The two largest backers of home loans in the United States have agreed to new over site.  New standards will be effected to increase the quality of home appraisals.

A long-term investigation by New York State Attorney General Andrew Cuomo’s office has led the two largest purchasers of home loans in the U.S. — Fannie Mae and Freddie Mac — to enter into cooperation agreements.

The pacts require the companies to only buy loans from banks that meet new standards designed to ensure independent and reliable appraisals. Cuomo’s office had been investigating fraud in the home appraisal process.

Deal reached with home loan companies - Business First of Buffalo

Home appraisals and fraud related to those appraisals were and are a significant part of the problem that has created the sub prime mortgage scandal.  Many banks performed appraisals or hired appraisals that never took place.  Many appraisers only viewed comparables and never set foot in the neighborhood of the home let alone the house. In extreme cases, some houses were not even confirmed to exist at all.

The loans that were made on these properties were very risky.  Banks essentially sold mortgage backed securities that were more risky than taking a bet in a Las Vegas hotel.  This is likely to be just one of many reforms that will continue to come and be developed.

In many areas of investments and accounting when a company has an assets on the books and the market value of the asset drops below the original cost of that asset, the company must write down the value of the asset on their books.  Writing down that asset requires taking an expense which can result in a loss for the company involved.  Good accounting principles require this move as it does most companies and especially investors no good to keep a fictitious value on their books.  Plus, the recognition of the loss can enable the company to save a little on taxes, a small condolence for losing asset value.

Fed Chairman Bernanke is essentially calling for something similar to help solve the mortgage crisis.  He’s calling on Treasury Secretary Paulson of the Bush Administration to take action to push lenders to write down the value of the mortgages that you might hold.

Bernanke said “more can, and should, be done” to limit foreclosures. He added that principal reductions “may be a relatively more effective means of avoiding delinquency and foreclosure” than renegotiating interest rates. … “the current housing difficulties differ from those in the past, largely because of the pervasiveness of negative equity positions.”  Bloomberg.com: U.S.

For example, if you have a mortgage in San Francisco for $800,000 and the real value of your property is now $650,000.  People are not companies and do not keep a lower of cost or market basis in their homes.  Banks however, take those mortgages and sell them to investors in a process known as securitization.  Banks would have to decrease the value of the mortgages they hold before the sale to investors and possibly after as well.  Think of it like Wal-Mart providing you a credit on a receipt if the price of a TV goes on sale within 30 days of buying it at their store.  Banks would essentially, have to give investors a credit on their investment, take a loss and let mortgage holders off the hook for the loss in home value and readjust the monthly mortgage payment downward.

That is definitely a tough pill to swallow for banks, but they may have no option. If they do not make such an adjustments, a homeowner that holds a property worth $650,000 with a mortgage of $800,000 might quite logically make the investment decision themselves to walk away from the house and allow a foreclosure to happen.  Every day they stay in that over mortgaged house, they are essentially making the decision to over pay for their own house by $150k.  That’s a bad financial move for a home owner thinking like an investor.

This same process could unfreeze credit from investors too.  If they get a refund on their investment, they could conceivably invest in new mortgages at more appropriate values.  Investors need to see that foreclosures are stopping, that people are buying houses, that the real estate market correction is over and most importantly that banks can be trusted again!

The Fed, the Treasury Secretary, banks, investors and home owners are all essentially trying to find a way to put some baby clothes back on the baby after throwing the baby out with the bath water.  The downside to this proposal is that it essentially puts the blame and the cost on bankers.  Except in the cases where banks created or contributed to fraud, homeowners are the ones that made the initial bad investment decision of buying a house that subsequently later devalued.  The fraud of the banking industry does appear substantial, but buying into a bubble can not be ignored either.  This will definitely be a difficult concept to pass through Washington DC during an election year.

For many people their home is their largest investment.  Second to that investment many people often times have life insurance.  These days most people that have life insurance have it in the form of Term insurance.  This means they pay a monthly, quarterly or yearly rate for life insurance.  If they pass away, a sum will be paid to their heirs.  However, there is no cash value to this policy.  If they stop paying the coverage stops and they are out all the money they paid in over the years.

There are several other forms of life insurance such as whole life insurance that essentially builds up a cash value to the policy.  These policies can be borrowed against.  As many Americans are facing foreclosure, some people are turning to life insurance like IRAs and 401ks as a source of money to pay their mortgage.  This can serve to protect their largest investment (their home) in the short run, but if there is no end in sight then it could be a bad move.  Depending on your state, your life insurance, even your retirement could be protected under bankruptcy laws (consider OJ protected his retirement from his former in-laws through Florida’s protective bankruptcy legislation).  However, if you borrow on your life insurance to pay your mortgage payments and still go bankrupt then you could end up with out a house and without life insurance too!

The same thing goes for IRA’s or 401ks.  It can also apply to people considering the possibility of tapping their savings or life insurance to come up with a down payment.  This is just as risky, but these people are presumably not so close to bankruptcy and buying into a market at current levels could make a good return on their money . . . IF the market has bottomed out!

This week we can expect yet another ‘Super Tuesday’.  The only people these Super Tuesdays are helping is the 24 hour news channels.  For Americans and the economy however, they are stretching out the political cycle and increasing the amount of angst and risk for investors.  That is not all of the problem, but definitely a component in keeping prices at the pump high and keeping investors on their toes as they try and determine whether or not Barack Obama would really bomb Pakistan or whether or not both Obama and Clinton were paying lip service to the notion of canning NAFTA with Canada, our closest supplier of oil, or Mexico, our cheapest supplier of labor.

I would not suggest that there is a lot of room for improvement in politics today, but purely looking at this from the investors perspective, a long drawn out political battle with risk is a bad thing for them and they pass that down hill to borrowers in the form of higher interest rates, tighter credit, lower savings rates and more.  The economy has a long way to go to heal itself, but if the parties do not get a move on in selecting their candidates we are all going to be looking at a factory job packaging dog supplies for minimum wage with a worthless dollar as a step in the right direction.