bailout

Who Should Face the Music When the Banks Fail?

Sarah Winfrey — Tue, 27 Apr 2010 12:00:03 +0000

Over the last two years, we've all seen who do face the music when banks fail. It's the average people, the consumers and employees who see their income tank, their jobs disappear, and the prices of everyday products skyrocket. And most of us know that it's not fair. Average people, after all, are not usually the ones who made poor investments on a large scale or who set up a system that would be initially profitable but unsustainable in the long run.

Yet the people who did make those decisions aren't being held personally accountable for their actions. While they lost their investments and (sometimes) their bonuses, their overall net worth was not on the line. Many of the high-ranking people who helped cause the recent financial meltdown still have their mansions, private jets, and other trappings of wealth.

Is There Another Option?

James Grant thinks this is wrong. In an editorial for the Washington Post, the editor for Grant's Interest Rate Observer advocates holding wealthy bankers personally liable if their bank fails. All of their property would be available for auction if people lost money because of their investments and needed reimbursement. This wouldn't happen very often, though, because Grant thinks that having their own financial well-being on the line would be enough to motivate these people to make sound financial decisions aimed at keeping things running well for years to come.

Grant argues that this structure has worked before. It was the standard structure in America before the 1930s, when people had confidence in the financial system even though most of their investment's weren't insured. Brazil has recently instituted a similar policy, and their financial sector is more stable than it has been in years.

Would It Work?

Grant's is a nice thought. Even though the collected assets of most banks' controlling stockholders, senior officers, and directors wouldn't cover the losses sustained if their institutions failed, it would be nice to know that they were suffering at a level commensurate with the misery they've inflicted. But would it do more than that?

If Grant's thesis is correct and laws like this kept banks from failing, they would be worthwhile. However, they would serve their purpose only as long as they didn't have to be acted upon. They would function mostly to make the top financiers afraid. If the banks still failed, the people still wouldn't have recourse to enough money to make much of a difference in their suffering.

Would the catharsis of liquidating the assets of wealthy bankers upon the failure of their bank be worthwhile to you, even if the money didn't come close to reimbursing losses? What choice would you make?

Bonus: For other economics nerds out there, read another plan for forestalling future economic crises. What do you think?

This article is from Sarah Winfrey of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

CitiMortgage Told Me to Default on My Loan

Paul Michael — Mon, 29 Mar 2010 13:00:03 +0000

Only in the completely screwed-up world of the lending industry would this be a logical and serious piece of advice. But that’s basically what I was told after calling CitiMortgage to ask about help with my home loan.

Like roughly 25% of homeowners in the USA, I find myself owing more for the house than it’s worth. Now, before I get people screaming at me for biting off more than I could chew, that’s not the case at all. We did everything right: bought a modest home within our means, didn't cash in on equity (when the house had equity) by refinancing, never missed a mortgage payment, ever. And now, some seven and a half years later, our modest little home, which we have completely grown out of, has an even more modest value. It’s lost 25% of it’s value in fact, and we now owe more than it’s worth.

We can’t rent the home out without losing serious cash every month. That’s because we would have to charge rent based on what the house is worth. And that would leave us roughly $500 a month out of pocket on the mortgage.

We can’t sell without taking a serious chunk of money with us to the closing table. We’re talking $20k-$30k, which is money we don’t have to spare. Not many people do these days. But if we did, would we want to completely wipe out our savings on a piece of property we were leaving behind?

We can’t just stop paying and walk away. Trust me, I’ve never had a bad debt in my life, so I don’t want to start now. I was seriously considering it though. But in Colorado, the financial institution has every right to come after you for any money they lose on a property that’s been foreclosed on. We could not only lose our savings, but our cars, possessions, and everything else. This is called a deficiency judgment. Some states have it, some don’t. Mine has it, so it’s impossible for me to walk away from this money pit of a home without suffering some huge consequences.

What about a short sale then? Well, it’s possible, but there are issues with that too. Short sales are notoriously difficult to arrange. We’d have to put our home on the market and get an offer. And after that, we’d have to hope the lender accepts the offer. If they don’t, we have to start again. This could take months or years. And the whole time, we’re sinking money into a house that continues to lose value.

The whole “buy property, it’s a guaranteed investment” mantra is now just hot air. But what do we do? We’ve seriously outgrown the home, one which we bought as a single couple and now have two children. With no basement and a garage that’s bursting with stuff, we continue to give things away to charity, or just throw things out. Even with a regular spring clean, we're just running out of space.

We decided to turn to CitiMortgage and see if they could help us. After all, a recent article about Bank Of America gave us hope. They’re now helping people like me out by reducing the principal owed on the property! That’s right, they’re actually slashing money off the books.

Anyway, I went to CitiMortgage.com and filled out the form in the homeowner assistance section.

I was delighted to see that, after putting in my information, we were indeed eligible for some help. I just had to submit some proof of earnings, which was no trouble at all. I then got a call from CitiMortgage a few days later, asking me to call them back and talk to a counselor! Excellent, I could see a glimmer of light at the end of a long tunnel.

Then, the games of phone tag began. I called, was put on hold for 10 minutes, and the line went dead. I got a call back asking to call again. I did. I was put on hold for 10 minutes, then the line went dead. Argh!

I was not happy.

The third time I called, I finally got through to someone. As it turns out, there was actually no counselor assigned to me at all. No one was sitting behind a desk, filled with great information and some paperwork that could help me out. No, as it turns out, there really wasn’t much they could do, or rather, were willing to do for me.

“I was told I had a counselor,” I said.

The customer service rep, who clearly had no interest in me or my predicament, told me that no one was assigned to me and there’s really nothing they can do right now.

“What about this Bank Of America program that’s out there right now, helping people who are upside down on their mortgage?” I asked. “Do you have plans to help in that way?”

“No” was the cold and curt reply.

I did a quick calculation in my head and realized I had given CitiMortgage over $100,000 in interest over the last 7 and a half years. Actually, way more than that. And all I had to show for it was a house that requires many thousands more dollars just to walk away from. If I had dropped $100,000 at a casino, I would be getting the red carpet treatment. If I dropped 100,000 bones on a new car, the salesmen would be breaking their backs bending over to help. But CitiMortgage? Sorry, no dice. Which I find odd, because my tax money, and yours, went to CitiMortgage in the form of billions of dollars of stimulus money. They received 1 billion dollars from the government, and their parent company CitiCorp got a whopping 45 billion dollars!

“Is there ANYTHING you can do to help me?” I asked. I had read earlier that CitiMortage was supposed to be helping homeowners who are underwater, so I knew there must be something they could do.

And that’s when this salient piece of advice came over the telephone.

“We can’t help you unless you have defaulted on the loan for 90 days” was the almost robotic reply.

Wait, did I hear that right? Is this lady telling me to stop paying my mortgage? Isn’t that some strange advice? I double-checked.

“Are you telling me that there’s nothing you can do to help me out until I actually stop paying you?”

“Yes” she said, “but even if you default there’s no real guarantee we can assist you.”

“So, I could wreck my credit, have debt collectors calling day and night, risk being kicked out, and it could all be for nothing anyway?” I asked.

“Yes.”

So, that’s where I stand today, and I suspect many of you are in the same boat. Why, why, why would any financial institution want their customers to stop paying them? Why will they only help bad customers? Why is defaulting the only way to get help? Why are good payers being treated poorly, and people who can’t pay getting the royal treatment?

I’m now finding myself in a position I never, ever thought I would be in. I’m considering just stopping the payments and putting the money in the bank. I figure the worst that can happen is that I just have to pay that money back to CitiMortgage at some point, but in the meantime it can sit and collect interest for me.

If anyone out there works for CitiMortgage, or a similar lender, please let us all know why you won’t help people unless they stop paying you. And why the bailout money you received isn’t helping the loyal customers as well as the poor payers?

I, for one, am just completely thrown by this whole situation. And, for the time being, I may be living in my small house and tripping over my things, but at least I’ll be doing it for free. Hey, not my suggestion. It was CitiMortgage’s idea.

This article is from Paul Michael of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

"Cash for clunkers" bill passed by Congress - what does it mean for consumers?

Xin Lu — Fri, 19 Jun 2009 07:09:50 +0000

A few months ago I wrote about several car buying incentives that were floating around. This was before the bankruptcy of Chrysler and GM and there was a rumor going around that the government would push consumers into buying new cars with a trade in program. Now it is official that a "cash for clunkers" bill has passed by both the Senate and the House. This $1 billion program was attached to the $106 billion war spending bill and offers vouchers to consumers who trade in their gas guzzlers. Here are some details on the program.

First, the cars eligible for trade in must be built in 1984 or later and get no more than 18 miles per gallon according to the Environmental Protection Agency's combined city-highway rating of a given model. You can find out the mileage per gallon of your car at http://www.fueleconomy.gov. The cars also have to be have been owned and insured by the purchaser for at least a year. I guess this is to avoid potential abuse where someone could purchase a piece of junk for a few hundred bucks and trade it in for much more money.

A consumer who trade in a car would receive at least a $3,500 voucher towards a car that gets at least 22 miles per gallon, and if the new vehicle gets more than 10 miles per gallon than the old car the voucher value would increase to $4,500. For small trucks and minivans that get at least 18 miles per gallon a consumer would receive a $3,500 voucher for a trade in that gets two more miles per gallon, and a $4,500 voucher for a trade in that gets five more miles per gallon. For a large truck that gets at least 15 miles per gallon a $3500 voucher would be issued for a trade in that gets at least one mile more per gallon, and a $4500 voucher would be awarded for a trade in that gets at least two miles more per gallon. The new cars must be priced at $45,000 or less, and both domestic and import brands are eligible.

The "clunkers" that are turned in by the consumers would be scrapped, so there is no trade in value other than the voucher itself. Therefore it would not make sense to turn in cars that are worth more than the voucher under this program. The $1 billion currently legislated is projected to last until September and the program is supposed to start sometime around August after the president gives final approval. The program is designed to last an entire year from the date of its enactment, but more funds for the program are yet to be found. It is possible that consumers may not have a very long time to take advantage of the program.

Obviously, car dealers have a reason to celebrate this new development because it is expected that it will lead to a lot of new car sales, but some are skeptical about the wisdom of this decision since it is another taxpayer funded program that seems to be bailing out a particular industry. Critics also say that the small amount of mileage increases required would not help the environment very much. What do you think? Do you have a clunker that you could trade in?

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Mortgage bailout redux: new incentives for modifying second mortgages in the Second Lien Program

Xin Lu — Thu, 30 Apr 2009 00:48:55 +0000

The United States government launched the "Hope for Homeowners" program back in October, 2008, and so far only one loan has received final approval to refinance under this program. This week the Obama administration took another step to expand incentives to banks and borrowers to modify mortgages. This time, the plan targets second mortgages and it is called the Second Lien Program.

Second mortgages were extremely popular in the past few years because they allowed a borrower to essentially borrow 100% of the purchase price of a home and avoid a Private Mortgage Insurance payment. Typically, the insurance is required on homes with loans that were bigger than 80% of the value of the home. In order to get around this requirement, many borrowers signed up for a first loan at 80% of the value of the home, and a second loan at 20% of the value of the home. Currently more than half of troubled first mortgages are tied to a second mortgage
.

Now that home prices have gone down by more than 30% in most of the nation, many homeowners with second mortgages may have problems refinancing their first mortgage because they need permission from the lender of the second mortgage. Now the Obama administration is offering cash to lenders to modify these mortgages and also money to borrowers to pay on time. Here are some of the highlights of this new development.

The second mortgage servicer gets $500 for modifying a second mortgage and $250 a year performance bonus for three years as long as the borrower continues to pay the mortgage on time.
Borrowers can receive $250 per year for up to five years as long as they are current on the second mortgage. This will be used to pay down principal on their first mortgage.
Non-interest only second mortgages will have interest rates reduced to 1% for five years.
Interest only second mortgages will have interest rates reduced to 2% for five years.
If lenders cancel or extinguish a second mortgage, they can get a payout possibly worth more than the second mortgage from the government based on a pre-set formula.
Modification of the first mortgage automatically triggers a modification of the second mortgage if they are held by participating servicers.
Modification of the second mortgage should not delay the modification of a first mortgage.
The Hope for Homeowners program is now part of the Making Home Affordable Program, which means that the same incentives discussed a couple months ago will apply to the older program.

Once again, I think this an expensive and temporary bandaid on a huge wound. This could definitely give some borrowers some breathing room, but it would last only five years, and these borrowers would essentially lose all the money they pay because their home is no longer worth as much as before. The second mortgage is a financial vehicle that enabled the instant gratification mentality because it is crucial in many 100% financed homes. It seems that spending billions to sustain these mortgages is even more irresponsible than the bailouts of the past.

What do you think of this new program? Will you get your second mortgage modified?

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Could you profit from Obama and Geithner's toxic assets plan?

Xin Lu — Wed, 25 Mar 2009 01:27:28 +0000

This week the United States Treasury announced the Legacy Loans Program. The program is meant to be a partnership between the government and private investors to clear "toxic" assets off the books of banks. Some large financial firms have expressed that they may set up mutual funds to buy these assets. Could you possibly profit by buying these funds as an individual investor?

First of all, lets explain how this plan from the Treasury works. First, banks pick out the loans and mortgage backed securities they want to sell. Then private investors would bid for these assets through the program, and the highest bid wins. Presumably these investors should have done their research and evaluated how much they are willing to pay for the assets. Next, the FDIC will finance a significant part of the purchase at a subsidized rate for the investor. The Treasury will kick in another portion of the purchase price, and the investor puts in cash equivalent to the amount the Treasury puts in. The amount the FDIC finances is at most six times of what the investor contributes.

Here is an example with actual numbers from the Treasury press release:

Sample Investment Under the Legacy Loans Program

Step 1: If a bank has a pool of residential mortgages with $100 face value that it is seeking to divest, the bank would approach the FDIC.
Step 2: The FDIC would determine, according to the above process, that they would be willing to leverage the pool at a 6-to-1 debt-to-equity ratio.
Step 3: The pool would then be auctioned by the FDIC, with several private sector bidders submitting bids. The highest bid from the private sector . in this example, $84 . would be the winner and would form a Public-Private Investment Fund to purchase the pool of mortgages.
Step 4: Of this $84 purchase price, the FDIC would provide guarantees for $72 of financing, leaving $12 of equity.
Step 5: The Treasury would then provide 50% of the equity funding required on a side-by-side basis with the investor. In this example, Treasury would invest approximately $6, with the private investor contributing $6.
Step 6: The private investor would then manage the servicing of the asset pool and the timing of its disposition on an ongoing basis . using asset managers approved and subject to oversight by the FDIC.

Why is this attractive to investors? First of all, it is possible that they will be getting a significant discount on performing loans and securities through the bidding process. Also, the investors are putting up a much smaller stake than the government so the leverage gives them bigger returns. Lets revisit the sample investment. Suppose the $84 investment ends up being worth $90, then the net profit is $6. Of this $6, the investor gets $3, and the Treasury gets $3 because they put up the same amount of equity in their 50/50 partnership. The FDIC gets its $72 loan paid back. This means that the investor gets a 50% return on their principal of $6 while the government technically gets a 3.8% return on its principal of $78. The goverment will also get some fees and loan interest paid by the investor related to the FDIC loan, but for the government to get a 50% return these fees and interests would have to add up to $36, and that is very unlikely.

So what happens if the assets are actually worthless? The loan the FDIC makes to the investor is a non-recourse loan, which means that the investor could walk away and the most he or she would lose is $6 plus any fees and interest paid in case the $84 investment is worth nothing. On the other hand, the government or taxpayers stand to lose a combined $78. So basically, most of the downside of the investment will be shouldered by the American taxpapyers.

It should be interesting to see how this plan turns out. Personally, I believe that some investors with deep pockets could potentially profit handsomely from this plan if they manage to somehow bid intelligently on the assets they buy. Currently at least three mutual fund companies are considering starting mutual funds to buy these toxic assets, and these funds will allow smalltime individual investors to get in on the action. However, these assets are still extremely risky because noone seems to know what they are actually worth so they are truly a gamble. I definitely would not bet my retirement on these funds, but considering that I already pay tens of thousands of dollars in taxes to support the program, perhaps it is not a bad idea to invest on the side that may give a positive return.

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Should The AIG Bonuses Be Taken Away Or Not?

Carlos Portocarrero — Tue, 24 Mar 2009 19:50:33 +0000

Everyone's making a huge stink about the $165 million in AIG bonuses that were recently paid out. It seems everyone is trying to figure out a way to take that money away from the people that were meant to receive them. The latest idea is to tax the bonuses at a 90% rate, which basically reduces them to nothing. Or for reference—closer to my bonus (just kidding, day job!).

But it doesn't look like it's going to happen. There are some legalities involved with taxing a specific group of people like this. As in, it's probably not cool. As a Biden economist says:

I think the president would be concerned that this bill may have some problems in going too far — the House bill may go too far in terms of some — some legal issues, constitutional validity, using the tax code to surgically punish a small group.

Why is the government looking into such drastic ways to take these people's money away? It's simple: we're all angry when we see a company that's getting bailed out paying out huge bonuses to the very people we believe put them in that mess. And we want payback.

Laying Blame

It's understandable to be upset, but is it right? Should these people have their bonuses taken away when they were contractually obligated to receive them? And if somehow they were taken away, why would these (presumably great) employees stay at the company? Why wouldn't they all take off, leaving AIG devoid of all the good talent that's left?

AIG could do several things here. They could encourage the employees to return the bonuses, or a portion of the bonus, like ING has done. Or the execs that are getting paid could volunteer to return all or a portion of the money. After all, who wants to be known as the guy who took a fat check when the company was tanking faster than ARod's reputation?

Right?

Think About It

Think about this long and hard before you answer because it brings up a very important point.

Would you return your bonus if your employer was involved in something that put it in crisis mode?

What if you had absolutely nothing to do with it though? Part of AIG's business (insurance) is a great company and does great work. What if you were an outstanding employee that brought millions of dollars of revenue to the company thanks to your hard, honest work? Would you still think about returning your bonus?

I wouldn't.

I'd keep it. I'd save it, especially these days. Or maybe I'd go to Paris for a month until it all blew over. I earned it.

My wife and I were having this conversation the other day and we couldn't agree. She felt that AIG employees shouldn't keep the bonuses—that it was unconscionable when the company is getting bailed out and tumbling faster than a 14-year-old Chinese gymnast. But when I asked if she would accept responsibility if her own company faced something similar, even if she did nothing wrong, she had to think about it.

And that's what I want people to do. Think a little bit harder about it before joining the millions of people calling for the heads of the AIG bonus babies. Not all of these people messed up. These bonuses were in their contract, so if you want to be upset then direct it at the people who wrote the contract (AIG). The law says AIG has to pay them. Taking the money away by taxing them at 90% is probably illegal, especially when it's being done simply to satisfy the angry mobs out there.

For a more detailed analysis on the AIG story, check out Michael Lewis' article about it—he's one of the few people writing about the "other side" of this story (he's also my hero, btw).

Now if you don't mind, I have to go submit my resume for a new position over at AIG: fall guy. The pay is OK but I hear the bonuses are pretty sweet.

This article is from Carlos Portocarrero of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Will Obama's new mortgage plan really reward responsibility?

Xin Lu — Thu, 19 Feb 2009 07:13:52 +0000

Today President Obama announced a new $75 billion Homeowner Affordability and Stability Plan to the world. It is touted as a plan that helps responsible homeowners who have not yet missed payments. However, will it really reward responsibility? Lets take a quick look at what is in the plan.

First, this plan will provide low cost refinancing for homeowners who have underwater mortgages. Since a lot of homes lost large chunks of equity in the past few years many people cannot refinance into lower rates right now. This plan basically allows people with conforming Fannie Mae or Freddie Mac loans to refinance at market rates. This actually is not very different from the existing Fannie Mae to Fannie Mae streamline loan that does not require new appraisals. The homeowners should be making ontime payments on their loans and this would just reduce their payments. This portion of the plan is supposed to help 4 to 5 million people who have mortgages guaranteed by one of the GSEs. Jumbo mortgage holders are out of luck.

The next portion of the plan is meant to stop struggling homeowners from going into foreclosure. Basically the government will give lenders incentives to modify loans so that a borrower's mortgage is no more than 38 percent of his or her income. Then the initiative would lower the payments down to 31 percent with more subsidies. This lowered rate would last for at least five years, and then be stepped up. Incentives to servicers include an up-front fee of $1000 for each successful eligible modification, and also up to $1000 each year for three years as long as the borrower is current. The borrower could also get $1000 per year for five years for staying current.

Another portion of the plan that encourages housing price stability is to discourage lenders from foreclosing on mortgages. Basically, the Treasury department will create an insurance fund of up to $10 billion to guarantee against home price decline. Basically the lenders will be receiving insurance payments on modified loans to guard against housing price drops.

Personally, I like the portion of the plan that lets responsible borrowers refinance into lower rates. I know several people who bought in the last few years and have no trouble paying their mortgages. However, they cannot refinance now because their home values have gone down 20% to 30% and their downpayment is gone. This will help them tremendously and cut their monthly payments by hundreds of dollars. The money they save could be spent on other things. It is unfortunate that it only applies to Fannie Mae and Freddie Mac loans, but I guess there is also comfort in the fact that the government cannot twist private investors' arms to accept low rates.

As to the second portion of the plan, I am not too sure how the servicer incentives will work out. In recent years mortgage servicers have been quite unscrupulous and rewarding them may not be such a good idea. I understand that many struggling homeowners are trying to do the right thing and keep their homes at all costs, but the reality is that it just may not be worth it to keep a loan that costs as much as 38% of a family's income. Considering that more than half of loan modifications failed last year, it seems like the servicers would come out the ultimate winners by collecting thousands of dollars in bonuses and then foreclosing on the homes.

More details about how to qualify for these refinances and modifications will come to light on March 4th. If you are eligible for the refinance and modifications, then you should get your ducks in order right now. Some documents you should have ready are paystubs and W-2s. You should also try to improve your credit score in case there is a lower bound on credit scores. I can see this plan helping many people reduce their mortgage payments, but many others may just end up being tied a bit longer to debt they cannot pay.

What do you think? Does this plan really reward responsible borrowers or does it stink of bank bailout? Feel free to leave your thoughts in the comments!

This article is from Xin Lu of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Should We All Just Stop Paying the Mortgage?

Paul Michael — Thu, 16 Oct 2008 15:42:00 +0000

I've been recovering from surgery recently, so that has given me the opportunity to do a lot of thinking on my sick bed. And with the recent turmoil in the economy, plus a focus on the housing market, I couldn't help a certain thought from bubbling up in my mind day after day. It's not responsible; it's not even fair; but I do have to wonder…should we all just stop paying the mortgage? (See also: How to Refinance Your Mortgage)

From what I understand, the $700 billion bailout plan has some provisions in it that will help struggling homeowners. John McCain also recently talked about using $300 billion of that money to "buy back" bad mortgages to help the struggling homeowner negotiate a decent, fixed rate. They may even renegotiate the cost of the mortgage, so you only pay what your home is now worth, not what you actually owe. Sounds great, right?

But it got me thinking…what about the people who did everything right? Take someone I know well — me. I bought my house almost seven years ago. I stayed well within my means and avoided any adjustable rates or sub-prime loans. I got myself a nice, traditional 30-year fixed mortgage at a good rate. I even got the homebuilder to pay the closing costs without rolling them into my loan.

Now, after being a homeowner for seven years, I am proud to say that I have NEVER missed a mortgage payment. Ever. Sure, times were tough on occasion. Sometimes I would pay the mortgage a few days late because there just wasn't enough cash in the bank. But the mortgage was paid, even if it meant staying home every night and eating Ramen occasionally.

What's more, I never used my home as a bank account. Even when the home was worth more than we paid for it (ahh, remember equity?) I never refinanced. I never got a home equity loan. I just stayed the course, knowing that after about five years my growing family would have some ready funds available to upgrade to a bigger home. (See also: Things You Should Know Before You Buy Your Second Home)

Well, all those plans were shattered. Now, my home is worth 15% less than I paid for it. I will be lucky if I break even when I sell it, considering the dreadful market and the associated costs involved in selling a house. My wife and I are even thinking of renting it out, and renting a bigger place for ourselves. With the market the way it is, we can rent a house twice the size of ours for the same price as the mortgage.

But here's the big question. Should we just stay in the house and stop paying the mortgage completely? An article I recently read by Peter Schiff seems to confirm my thinking. Let's look at the pros and cons. First, if we stop paying the mortgage we know we won't be kicked out. There will be a moratorium put on foreclosures, so we could quit paying our largest bill and put that money in the bank, ready to use to buy a new home.

Second, as we have now stopped paying our mortgage we would fall into the category of "struggling homeowner." Which means, ladies and gents, that the government will swoop in and help us out! Yep, as unfair as it sounds, we'll get help if we suddenly become irresponsible. My mortgage would be renegotiated, probably at a lower rate, and for the current price of my home. Plus, I'll have saved thousands on mortgage payments until that happens. It could take six months…that's around $10,000 we'll have saved.

The only downside I can see would be a tarnished credit rating. But so what? For the amount of money I'm saving, it seems well worth it. And I'll still keep my house. (See also: 10 Surprising Ways to Hurt Your Credit Score)

This is wrong. I will, no doubt, keep paying my mortgage. But I cannot help but be angered by this whole system. It is rewarding people who made bad, bad choices. No one forced anyone to buy a home way bigger than they could afford. No one put a gun to Joe Schmo's head and said "Hey, sign this, take a huge mortgage and do it with an adjustable, interest-only rate." And yet those guys, the ones who bit off way more than they could chew, are now going to get help. They get to keep their big house and pay a nice new low-rate mortgage. They don't even have to pay back the money they didn't pay on mortgage payments.

Now, there are exceptions to the rule. People who lost their jobs and couldn't pay the mortgage, they genuinely need the help. People who got sick and had massive medical bills to pay, fair enough. But for the average greedy speculator who bought too much house with no money down and a sharply rising interest rate…well, in my opinion, that person should have to live with the consequences. I have my own problems, as do many of you. But why should my hard-earned taxes bail out the irresponsible segment of our society? It's complete BS.

The one reason I've been given is that we need to help these people, or our home values will suffer. But the market has pretty-much bottomed out anyway. So, that's no consolation to me. No, I'm mad as hell and I just can't think of a better way to prove it than to stop paying my mortgage and get in on this nationwide handout. How about you?

This article is from Paul Michael of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

How a $700 billion bailout became a $800 billion "rescue plan"

Andrea Karim — Fri, 03 Oct 2008 22:07:02 +0000

You know how, when the bailout package was first proposed by Henry Paulson and Ben Bernanke, Congress and the public were generally outraged that the Fed Chairman and the Secretary of the Treasury would ask for so much money to bailout large corporations and Wall Street? Seriously, Congress was all "OMGWTF, $700 billion!?!?!? That's, like, nearly a trillion dollars! FAIL."

Joe Public probably thought that Congressional outrage was along the same lines of the outrage felt by most tax-payers. Something like "Shucks, that's a heckuva lot of money."

Turns out what Congressional leaders meant was: that wasn't nearly enough. That's why the Senate and the House both passed a bail-out bill that now includes 100 billion dollars in pork, for a grand total of $800 billion.

How on earth did Congress manage to pack so many earmarks into such a bill. Here are some of the tax benefit recipients, as listed by the San Francisco Chronicle:

$2 million tax benefit for makers of wooden arrows for children
$100 million tax break to benefit auto racetrack owners
$192 million in rebates on excise taxes for the Puerto Rican and Virgin Islands rum industry
$148 million in tax relief for U.S. wool fabric producers
$49 million tax benefit for fishermen and other plaintiffs who sued over the 1989 tanker Exxon Valdez spill

How ridiculous are these (with the exception of the rum benefit, of course) tax benefits?

But wait, there's more - for instance, Washington residents (as well as residents of Texas, Nevada, Florida, and Wyoming) can continue deducting their sales tax from the their federal taxes, something I've never taken advantage of because I am too lazy to save my receipts.

The bill passed the house by a vote of 263-171, meaning that 58 more Representatives voted for the bill today than on Monday, when the bill was defeated by a few dozen votes just before Congress all pretended to be Jewish so they could take Rosh Hashana off and go drink some of that subsidized rum and shoot wooden arrows at each other.

I'm not one who thinks that earmarks are all bad, not by a long shot. But I find it interesting the lawmakers who were completely obsessed with government waste and disturbed by government intervention and special interests were happy to pass along over $100 billion in pork.

Anyone else bothered? Does this seem hypocritical? Especially considering that there are no actual revisions or reforms to the laws that govern the mortgage industry to begin with?

Other fun things to consider:

The money being used to finance the bailout doesn't technically exist. Yet.
The result of creating the funds necessary to fund the bailout can crush the American dollar in a landslide of inflation.
Some former members of Congress would like to further deregulate industry accounting practices by repealing part of the Sarbanes-Oxley Act of 2002. You know, the part that dictated that companies "must value the assets on their balance sheets based on the latest market indicators of the price that those assets could be sold for immediately".

This article is from Andrea Karim of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Download the 451-page bailout proposal

Paul Michael — Wed, 01 Oct 2008 19:08:03 +0000

Well folks, I hope you have plenty of time on your hands. The initial 3-page document that Bush and Paulson put forward has grown somewhat. It's hardly surprising, considering how much of a broad sweep the initial bailout plan was. However, you have to wonder how many people out there have the time, patience and understanding to read a 451-page economic document. But, if you want, you can download it right here.

Simply click this link and you should be prompted to save the entire document to your computer. For those with slow connections, this could take a while. But certainly nowhere near as long as the monumental read that awaits you. A document like this could hide all sorts of legal loopholes and technicalities, so I hope there are plenty of non-partisan economists looking through this for the sake of every American taxpayer. Happy reading.

Note: This PDF was current at the time this article was published. These days, an hour is a long time in politics.

This article is from Paul Michael of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Root cause of the financial crisis

Philip Brewer — Tue, 23 Sep 2008 18:21:19 +0000

Several times recently, Treasury Secretary Paulson (and many others) have claimed that the "root cause" of the current financial crisis is "the housing correction." This is completely wrong--and unless policy makers realize that it's completely wrong, they're not likely to make the right policy decisions.

Just today, in his testimony before the Senate Banking Committee, Paulson said:

And that root cause is the housing correction which has resulted in illiquid mortgage-related assets that are choking off the flow of credit which is so vitally important to our economy. We must address this underlying problem, and restore confidence in our financial markets and financial institutions so they can perform their mission of supporting future prosperity and growth.

Now, first of all, the proposal doesn't address the housing correction--it addresses the illiquid mortgage-related assets (by buying them)--so it's still a step removed from what Paulson claims is the root cause. (Directly addressing the housing correction would involve buying houses, not buying loans.) But that's neither here nor there, because the root cause is not the housing correction. The root cause was the housing boom.

Roughly speaking, an average household needs to earn enough money to be able to afford an average house. You can adjust that a bit--smaller, younger, poorer households can be left out of the calculation if you assume that they'll rent rather than own--but after leaving them out, it's just not sustainable for the average house to cost more than the average household can afford to pay--who else is going to buy it?

Now, you can back things up yet another step in your search for root cause: How did house prices get too high? The answer to that question (which has mostly to do with bad interest rate decisions from the Fed interacting with bad public policy in financial market regulation) will help us prevent the next financial crisis. But for addressing this financial crisis, all we need to understand is that the correction is not the root cause. The root cause is that house prices got so high that the average household couldn't afford an average house. Once that happened, a correction was inevitable.

The way to address the root cause is to let house prices drop to where an average house is within the means of an average household. (Or, alternatively, boost the income of the average household to the point that they can afford an average house. But that's very hard. Letting houses prices go on falling, although painful for everyone who owns a house or who has lent money to someone who owns a house, is very easy.)

Now, some sort of bailout plan may be necessary to keep the financial system from simply collapsing under the weight of all that bad debt. But if that plan is focused on keeping house prices from falling, it's a hopeless plan. If you successfully kept house prices up, we would remain mired in this problem until incomes rose enough to make house prices affordable.

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Me too, Secretary Paulson!

Philip Brewer — Sun, 21 Sep 2008 16:08:05 +0000

Dear Secretary Paulson: I've looked over the fact sheet on the proposal to give the Treasury the authority to purchase "troubled assets," and although I have some doubts about the wisdom of the program, if there's going to be one, I want to get in on it!

With that in mind, I thought I'd sent you a quick list of some of my troubled assets, so that you can make sure the appropriate people know about them, when they start buying. (I have no doubt that others are doing much the same thing, so I wanted to be sure to get my request in early.)

I guess my biggest category of "troubled asset" is clothing that doesn't fit. Not only do I have quite a bit of money sunk into these assets--which are worth much less than I paid for them--but they've got my closet filled to the point where there's scarcely any room for my wife to store her wool! (She's a spinner and weaver, so she has lots of wool to store.) Because of that, I'd be willing to let my old clothes go for a substantial discount from their original cost. I don't know if the Treasury would have much hope of realizing a profit on these assets--but if the dollar goes on losing value, we might no longer be able to afford to import clothes from abroad, in which case, they just might have more value than I realize.

The next category of "troubled asset" that I'd like the Treasury to take off my hands are old books. I've got lots of them. Since the internet has made it easy to buy and sell used books, the value of most used books has plummeted! Check the prices of used books at amazon.com, and you'll see that many books are worth less than the cost of shipping them--even if you ship them book rate! (They call that "media mail" now, but I'm old enough to still think of it as book rate.) Anyhow, these assets are quite troubled. They are not only worth a lot less than what I paid for them, they're also (like the old clothing) taking up a lot of room--my book cases are completely full, and I've got stacks of books all over the place!

I wanted to mention those two categories first, because they're the most important to me. I understand, though, that you're mainly focused on financial assets. My own financial assets have held up pretty well so far, but I do have some stock in a certain former employer that's done quite poorly. I can't really say it's "clogging up" my balance sheet, but if the Treasury could take it off my hands and get the economy going again, it could be a win-win.

Thanks very much for your thoughtful consideration, Secretary Paulson, and I hope you'll let the appropriate people know so that my trouble assets can be included when you start buying. I want to assure you that my old clothes and books can be had for a tiny fraction of the $700 billion that you're talking about spending. I'll need much less than 1% of the money--much, much less! You don't have to worry about me hogging the program. And, thanks again.

Yours sincerely,
Philip Brewer

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

They used to call it "loan workout"

Philip Brewer — Fri, 30 Nov 2007 21:15:17 +0000

It has never been unusual for borrowers to run into difficulty, and sometimes it becomes clear that a loan will never be repaid in full. The lender's job then is to recover as much money as possible. Because foreclosures are expensive and the eventual recovery is uncertain, it's often a better bet for the lender to restructure the loan--settling for less than they are owed, but more than they'd get in a foreclosure. One of things that has made the subprime debacle go from bad to worse is that loan workout is much tougher when loans are securitized--sold, packaged, diced up, and sold again.

Banks used to have whole departments dedicated to loan workout. (No doubt they still do, but since banks mostly don't hold mortgages any more, their loan workout departments don't get involved when a mortgage goes bad these days.) The structured investment product that mortgages get packaged into these days is a trust, and those trusts are very nearly not in the "workout" game at all.

Packaged loans

One aspect to the packaging of these loans was a division of a package of loans into groups (called tranches, from a French word meaning slice) based on quality. The quality determination, though, isn't made in advance. Rather, they work like this: The first (best) tranche gets all the payments until it's investors have been paid what they're owed. Once they're paid, the second tranche gets all the payments, and so on, until the fifth tranche gets whatever hasn't gone to any of the previous tranches.

Different investors were interested in different tranches. A pension fund might have paid top dollar for the first tranche, which was expected to provide predictable income for many years. The fifth tranche would pay less (starting as soon as the first borrower missed a payment), but would also cost less, and could turn out to be a good investment for a hedge fund that bought it cheaply enough.

It turns out that--and this is the whole point of the thing--because different investors will pay up to get exactly what they want, the selling price for tranches one through five add up to more than the sum of the value of the individual loans that went into the package.

Predictable value

The values of the individual tranches were calculated according to complex mathematical models. Everybody involved in the arrangement--the banks who created the packages, the investors who bought them, and the agencies that gave them credit ratings--had their own models, but all those models depended on predictability. If some loan officer could look at a loan and decide that this or that loan might pay more if a workout kept it from going into foreclosure, that predictability was lost--and once the predictability was lost, the valuation model would become less dependable.

To avert that threat, the trust documents that created these packaged investment vehicles often drastically limit the ability of the trust to modify the terms of the loans.

No more workouts

The upshot is that several of the incentives to workout problem loans no longer exist:

No customer relationship. A local bank knows its borrowers--they are probably depositors, and very possibly future borrowers. In addition, they might have any number of other connections to the bank. For example, they might be a key employee at a local business that is an important customer of the bank.

No incentives. There's real work involved in restructuring a loan. Some fairly smart person needs to look at the collateral, look at the borrower's finances, look at the loan terms, and decide whether the best return to the lender would come from a workout or a foreclosure. And after all that, it often turns out that a foreclosure is still the best plan. Somebody would have to pay people to do all that work, and there's no particular incentive for the trusts that own the loans to do that. They get paid a fee to manage the payments, and it's much simpler for them to just routinely foreclose, even if it brings in less money--after all, it's not their money.

Limited legal options. Since the legal document that creates the trust limits the ability of the trust to modify the terms of the loans (in the name of predictability), there is simply no one with the authority to negotiate a workout agreement.

Fixing the problem

Because of the nature of trusts, there's often no way for the parties involved to solve this problem--there is simply no one who can decide to change the terms of a trust, even if all the interested parties were inclined to agree. The result of that is that the federal government is getting involved. I have a post coming up about government efforts to fix the foreclosure crisis.

(The picture for this post is of a statue of Alexander Hamilton, who architected a restructuring of the revolutionary war debt of the new--and essentially bankrupt--United States of America. His plan established the credit of the new country, which has not missed a payment on its debt since.)

This article is from Philip Brewer of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: