On the morning of Wednesday, March 26th, 2008 throngs of organized protesters belonging to the Neighborhood Assistance Corporation of America ("NACA") poured into the lobby of Bear Stearns shouting slogans to employees and bystanders alike. Participating NACA members are angry with the Fed's recent action to "bail-out" Bear Stearns and were intent on getting their message out. Muniwiseguy was promptly on the scene a couple hours after the protest to interview members of the NACA. After their protest at Bear Stearn's office the NACA regrouped at the side entrance of St. Bart's Church in midtown Manhattan.
"SUPPORT MAIN STREET NOT WALL STREET"
NACA members could be spotted on the scene with yellow T-shirts emblazoned with the words "Stop Loan Sharks" superimposed over the figure of a shark. Fliers were distributed entitled "Support Main Street Not Wall Street" which criticized Bear Stearns, JPMorgan, the Federal Reserve and the Bush Administration for actions related to the housing bubble. The NACA's message today was largely one of opposition to the specific action by the Fed to bail out Bear Stearns but it was clear after speaking to NACA members that the goals of their organization is much broader. According to the NACA website: "The [NACA] is a non-profit, community advocacy and homeownership organization. NACA's primary goal is to built strong, healthy neighborhoods in urban and rural areas nationwide through affordable homeownership."
Muniwiseguy was able to speak with Darren Duarte, the NACA Director of Public Affairs, who was very helpful in describing the purpose of the protest and sharing his thoughts on the real estate market in general. Darren expressed his concern that parties involved in the mortgage market did not have the best interests of the homeowner in mind. Mortgage brokers, investment bankers, loan servicers and rating agencies "did not have any skin in the game" according to Darren. He believes that many of the market participants knew that the mortgage loans were going to fail but they simply didn't care.
The recent market innovations that bifurcated the role of mortgage originator and mortgage holder have created an incentive structure that benefits mortgage originators with weaker underwriting standards. As a mortgage broker, the upfront origination fee of 1% is going to be paid so long as the mortgage can be sold to someone else. There was some protection against lackluster underwriting standards in the form of Early Payment Default ("EPD") provisions, which allow for contingent put rights if a certain number of mortgages within the mortgage pool experience defaults in a certain period of time (generally the first few months). Beyond the EPD provisions, market participants had successfully divorced the role of origination, and hence underwriting, from the role of bearing credit risk.
THE NACA SOLUTION
No protester is worth his or her muster without a feasible set of solutions to the problems that he or she is identifying and speaking out against. NACA has provided the following four point proposal to "Support At-Risk Homeowners": (i) Stop all interest rate increases; (ii) Roll back all interest rate increases to initial-qualified rate; (iii) Impose a moratorium on all foreclosures; and (iv) Restructure mortgages to affordable monthly payments. Darren mentioned the use of a "safety and soundness directive" on the part of the Fed as the mechanism to modify the mortgage contracts.
NACA is completely right to oppose the Fed bail-out of Bear Stearns. Participants in the capital markets must realize that their actions do cause real and irreversible effects up to and including bankruptcy. Without this specter and fear constantly reminding our bankers that risk comes with a cost, we will, in the end, subject ourselves to more destruction. The most destructive system we could have in place is heads I win, tails the Fed loses.
While it is a noble cause to help homeowners, the solution proposed by NACA is reckless and creates a terrible moral hazard. For starters, unless their is evidence of fraud (by evidence we are referring to specific evidence of fraud on an individual loan not a series of random anecdotes about homeowners who didn't understand the mortgage they were signing up for) it is a dangerous idea to have the Fed modifying private contracts. If the Fed goes down this road our nation is setting a dangerous precedent. Our public would have ceded the individual right to contract with one another by granting the Fed the ability to void our dealings based on its moral position. The four prong solution, as put forth by the NACA, goes against our most fundamental legal and economic principles.
Beyond the moral wrongs of the four prong solution, the plan would have diametrically opposed effect of what its orchestrator intends. In fact, the solution presented is a perfect blueprint for a policy designed to halt all mortgage lending. By suspending foreclosures the Fed has removed collateral rights from private loans made by the mortgage holders who understood that they were buying secured loans. What would be the result? Market participants would realize the legal risk surrounding the mortgage collateral and price them under the assumption that they are unsecured. Consumers are already familiar with the rates on unsecured loans with their credit cards. Imagine how housing prices would react when you have cities with a median income of $50,000, a median house price of $500,000 and 30-year fixed rate mortgages are available at 20%. That assumes that some lenders are left after their depressed mortgage holdings plummet even further.
The other solutions would lead to similar results although the effect would probably not be quite as detrimental as taking away the lender's collateral. Mortgage holdings would plummet much like the previous case in which the collateral was held to be unattainable. The remaining lenders would greatly increase their coupons on new loans because there would always be the risk that the Fed would come in later and lower coupons if people couldn't make payments.
In conclusion, we would like to speak to a moral aspect of the housing market that seems to have been glossed over by so many in the national media. America is raising a generation of young people that will only dream about owning a house in many parts of the country. In the New York area for example, it is hard to find a shack for under $750,000. At the height of the bubble so many individuals felt like they would never be able to own a home if they didn't buy immediately. In order to do so, they had to take out extremely risky loans to purchase homes that were well beyond their means.
As with any risk there are times when it works out and times when it doesn't. This time it didn't work out for some homeowners who took a great deal of risk and now they want to try to change the rules simply because of the result. To grant the homeowners their wish would cause the moral hazard of a lifetime. Patient individuals, who also wanted to purchase a home just as bad as the current homeowners, made the choice not to take out a risky loan. A government intervention on behalf of the homeowners that took out risky loans would put homeownership out of the reach of these patient individuals who made the correct choice. The patient individuals also have families just like the families that took out the risky loans but chose to rent. Of course those people who had been patient would have also bought a home if they had known that the government was going to force lenders to finance it at 1% indefinitely and there was no chance of foreclosure!