The real estate blog.

Now that major lenders, especially in the subprime space, have declared bankruptcy or shuttered operations, more and more people are calling for a bailout of American homeowners with adjustable rate mortgages or payment option ARMs with negative amortization.

How likely is this to happen on a wholesale basis? Nobody knows for sure, but I have a few ideas and already we’re seeing them come into play.

1. It’s about to get political -

With the 2008 Presidential race heating up, candidates and the sitting President, are turning to housing as a pain point. Senator Chris Dodd is lobbying the Federal Reserve to do all it can including raising the amount of loans Fannie Mae and Freddie Mac, the government sponsored enterprises that manage the bulk of home mortgages,

can hold at this time of decreased liquidity. I won’t be surprised to see “conforming” loan limits increase from the $417,000 they’re currently at, especially in the face of Jumbo loans (those above the conforming limit) being priced a full percentage point higher now.

Today Bill Gross, a powerful hedge fund manager, called for President Bush to step in and bail out homeowners with subprime mortgages.

“If we can bail out Chrysler, why can’t we support the American homeowner?” Gross wrote in his monthly investment outlook on PIMCO’s Web site.

“Write some checks, bail ‘em out, prevent a destructive housing deflation that (Fed Chairman) Ben Bernanke is unable to do. After all ‘W’, you’re ‘the Decider,’ aren’t you?” Gross wrote.

2. There won’t be a wholesale bailout -

Despite what the media says and proclaims, a wholesale bailout is impractical. Who should be bailed out? Lenders facing bankruptcy? Home builders seeing decreased sales? Realtors making less money? Mortgage brokers making less money? Homeowners facing foreclosure? Bail out one group and the rest will be screaming bloody murder. Should the real estate speculator with multiple homes be helped as much as the retired pensioner who foolishly took out an Option ARM? Talk about a political nightmare!

3. Change will come -

The way I see the subprime mortgage mess being resolved is going to be slowly, but surely and market driven. We’ve already seen the Fed and the European Central Bank inject liquidity into the markets. For now, we’re dealing with fear based on speculation. Until the ARM resets happen and the foreclosures take place that’s all we’re dealing with. It’s good to know the Central Banks are paying attention. While intending to cause stabilization, those moves only prompted more fear.

Then we saw the Fed drop its discount rate and change the terms of its loans direct to banks. This has drastically increased the amount of money the Fed is loaning and stabilized the stock market.

The Housing Administration has already increased the loan limits in many markets across the country through its FHA mortgage programs. These loans are designed for people with no credit or some past bad credit and will fill a lot of the void subprime has left open. I have even heard calls for FHA loan limits to exactly mirror those of conforming which will open up a wider range of borrower.

With one of the effects of the liquidity crisis being higher costs for jumbo loans, I think we’ll also see an increase in conforming limits. It only makes sense with the higher cost of housing and doing it within the next six would be beneficial to homeowners, lenders and politicians.

What I don’t see happening is the Fed lowering the overnight lending rate at its next meeting in September. While this rate doesn’t directly affect fixed mortgage rates, it is used as a barometer of economic health. For the Fed to drop rates in September would be sending a message its not prepared to deliver yet. Wall Street has been hoping, betting and speculating on a Fed rate drop ever since it started holding them steady last August. Now is not the right time as there are many other actions that can ease the housing pain before having to drop rates.

As you can see, we have a long way to go as a country before government will step in and offer a formal bailout. However, there are a lot of smaller steps already taking place that will ease the pain for everyone in this downturn. Lets not forget either that we live in a free, market driven society. Where did ARM loans come from? The pain of the high interest rates of the late seventies and early eighties. Where did subprime come from? HUD not quickly adjusting loan limits as the housing markets heated up in the late nineties. Where will we go next? I’m not sure, but I do know someone is already working on it.