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The mortgage crisis and its effect on the economy

Tom Silvia '83 Leads February 2008 Web Chat

On Tuesday, February 12, 2008 at 1 p.m. EST, Tom Silvia '83 joined us to respond to your questions about the mortgage crisis and its effect on the U.S. economy.

Tom Silvia '83 is group leader of the Bond group for Fidelity Management & Research Company, the investment management arm of Fidelity Investments. He is responsible for management of the taxable and municipal bond teams including portfolio management, research, and trading.

Mr. Silvia received an MBA from Columbia Graduate School of Business in 1987, joined Fidelity in 1993 as a senior mortgage trader, and co-managed the Fidelity Mortgage Securities Fund and Fidelity Advisor Mortgage Securities Fund from 1997 through 2003. In his career at Fidelity, he has managed the Fidelity Ginnie Mae Fund, the Fidelity Advisor Government Investment Fund, the Fidelity Inflation-Protected Bond Fund, and the Fidelity Advisor Inflation-Protected Bond Fund, and served as director of taxable bond portfolio managers from December 2002 to December 2004, when he was named to his current position.

Web chats are a feature of the URI Division of University Advancement electronic communications program. Answers to other frequently asked questions can be found in our FAQs. If you have other questions about Web chats, please contact the URI Publications Office at 401-874-4383 or email: eservices@advance.uri.edu

Tom Silvia '83, Fidelity Investments: Hello, this is Tom Silvia. I am looking forward to chatting with you today about the effects of the mortgage crisis on economy.

James Hagerty, Cranston: Tom, how can I reduce my tax liability using bonds? My situation is this; I am single with no dependents and make over 60K a year from all my sources of income (a retirement distribution and a salary). I do not own a home and as a consequence this puts me into a tax bracket where I must pay over 30% of my gross income in both state and federal taxes. What can I do to reduce this tax liability?

Tom Silvia '83, Fidelity Investments: My first suggestion is to contact a financial advisor. I would outline your investment objectives and look to construct a portfolio that meets your long term goals. It may make sense that one of those objectives is minimizing tax liability. Typically, your risk profile and cash needs should dictate your investment decisions before the tax consequences. Once the portfolio decision is made, then it would be good to minimize the impact of taxes. Given your tax bracket, I would consider Municipal Bonds.

Ed Taub (mtn. view ca): Will raising the conforming loan limits allow fannie/ginnie to buy up all the "poisoned" subprime mortgage securities and then wreck them leading to a taxpayer bailout of the banks that made money illicitly?

Tom Silvia '83, Fidelity Investments: Fannie Mae and Freddie Mac (GSEs) have two parts to their business. One is their portfolio in which they buy mortgages and finance those purchases by selling debt. The second part is the guarantee business. In the guarantee business they receive a fee to insure the cash flow of their mortgage-backed securities. The types of mortgages that they insure are well defined. By and large, the mortgages are prime mortgages. Prime mortgages have strict guidelines about debt-to-income, down payment, loan-to-value and the size of the loan. If the loans fit the GSEs criteria, they are deemed to be conforming loans. The mortgage credit crunch has moved well beyond subprime mortgages. Any segment of the mortgage market that does not meet the GSE criteria is having difficulty accessing capital. The purpose of raising the loan limit for the GSEs is to provide financing for prime loans that are currently above the size allowed. They will not be taking on additional subprime risk solely due to a higher loan limit. Subprime loans are usually smaller loans. The GSEs do have subprime exposure but it is a small part of their holdings. They have more stringent credit protection requirements for the subprime loans. They have made this investment to reach their affordable housing goals established by Congress. Like every other subprime investor, it is likely they will need to write down a portion of their investment.

Mary, Wakefield, RI: Some people who took advantage of shady loans may have sadly been uninformed or uneducated financially, but do you think it's a good idea for the federal government to bail people out of bad mortgage loan deals?

Tom Silvia '83, Fidelity Investments: The cost versus value of a bailout is an interesting debate. On the surface, it feels questionable to use taxpayer money to bailout people that were duped or just made a bad decision. Many feel that the markets should work out these issues and the government should not be involved in a solution. The government needs to evaluate if the long run situation would be better with a framework and funds for a more orderly solution. The consequences of doing nothing could be a significant economic slowdown or recession. Smart policy could save the taxpayers money in the long run versus the negative impact of a sustained period of weak real economic growth. The bailout of the S&Ls in the `80s and the creation of Home Owners Loan Corporation during the Great Depression are two examples of government programs that improved the outcome. Similar programs are being discussed in Washington, DC, and should warrant serious consideration.

Michael Mainelli (New York City): Since we have the FDA to ensure drugs are not contaminated, as well as other regulatory entities to ensure truthful labeling, do we need monitoring of CDOs to the same end?

Tom Silvia '83, Fidelity Investments: There is significant regulation in the financial service industry. The SEC, Federal Reserve, OTC, OTS, and US Treasury, just to name a few, all have oversight roles. The complexity and size of the financial markets makes it extremely difficult to create sound policy for all aspects of the market. Many market participants believe that already we have too much government involvement. Investors need to play the role of managing their risks versus rewards intelligently. Given that we are going through the "cost" stage of the market cycle, more oversight feels "right" but it may be an overreaction.

Mary, Wakefield: This morning's news talked about a 30 day hold on interest rates and a 90 day freeze on interest rates for mortgage holders in trouble. This would be a short-term solution, but what would work for the long term?

Tom Silvia '83, Fidelity Investments: The best long term solutions in the past deal with the core problem. The problem we face is that home owners can not afford their monthly payments and consequently, the investor will not recieve that cashflow. The way to address this is for the government to step in and make the payments. This would eliminate the losses and keep people in their homes. The cost would be roughly $300 billion. The S&l bailout cost $180 billion.

Larry Schultz ('63-Plymouth, MI): There has been some concern that the subprime problem will spill over into other areas, such as car loans. How likely do you think this would be? To me this seems to be a key issue. Is the subprime issue contained, or will it spread?

Tom Silvia '83, Fidelity Investments: The total loss in the residential mortgage sector is forecasted to reach $300-$400 billion. Consequently, the potential for spill over into the broad economy is the biggest concern we now face. This has already begun in auto loans as you mentioned. Capital for credit cards, student loans, and other receivables has been greatly reduced. Monoline bond issuers have struggled. The bank loan market has experienced significant liquidity issues. We are in the midst of a significant credit crunch. The sector that is having the most difficultly right now is commercial real estate. The market is now forecasting a significant increase in losses in commercial properties. This is not just an issue in the United States. The credit crunch is impacting housing in Europe as well.

Margaret A., Warwick: What is the federal government doing right now, in the short term, to rescue the millions of homeowners affected by the subprime crisis and at risk of losing their homes?

Tom Silvia '83, Fidelity Investments: The Federal government has implemented several changes and is working on more. Several bills have been drafted and are working their way through the process to provide more capital and flexibility for subprime mortgagors. The US Treasury announced a program in December called Hope Now. The objective of this program is to help subprime mortgagors refinance into a fixed rate loan. There have been changes to the capability of FHA (Federal Housing Administration). The latest program is the stimulus package that was announced last week. Given that we are in an election year, I would expect to see more jawboning and some implementation of plans to bolster the economy. The overall objective is to keep people in their homes.

Chris, Woonsocket: Can I refinance my subprime mortgage before the end of its term? Will I have to pay a penalty?

Tom Silvia '83, Fidelity Investments: I would contact the company that services your mortgage. Most subprime mortgages do contain some form of prepayment penalty. However, given the current situation, there is far greater flexibility for borrowers than what is normally the case. It is possible that a new mortgage could be granted without significant cost. Each case is unique and this speaks to the difficulty of finding a solution for 2 million subprime loans.

Lisa Harrison (Moderator): Tom, where do you see the U.S. housing market going in the next six months to a year?

Tom Silvia '83, Fidelity Investments: On a national basis, housing prices have already delined 8%. Most forecasts call for an additional decline of 12% for a total drop of 20%. The hardest hit areas of the country such as California, Nevada, Florida and Michigan may have a decline up to 35%.

Lisa Harrison (moderator): Tom, how did your undergraduate work at URI prepare you for your success today?

Tom Silvia '83, Fidelity Investments: I received an excellent education at URI. I got a degree in Chemical Engineering. My education taught me how to breakdown a problem and find a robust solution. That skill goes well beyond engineering. I also learned discipline and dedication to an end goal. The rigorous education process of engineering taught me that I had to be dedicated and disciplined to succeed. URI is a diverse community, so I learned to deal with a range of people from different walks of life.

Lori, Warwick: Do you think that we are going into a recession?

Tom Silvia '83, Fidelity Investments: Currently, Federal Reserve Chairman Bernanke believes that we are not in a recession but the risk has increased substantially that we could enter into one. I think it is fair to say that in some areas of the country we have already entered a recession. The longer the credit crunch lasts, the more likely we will have a decline in economic growth. At this point, I see it as likely that the country could be in a recession in 2008.

Brad (Wakefield): Regarding the root cause of the mortgage crisis, what about prevention and family budget counseling?

Tom Silvia '83, Fidelity Investments: An educated consumer is the best consumer. Hopefully, this episode will teach people that they must understand what they are getting into.

Mary Patty, Moderator: Thank you for taking the time to answer these important questions about subprime mortgages and the economy, Tom.