2009 May 9, 2:59pm
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Imagine, about 20 years ago, a group of high level banking professionals are in a planning group. The subject of this meeting is a new profit opportunity. The group knows that seniors all over the country are sitting on large piles of â€œlocked upâ€ homeowner equity. Although paid-for (or nearly paid-for) homes are good for the home owning seniors, such widespread equity offers no profit to institutions whose livelihoods depend on renting money. The group needs a way to â€œunlockâ€ that equity and turn it into nice, interest paying debt. Of course, the conversion process should generate fat fees, along with a premium over the prevailing interest rate. Time for the group members to call the Congressmen they have on retainer.
At first, they started small, with The Housing and Community Development Act of 1987. This Act started the Home Equity Conversion Mortgage (HECM) aka â€œReverse Mortgageâ€, but only authorized HUD insurance for 2,500 of them. No problem, by 1990, the authorized number was up to 25,000. Soon afterward, even that limit was removed, and all FHA lenders could offer Reverse Mortgages. Surprisingly, the demand for reverse mortgages never really caught on big. Not yet.
In its present form the HECM gives lenders several tools to convince equity holders 62 years and older to cash out. First, tell the geezer that he can get a wad of cash but will never have to make any payments. Next, dismiss any concern over the extreme fees (2% FHA insurance premium, $2,500 minimum broker fee, plus interest rate juiced by an additional .5%) by pointing out that none of the fees come out of the geezerâ€™s pocket. Finally point out that the geezerâ€™s income is irrelevant. The amount of cash he gets depends his age, his home equity, and his interest rate. It does max out at a generous $625,500, however.
One could argue that such a product could actually be good for some geezerâ€™s, and if not, so what if he only hurts himself or his heirs. But if these loans catch on, there will be a likely hit for future taxpayers. The reason for a taxpayer hit is that the HECM loans are non-recourse, along with the fact that FHA reverse amortization schedule assumes a perpetual 4% per annum home appreciation. Consider a geezer who obtained a HECM loan 3 years ago. His â€œequityâ€ before the falling house prices was 30% more than it is today. If the geezer defaults or dies after the home value falls to less than the mortgage amount, the lender will collect the difference through FHA insurance.
Are we going to see another bubble and tax payer bailout? With all the job and stock market losses, are we going to see an explosion in HECMs? And if house prices continue to fall while the FHA backs loans based on 4% appreciation, are we going to see mass defaults? Another bomb is that the HECM does not have to be a fixed rate, and a lower rate means more money can be taken out. For example, a geezer can get more cash if he takes a LIBOR 3% variable over a 6% FHA fixed. However, the LIBOR can vary up to 10%, so Geezer may get soon get smacked with a 13% juice, which will put him underwater fast. If current economic circumstances lead to a mass increase in the creation of Reverse Mortgages, and house prices continue to decline, the 2% FHA up front insurance fee may not be enough to fund the defaults. Hello taxpayer bailout.
Any estimate of how much FHA (meaning me, my taxes) could be on the hook for?
On the hook? Let's see. Miami alone has almost 10,000 of these reverse mortgages. I suppose a few originated in 2006 or earlier, which means those lucky souls took out lots of cash based on the then equity values. All such loans would be seriously underwater today. When those folks die off, the FHA fund will be depleted somewhat.
I'm wondering if we will see a HECM bubble in 2009-2010, with the corresponding SHTF around 2016 or so.
If China loses faith the dollar will collapse
Andy Xie, FT.com | FT1 | May 06, 2009 | 10:06 IST
Emerging economies such as China and Russia are calling for alternatives to the dollar as a reserve currency. The trigger is the Federal Reserve's liberal policy of expanding the money supply to prop up America's banking system and its over-indebted households.
Because the magnitude of the bad assets within the banking system and the excess leverage of its households are potentially huge, the Fed may be forced into printing dollars massively, which would eventually trigger high inflation or even hyper-inflation and cause great damage to countries that hold dollar assets in their foreign exchange reserves.
The chatter over alternatives to the dollar mainly reflects the unhappiness with US monetary policy among the emerging economies that have amassed nearly $10,000bn (Euro7,552bn, Pound6,721bn) in foreign exchange reserves, mostly in dollar assets.
Any other country with America's problems would need the Paris Club of creditor nations to negotiate with its lenders on its monetary and fiscal policies to protect their interests.
But the US situation is unique: it borrows in its own currency, and the dollar is the world's dominant reserve currency. The US can disregard its creditors' concerns for the time being without worrying about a dollar collapse.
The faith of the Chinese in America's power and responsibility, and the petrodollar holdings of the gulf countries that depend on US military protection, are the twin props for the dollar's global status.
Ethnic Chinese, including those in the mainland, Hong Kong, Taiwan and overseas, may account for half of the foreign holdings of dollar assets. You have to check the asset allocations of wealthy ethnic Chinese to understand the dollar's unique status.
The Chinese love affair with the dollar began in the 1940s when it held its value while the Chinese currency depreciated massively. Memory is long when it comes to currency credibility.
The Chinese renminbi remains a closed currency and is not yet a credible vehicle for wealth storage. Also, wealthy ethnic Chinese tend to send their children to the US for education. They treat the dollar as their primary currency.
The US could repair its balance sheet through asset sales and fiscal transfers instead of just printing money. The $2,000bn fiscal deficit, for example, could have gone to over-indebted households for paying down debts rather than on dubious spending to prop up the economy.
When property and stock prices decline sufficiently, foreign demand, especially from ethnic Chinese, will come in volume. The country's vast and unexplored natural resource holdings could be auctioned off.
Americans may view these ideas as unthinkable. It is hard to imagine that a superpower needs to sell the family silver to stay solvent. Hence, printing money seems a less painful way out.
The global environment is extremely negative for savers. The prices of property and shares, though having declined substantially, are not good value yet and may decline further. Interest rates are near zero. The Fed is printing money, which will eventually inflate away the value of dollar holdings.
Other currencies are not safe havens either. As the Fed expands the money supply, it puts pressure on other currencies to appreciate. This will force other central banks to expand their own money supplies to depress their currencies.
Hence, major currencies may take turns devaluing. The end result is inflation and negative real interest rates everywhere. Central banks are punishing savers to redeem the sins of debtors and speculators. Unfortunately, ethnic Chinese are the biggest savers.
Diluting Chinese savings to bail out America's failing banks and bankrupt households, though highly beneficial to the US national interest in the short term, will destroy the dollar's global status. Ethnic Chinese demand for the dollar has been waning already. China's bulging foreign exchange reserves reflect the lack of private demand for dollars, which was driven by the renminbi's appreciation.
Though this was speculative in nature, it shows the renminbi's rising credibility and its potential to replace the dollar as the main vehicle of wealth storage for ethnic Chinese.
America's policy is pushing China towards developing an alternative financial system. For the past two decades China's entry into the global economy rested on making cheap labour available to multi-nationals and pegging the renminbi to the dollar.
The dollar peg allowed China to leverage the US financial system for its international needs, while domestic finance remained state-controlled to redistribute prosperity from the coast to interior provinces.
This dual approach has worked remarkably well. China could have its cake and eat it too. Of course, the global credit bubble was what allowed China's dual approach to be effective; its inefficiency was masked by bubble-generated global demand.
China is aware that it must become independent from the dollar at some point. Its recent decision to turn Shanghai into a financial centre by 2020 reflects China's anxiety over relying on the dollar system.
The year 2020 seems remote, and the US will not pay attention to something so distant. However, if global stagflation takes hold, as I expect it to, it will force China to accelerate its reforms to float its currency and create a single, independent and market-based financial system.
When that happens, the dollar will collapse.
The writer is an independent economist based in Shanghai and former chief economist for Asia Pacific at Morgan Stanley.
Copyright: The Financial Times Limited 2009
These reverse mortgages may get a new lease on life if Obama follows through with confiscatory estate taxes. You heirs won't get it anyway: why not spend it yourself?
Hey Bap, it's OK, extra-gay or not, you're welcome here.
Bap: the auto loan title process recognizes that the vehicle instantly has lower worth than the loan. The timeframe is also much shorter. A house is a (usually) appreciating asset, which means that if somebody bails in Year 5 of a 30 year mortgage, the lender has a meaningful chance of recovering most of the principal.
In short, lenders distinguish between consumption lending and hard goods lending.
...but that does not explain why the hard-goods salespeople than the rusting-good salespeople, does it ;-)
...have to be sleazier than ....
These reverse mortgages may get a new lease on life if Obama follows through with confiscatory estate taxes. You heirs wonâ€™t get it anyway: why not spend it yourself?
Interesting. A back door way to encourage spending over saving.
I wonder if anyone will find a way to beat such a confiscatory estate tax by using a reverse mortgage.
Example: Geezer and Wife get a Reverse Mortgage for the $546k "equity" they have in the old home. They use this money to fund gifts of $26k per year for 7 years for each of thier three kids. This prevents the gift tax, as Geezer and Wife can each give up to 13K per kid per year without triggering the tax. Yet during that 7 years, house values decline and the equity cannot cover the loan when the house is eventually sold. Not only did the Geezer and wife beat any possible Obama estate tax, they got a taxpayer subsidy of the kids inheritance by using a non-recourse loan based on an old equity value.
Do you know what's the max % of home equity that could be converted to debt through reverse mortgage? I mean, what are the underwriting standards? What if I am 70 years and take out all money by 80 and don't die till 90?
what you described can hardly happen. It will actually be stupid for homeowners to go that route.
To qualify for reverse mortgage (and I know a couple of elderly who did this), you need to almost own your home outright, anything less than 50% is impossible. The prerequisite for RM is to have you use your proceeds or personal money to pay off the existing mortgage entirely.
Then, the valuation sucks. The bank essentially buys your property at 50% or more discount, unless you are above 90. There are cases of as low as 30% of market value.
RM is a complete rip-off, and usually taken advantage of by childless couples, because if they have kids, the kids will be much better off paying mom and dad the monthly living expense and inheriting their home outright. It is possible to inherit $13K worth of the property on an annual basis bypassing the gift tax, so if your parents live for another 30 years, you can inherit $390K worth of the property when they pass away, tax free. If kids are paying parents monthly expense, they can inherit more than $13K a year because what they pay can be considered "buying".
As far as I know, RM is not that popular in the Bay Area. You see intra-family transfers all the time, and of course the parents don't give away their house for nothing.
RM makes more sense for places with much lower housing price and price income ratio, so that the kids are discouraged to take over low-priced rotten houses from parents. Here, it makes more financial sense to gift the million-dollar shack to kids (along with the very low property tax base!) and get the financing from kids.
Bap: How does consumable vs. Durable get blurred so badly? Free money. The bank-casino allowed people to make an upside-only bet with no questions asked (aka a NINJA 0% down loan). That sort of thinking leads to manias as it distorts the markets. I mean really, all manias as "legitimate" revenue producers until iteration N, at which point bagholders are assigned... Or in the case of TBTF banks, passed to taxpayers.
It's the same mentality as Madoff--nobody cares that the game is a few chairs short until the music stops.
In moderation. iPod made a double post misfire.
Brand's 12:12 comment is out of moderation now. I think it was the spam-word "casino".
I see your point. Now if we can connect this baby to Fannie & Freddie, we could go some place. The seed is sown.
In one of these days we would have a new invention "Reverse Assets". You would put all assets into a basket held by Goldman Sachs and they pay you monthly $ amount. You would only pay an upfront fee of 5% and a service fee of 2%/year and exit fee of 20%.
God, I am in the wrong business.