Feb 26, 2009 For Private Circulation only
So, is America careening into socialism after the castle of crony capitalism collapsed?
Deepak TiwariResearch Analystdeepakt@arthamoney.com T: + 91 22 4600 0345
It’s Socialist America
We all know that unless the US and other developed European markets recover fromthe current crisis, India cannot maintain robust growth rate of even 5-6% in midterm.And for the US economy to rebound it’s inevitable that their housing crisis settles soon.If it’s too important for the US and all of us, we must be curious to know what correctivesteps the new administration in the US is going to take. Here we will discuss what arepolicies the US government has formulated to counter the crisis and how effective theyare.
About 6 million house owners have either faced foreclosure or are at risk of foreclosureacross the US. Home prices in cities across the country have fallen by more than 25%since 2006 and in some cases by 43%. In Obama’s words “In the past, if you foundyourself in a situation like this, you could have sold your home and bought a smallerone with more affordable payments, or you could have refinanced your home at a lowerrate. But today, home values have fallen so sharply that even if you make a largedown payment, the current value of your mortgage may still be higher than the currentvalue of your house. So no bank will return your calls, and no sale will return yourinvestment”.Let’s first understand what went wrong in the US housing sector. In 2003 there was agreat demand for American home loans. To meet the growing demand for the homeloans, the mortgage lenders like Fannie and Freddie tempted to relax their norms forlending. Since the values of houses in the US have been on continuous rise ever sincethe World War II, everybody assumed that it would continue to move upward only. As aresult a time came in 2005 when almost anyone in the US could buy a home withoutincome proof, other assets, credit history or sometimes even without a proper job. Suchloans were called NINA which stands for "No Income No Assets". To make thingsworse, interest rates began to rise during 2004-2006. This led up to a chain of defaultsmaking home prices going down and down. This housing bubble is the root cause ofcurrent global crisis which has inflicted economies across the world.
(For more details refer
World Financial Crisis II
dated October 13, 2008).
President Obama has announced a $275 billion program that will move to cut mortgagepayments by matching reductions lenders make to interest payments to 31% of theborrower’s monthly income. The Treasury will also buy up to $200 billion of preferredstock in Fannie Mae and Freddie Mac, and detailed guidelines are due to be releasedon March 4. It is necessary to discourage foreclosures because it may cause further fallin the prices of nearby homes creating the potential that even borrowers who makeevery payment suffer. This program has four components:
1. Refinancing in cases where home value has fallen below mortgage value
In order to support as many as 4-5 million families which are facing foreclosure,refinancing (up to 105% of home value) has been allowed in cases mortgages exceedhome value. Refinancing means reducing interest rate. Though Fannie and Freddiewould receive less money in payments due to reduced rate, this would be negated by areduction in defaults and foreclosures. This plan could stop the slide in home pricesdue to neighbouring foreclosures by up to $6,000 per home.