Treasury Secretary Henry M. Paulson visited the editorial board to discuss the sub-prime crisis, and the Department of the Treasury's responses to it. The department is organizing a voluntary loan-modification program designed to stave off the growing rate of defaults and foreclosures.
All the disclosure that fits on one page
Henry Paulson: The key is to get the balance right and not go so far that you cut off credit and make the situation worse. The Fed has also been looking at disclosure. I think when you look at the mortgage area, it's almost a caricature of what you see in other areas. You've got pages and pages of disclosure, which doesn't mean you're getting the people good information that they can understand. It's sort of, "Everybody cover their rear end," protect themselves legally. But, I've made the case several times, with all the disclosure there should be one simple page signed by the lender and the borrower that says, "Your monthly payment is x and it could be as high as y in a couple of years." The Fed I know has done some real consumer research on this.
How does the Treasury plan work?
Henry Paulson: I view it as government facilitating the industry coming together to prevent a market failure. And the way I think about it is this: that historically when a homebuyer, homeowner has a problem, a default's clearly not in the homeowner's interest. And it's clearly not in the lender's interest. It's very costly; defaults are very costly. So in a normal world the two sides come together and they strike a deal. Today we're dealing with two factors that make this more difficult. First, as you know, the institution or company that made the mortgage no longer holds it. It's spread all around the world with investors. That creates a cumbersome, complex decision-making process. It's one that can be dealt with when you've got home prices rising or you've got a stable mortgage market. But what we have is a volume of resets increasing, and they're going to be at a very high level next year, 1.8 million resets in 2009. What this program does is get the industry together we've had eight more firms join, we cover 90% of the market. Investors have signed on, which is very potent, to have the investors signing on right along with the servicers.
Tom Petruno: Is there a list of the investors who have signed on?
Henry Paulson: I don't know if there's a list. The American Securitization Forum has 36 investors, and so there's...
Tom Petruno: Individual?
Henry Paulson: Yes. Oh, absolutely.
Tom Petruno: I don't think they've been quite forthcoming with that.
Henry Paulson: I don't know whether they have or not, but I'll tell you, I was quite aware when they had the vote, and the number of investors that voted, and I think that's an important part of this... People talk about contracts, and the servicing agreement doesn't just give servicers flexibility: They've got the responsibility for making modifications that are in the best interest of the investor group. So I want to step back for a second and say, with this industry coming together, we're bringing people together to avoid a market failure. The industry's dealing with an unprecedented situation, and the steps they're taking to fast-track these modifications are intended to approximate an outcome that's a market-related outcome.
And the way we had it there is: A number of servicers at more sophisticated institutions were already doing this. Because they said, "How are we going to deal with what's coming down the road?" And as I talk about this I think in some instances the press and the public have focused on the wrong thing, because they focused on the interest-rate freeze. Because this is not about an interest-rate freeze. This is about foreclosure avoidance. And so what you see is, there's some systematic process that's been established, such that there is a group of homeowners who are not going to afford the higher rate, and can't afford to stay in the home these are people who have made the initial payment and they will be fast-tracked into a modification with an interest-rate freeze.
We've looked at the group. There are probably 1.8 million ARMs that are going to reset. There are probably 600,000 of those where they've made the initial payments, if you look at their credit ratings and other data, they will be fast-tracked into a modification. There's another 600,000 who have got stronger credit statistics, and as they're dealt with, some can afford the stepped-up rates, a reasonable number will qualify for a refinancing and can refinance at a lower rate than the original rate. And some won't qualify for a refinancing and will go through a somewhat longer process to make the case that they need a modification with an interest-rate freeze. But you're talking about 1.2 million where you're avoiding foreclosure. And then you're freeing up the resources [that the] industry has to work on the other 600,000, which would have to get a more customized approach. And there's a reasonable number of those that will result in foreclosure; people will become renters again. And there are others who will be put into a HUD product or some other form of refinancing. So again, this was never about "Let's see how many interest rates people can freeze." It's how can you avoid foreclosures that should be avoided, which are in no-one's interest.
I'll give you one example: If someone has made the initial payments on their mortgage, and they're going to have trouble making the reset, and the loan/value ratio is 97 or above, they move immediately into that category which is fast-track, because you know you've got to do a refinancing. So the criteria are set up to let the servicers do the processing quickly.
More air for an inflated market?
Jon Healey: Many of the people we speak with don't like this because they see the results of the government's work being sustaining housing values that should have been allowed to come down.
Henry Paulson: Again, I've given my answer to that. I think what we're doing is avoiding a market failure that would have forced housing values down in a way that was not in the investors' interest, and in a way that the market wasn't intended to work.
Tim Cavanaugh: How can you force values down? Why aren't values finding their natural level?
Henry Paulson: The way values would go down is, as I've said, you'd have market failure. You'd have a situation and again, I don't know how much more clearly I can say this I don't want to debate this with you; I just want you to understand the point, and you may have a different view. I spend a lot of time looking at markets and I say to you it's expensive for investors to have a foreclosure. You take a house, and 20-40% of the value you lose. It's hard to maintain homes. They're subject to vandalism. Lenders don't want to own homes. And lenders, in normal circumstances, when someone's able to meet the initial rate, there would be very often a modification, so what we're working against, as I said, is two developments.
The securitization model has become the model during an up period in real estate. We haven't had a lot of foreclosures and you've had investors spread all around the world. That creates an unwieldy situation. And you're going to have a wave of foreclosures coming.
Market failure defined
Peter Hong: Could you be a little clearer on what you mean by "market failure"?
Henry Paulson: As I've said, chaos. If ever there is a role for government to bring the private sector together to deal with a situation that when I say market failure I say that we have an unprecedented situation, and the private sector has to find a way to deal with that. Otherwise you're going to see them drowning in people who can't make resets, whom they would ordinarily want to keep in a home.
And again, I think if you take the time, call in servicers, talk to people at Wells Fargo and others, take the time to really understand it, they'll see that once you get into the process of underwriting a new loan refinancing or modification and you go through all the paperwork they have to go through and collect the data, that takes a long time. And they don't have the resources to do that and handle the volume at the same time.
Tim Cavanaugh: Well, wait a second, they had the resources to do it and handle the volume when they wrote the loans in the first place.
Henry Paulson: Well, it's different than these were securitized. I'm not going to defend what went on, but I haven't talked to anyone out there, who is knowledgeable about the industry and is in the industry, who says they have the resources to handle all the underwritings to handle the modifications.
Tom Petruno: Some would argue that it was lax underwriting that got us into trouble in the first place: no assets, no income, no problem. So we're asking the underwriters to go to fast-track not ask too many questions and give these people a break. It's...
Henry Paulson: Well again, the lenders are giving themselves a break also. They're acting in a way that's in their interest. This is not I think you all I see I've got a skeptical group here. It's amazing: I've spent my life in the private sector, and it's amazing how many people I've met who've never spent a day in the private sector who think any kind of government involvement is somehow hurting market.
Tim Cavanaugh: This ain't Stockton!
Tom Petruno: We're all in the private sector here!
Henry Paulson: No, I mean various idealogues I've discussed this with, because the fact is, if you understood my point, lenders like to keep people in a home, keep payments coming. Who are they helping if they keep getting bogged down?
Jim Newton: Well given that it's in their interests, why is the government needed to bring this along?
Henry Paulson: Because it's a diffuse industry, and I think some of the bigger, more sophisticated people understood this earlier. There's a whole host of issues, including accounting issues, a whole host of issues and obstacles that they were working through.
Tim Cavanaugh: But you're not going to do their accounting for them. What's the service that you're providing?
Henry Paulson: It just took a while, it took a good while, for people and it wasn't like there was resistance; this group kept growing and learning and working and being added to. It's amazing to me, the skepticism out there when you have the servicers covering the industry, they've got their investor group that is speaking for them, and they had all the regulators come together.
I thought the skepticism would be of another source. We've got a housing downturn created by a whole series of lax lending processes, easy credit, runups in markets that were unsustainable. This effort doesn't solve that problem. OK? This is one piece of the issue. And this will not in and of itself solve what's happening in the housing market. What this will do will make a difference in that we won't have housing prices driven down in ways that distort the market because the industry wasn't able to come up with procedures to deal with an unprecedented situation.
Tim Cavanaugh: Is it distortion in the market when the market was already distorted up to a degree that maybe wasn't unprecedented, but was certainly unusual in American history?
Henry Paulson: So you'd like to see it distorted down too. Well, that's reasonable people can disagree. I think that would be a market failure and I think that's why the market players came together ... There's a theory here that the process that led to this problem was so flawed, that let's hope that the unwind can be so messy that people will get what they deserve.
Jon Healey: No no no, it's more about learning. The risk to investors in securitization were masked somehow, because they found themselves surprised.
Tom Petruno: They claim they were surprised ...
Jon Healey: Yeah, they claim they were surprised, but if you look at some of these writedowns...
Henry Paulson: Right. Again, I don't think this is doing anything to mask the risk. I think this is an innovative way and a practical way the private sector's come together to deal with a problem that they've never come up with before, and that's an innovative way.
You sure you're not blowing air into an inflated market?
Peter Hong: You used the phrase "distort down." Is it distortion or is it a correction?
Henry Paulson: What I want is markets to work. And I would define a market failure as the system not being able to cope with the wave, so that foreclosures took place that would not have taken place if there were smaller volume. So foreclosures take place that aren't in the investors' interest, aren't in the homeowners' interest, aren't in the community's interest and aren't in the greater economy's interest. I'd call those needless foreclosures. There are going to be foreclosures that take place because homeowners can't afford to own a home we're not talking about that. We're not talking about sending a check to multiple people whether they can afford to live in a home or not. This is a program that ...
Peter Hong: But are house prices too high?
Henry Paulson: I'm not going to foreclosures are bad for neighborhoods. You have needless foreclosures that are driving down prices, created by a situation that is unprecedented and that would under normal circumstances not have taken place. I think what we're having is not a difference over the facts but a debate on whether the industry should have come together.
Peter Hong: Well, your folks at Goldman Sachs say 30% overvalued ...
Henry Paulson: Oh, they're not my folks at Goldman Sachs! I'm the treasurer, I'm not going to talk with you about warehouse prices, about where prices should be going ...
Tim Cavanaugh: Then why have you looked with favor on the prospect of Fannie Mae and Freddie Mac buying jumbo loans. It seems to me that involves Fannie and Freddie getting into the business of saying, "We want to keep high prices." $417,000 for a loan is ...
Henry Paulson: I'll say this: We could have a long discussion about Fannie and Freddie. Instead I'm going to have a short discussion about Fannie and Freddie. The mortgage market is not functioning as normal. It's been built up around a securitization model. I am not an advocate of, on a permanent basis, having Fannie and Freddie have their loan limit raised and getting into the jumbo area. I think it involves difficult public policy questions and flies in the face of their affordable housing mission. So I think you and I philosophically would be in the same spot. I do believe it makes sense now these are not normal times to raise the limit for a limited time, to let them get involved with jumbo loans for securitization purposes. But I only want to see that if we have reform.
Tom Petruno: Only want to see that on a temporary basis?
Henry Paulson: Only on a temporary basis as part of a reform. The idea that Fannie and Freddie aren't going to have a regulator with at least the authority that other financial institutions have just doesn't make sense. So we believe raising the loan limit on a temporary basis for securitization purposes, not for investment purposes would be good for our economy.
Is homeownership too special for the market?
Arthur D. Buckler: You mentioned securitization as something you'd like to look at. Is it possible that even though securitization has allowed a lot of money into the mortgage market and dispersed the risk, is it possible that because homeownership is such a special category in this country, that securitization is not right for the industry?
Henry Paulson: So you would put homeownership in a different category than all the others: credit cards, auto loans, home-improvement loans ...
Arthur D. Buckler: I'm raising the question.
Henry Paulson: Homeownership is clearly, when you look at consumer credit and look at the percentage that goes to homeownership and mortgages, it really is the lion's share of credit; 50 million people are in mortgages. But I wouldn't go that far. I understand your question and why you're asking it. I think it's a relevant question to ask. But I really believe we don't want to overreact. There's often a temptation to go too far and forget that, you know, virtually everywhere I go around the world, people aspire to the level of homeownership that we have in this country. It's amazing, the conversations I have in Latin America or Africa or Asia are all about how you take the economic benefits of top-lying growth and spread the benefits among the society. And it's always about credit. How do you make credit more available, more credit options, choice, lower-cost credit? And I wouldn't forget the fact that 93% of the people who have mortgages in this country make their payment every month and they make it on time, and that most of the sub-prime borrowers are going to keep their homes. A job needs to be done at the policy level, and there are important issues to look at around the process and the rating process. I understand your question, but I don't think that's necessary.Copyright © 2015, Los Angeles Times