For the last few months every time you turn on the tv or open the newspaper or get online, all you see is news of the Bailout Bill. So, who exactly is getting bailed out? Is it the bank that made the risky loan, knew they were making the risky loan, and are now surprised that the loan is in default? Is Wall Street being bailed out and does Wall Street deserve to be bailed out? Can’t Wall Street handle themselves? Is it the executives of large companies with troubled assets being bailed out? Is it the consumer who accepted a risky loan that is being bailed out? Or, is it the average consumer who did not take on a risky loan, but has been dragged down by the credit crisis anyway, being bailed out? Well, I think it’s a combination of all of the above.
How Did We Get Here & Where Are We?
Let’s take a look back at the mortgage market in the past few years. We hear buzz words like sub-prime, ARM, interest only loans, short sale, and foreclosure; but what do they mean? The sub-prime market began picking up speed around 2003. This market allowed consumers with less than stellar credit to obtain financing for a home loan. Many of the sub-prime consumers were sold risky loan products because they were higher risks for the banks. Their interest rates were higher and many times they were pushed into loans that had adjustable interest rates. The sub-prime consumer usually maxed out their loan amounts and their loan programs required little to no money down. Adjustable Rate Mortgages were very popular during the height of the market. For the most part, if a consumer took on an adjustable rate mortgage they started out with a lower interest rate than a conventional loan and could qualify for a larger loan amount. However, the interest rate would adjust at set intervals, such as after 3 years, 5 years, or 7 years. The interest rate would continue to adjust several times a year for the life of the loan. Many of these ARM loans have seen their interest rates sore upwards of 13-18%. Interest Only loans were also offered to the sub-prime consumer on a regular basis. These loans require that the borrower only pay the interest due on the loan, not the principle. The principle is due at the end of the loan period. It is important that the home appreciate during the life of the loan. That is the only way the consumer will be able to profit from the sale of the home. If the home depreciates it becomes almost impossible for the borrower to sell the home and pay off the loan. Short Sales are one result of borrowers not being able to sell their homes for what is owed on the loan. Simply put, the bank agrees take less than what is owed on the loan and will still release the lien from the deed. Foreclosure is the process of the bank taking the home into bank inventory from a defaulting borrower. The loans we are seeing short sold and foreclosed on most often in this area are the sub-prime loans, the risky loans.
The massive amount of loans being defaulted on combined with declining housing prices nationwide has helped lead to numerous bank failures and collapses. These bank failures and collapses have led to chaos in the credit markets as banks are afraid to continue to lend money to each other. This, in turn, makes banks less willing to extend credit to businesses, which trickles down to consumers. If this continues, the cost of credit could skyrocket! If more business are strapped for cash they are more likely to cut back on hiring and possibly reduce their current workforce. Some believe that having the bailout will lessen the likelihood of bank failures and collapses, therefore reinstilling confidence in banks to lend, thus opening the credit markets back up to the average consumer.
Bailout Bill
The core of the Bill has remained the same throughout the last few weeks and the failed attempt at passing it the first time. The Bill gives the government the ability to buy up to $700 Billion in troubled assets, mainly mortgage related, from financial institutions. These troubled assets are believed to be the catalyst for the lack of confidence in the credit markets. But, there are several other provisions that affect the average consumer.
1. 3 Important Tax Breaks – a. The Bill extends a number of renewable energy tax breaks, including a reduction for the purchase of solar panels; b. the Bill continues to allow individuals to deduct state and local sales tax on federal forms – this was set to expire; c. there will be one more year of relief from the Alternative Minimum Tax.
2. Insurance for Bank Deposits – The Bill temporarily increases the FDIC insurance cap from $100,000 to $250,000, as well as temporarily increasing the federal insurance for credit unions to $250,000.
3. Mitigating Foreclosures - The Bill encourages loan servicers to modify mortgages to include reducing principle and lowering interest rates. The Bill also extends the temporary provisions that exempt defaulting borrowers from paying federal income taxes on the forgiven debt amount.
So, Who Gets Bailed Out?
The biggest problem with any bailout plan is that some companies, and even some consumers, will be relieved of the consequences of their bad decisions. However, not having some sort of bailout plan could hurt the average consumer much worse. The big question remains – Does the Bailout Bill really address the real ecomomic problems facing the United States? That is yet to be seen. But as of now, it appears that everyone stands to benefit from the Bailout Bill at varying degrees. The big companies that are holding troubled assets , and the industries that will benefit from the “sweeteners” included in the Bill, stand to benefit the most. The consumer who is defaulting on their mortgage may benefit, however, the renegotiation of loans will take some time to come to fruition, if it happens at all. The average consumer may benefit a little more if the credit markets are strengthened and credit costs are stabalized. This would result in consumers being able to obtain loans to buy houses, cars, etc… and would help fuel the economy. The housing market can only stabalize if potential buyers can obtain mortgage loans at reasonable interest rates. Only time will tell if we have prevented financial disaster or just prolonged the inevitable.
