two part scheme assures that there are no crumbs left on the table for the borrowers.

In summary, regardless of its devious intent, this bailout plan will not work. After all, the plan is concocted by the same financial engineers who got us into this big mess in the first place. I have heard and read numerous analysis of the plan since it came out last week. As I was typing, some professor from Wharton was on CNN, explaining how this is a good start and how it could cut foreclosures by 25%. No wonder. Half of these financial engineers were probably her students.

I will let Will Rogers finish this email.

If Stupidity got us into this mess, then why can’t it get us out?
— Will Rogers

—

The following is an email I sent out 12/4/07. I do not see how the bailout is going to help these borrowers.

In response to the Treasury Secretary’s comical ideas today, I decided to take a look at a few recent REOs from the perspective of a workout.

The following 4 properties are just the first 4 REO closings on November 30, 2007 from the MLS. Here are their stories:

Property 1 – Manchester Ave.

This property was last purchased for $350,000 on 8/3/03 and sold as an REO for $380,000 on 11/30/07.

In between, the borrower refinanced, took out a 1st of $400,000 and a 2nd of $73,965, totaling $473,965.

This borrower had a choice. He could have done nothing and the property would have appreciated by $30,000. Or, he could have refinanced as he did and taken out a “profit” of $123,965 ($473,965 – $350,000). Since he probably put nothing down in the first place, this is pure profit.

If this borrower walks away from the loan, he pockets the $123,965 plus a year of free housing.

If this borrower stays, his gross equity is a negative $93,965 or -24.7%.

Hank, assume this borrower was facing a reset and could easily have made the old payment, what could you have offered him that would be to his benefit?

Property 2 – Ledgeview.

This property was last purchased for $274,000 on 10/3/02 and sold as an REO for $340,000 on 11/30/07.

In between, the borrower refinanced, took out a 1st of $345,600 and a 2nd of $86,400, totaling $432,000.

This borrower had a choice. He could have done nothing and the property would have appreciated by $66,000. Or, he could have refinanced as he did and taken out a “profit” of $158,000 ($432,000 – $274,000). Since he probably put nothing down in the first place, this is pure profit.

If this borrower walks away from the loan, he pockets the $158,000 plus a year of free housing.

If this borrower stays, his gross equity is a negative $92,000 or -27.1%.

Hank, assume this borrower was facing a reset and could easily have made the old payment, what could you have offered him that would be to his benefit?

Property 3 – Creek.

This property was last purchased for $82,500 on 2/27/81 and sold as an REO for $330,000 on 11/30/07.

In between, the borrower refinanced, took out a 1st of $356,000 and a 2nd of $54,000, totaling $410,000.

This borrower had a choice. He could have done nothing and the property would have appreciated by $274,500. Or, he could have refinanced as he did and taken out a “profit” of $327,500 ($410,000 – $82,500). In this case, since he held on for so long, it was only an extra $53,000 “profit”.

If this borrower walks away from the loan, he pockets the $327,500 plus a year of free housing.

If this borrower stays, his gross equity is a negative $80,000 or -24.2%.

Hank, assume this borrower was facing a reset and could easily have made the old payment, what could you have offered him that would be to his benefit?

Property 4 – Neddick.

This property was last purchased for $145,000 on 10/27/95 and sold as an REO for $322,500 on 11/30/07.

In between, the borrower refinanced, took out a loan in the amount of $432,000.

This borrower had a choice. He could have done nothing and the property would have appreciated by $177,500. Or, he could have refinanced as he did and taekn out a “profit” of $287,000 ($432,000 – $145,000), an extra $109,500 versus just hanging on without the refi.

If this borrower walks away from the loan, he pockets the $287,000 plus a year of free housing.

If this borrower stays, his gross equity is a negative $109,500 or -34.0%.

Hank, assume this borrower was facing a reset and could easily have made the old payment, what could you have offered him that would be to his benefit?

…I can keep going down the list and I can assure you that all the REOs tell similar stories.

Hank, these little guys are making out like bandits, at the expense of your Wall Street buddies. Tell your buddies there aren’t much you can do to bail them out. Tell them to take their lumps and move on.