Here is a great piece from Anthony Sanders at ASU’s W. P. Carey School of Business. Here are my comments on the article.
The Real Cause of the Economy’s Problem
“The underlying core of the economy’s problem is that the housing and mortgage market is still collapsing at record speeds,” he said in a December speech before the Dean’s Council of 100, an advisory group at the W. P. Carey School of Business.
Both federal regulators and private lenders have tried tinkering with the mortgage market via proposals to reset the loans of struggling borrowers. The trouble is, their methods — freezing interest rates on adjustable-rate loans and extending mortgage lengths — have made little difference. Most borrowers who’ve received these sorts of loan modifications have ended up defaulting anyway, Sanders pointed out. In fact, modified borrowers are re-defaulting at rates of between 50 and 60 percent.
Instead, would-be mortgage doctors need to focus their efforts on the real cause of virus — disappearing equity. With house prices falling fast, more and more people are “upside down” on their mortgages, owing more than the market value of their homes. Any attempt to restructure these loans without adjusting the principal won’t bring the market back into balance, Sanders said.
People come up with a lot of wrong explanations for the financial crisis. In reality, the root cause is falling home prices. It wasn’t a credit crisis or liquidity crisis. It was a solvency crisis. Falling real asset values made lenders skiddish about lending to companies that were possibly insolvent.
Banks: Dumber Than a Box of Builders
Laws in two of the states hit hardest by the crisis — Arizona and California — limit the ability of lenders to sue foreclosed borrowers to force them to pay the difference between the proceeds from the sale of their residence and their debt. “If you throw your keys to the lender, they can’t touch you,” Sanders explained. “They can ruin your credit — but there’s no credit out there anyway. You can just walk away with no real consequences. Plus, in four years, your default disappears from your credit rating.”
In a foreclosure, a lender often loses some of the money that it lent and faces hefty administrative hassles. In fact, loss severity on defaulted loans can run 50-60 percent of the loan balance. The lender ends up with a house that it can sell, but that’s the last thing that lenders and investors want, Sanders said. (Many loans are converted into mortgage-backed securities and sold to investors like pension funds.) Foreclosure is complicated and costly, and a seized house typically won’t fetch top dollar because delinquent borrowers often stop tending their properties.
Foreclosure, in other words, is a fool’s game; everybody loses. The borrower loses his home and mars his credit, and the lender incurs costs to seize and sell the house.
This whole “How can banks be so stupid” discussion is common among Realtors.
I keep thinking lenders will eventually adapt their massive bureaucracy to the new reality but so far they have been as dumb as the home builders.
Banks Don’t Do Math
Sanders argued that a better outcome for all would be reducing the principal amount of mortgages like these so that borrowers can remain in their homes and continue to pay off their loans, even if at a reduced rate….
The federal government thus should encourage lenders and investors to write off part of the value of troubled mortgages, he said — that is, it should persuade them to reduce principal amounts to reflect slumping real estate values. Lenders and investors would then have to take losses on their books, but they wouldn’t lose as much money as they would in foreclosures. “Twenty percent write-downs trump 50 to 60 percent losses,” he noted. Sanders called his proposal a “voluntary private market solution.”
Sanders makes some good suggestions.
Ditching the Principal
I highlighted in the quote below, an idea that is totally new to me.
In a November testimony before a congressional committee, Sanders suggested that principal adjustments could take a variety of forms. A lender might just cut the amount and be done. Or it could reduce it, but the government would then require the borrower to pay capital gains tax on the amount of the reduction when the house sold. That way, the government would recoup some of the cost of its wide-ranging effort to stabilize financial markets.
A lender might also enter into shared-appreciation mortgage with its borrower: it would grant a principal reduction in exchange for a share of the future appreciation when the house sold. Or a lender might allow a borrower to reduce the principal gradually, granting a small cut with each subsequent mortgage payment. That would encourage people to keep making timely payments.
I don’t love that idea but I love that new ideas are being thought through.
Wrong Way Write-Downs
I suspect, without evidence, that banks are afraid to do write-downs of principal because of the possible contagion effect.
When the Feds bailed out the banking industry, we saw how many other industries wanted their bailout too.
What would happen if banks started to bailout some home owners by cutting principal? Every homeowner who was under water would want one, it’s only fair. How do you stop that small pox from killing the banking industry?
At least if the family loses ownership and is kicked out of the home, it increases the costs to the family of not making payments and that would tend to lower defaults.
If, however, when you stop making payments, you are NOT kicked out of your home and you are instead given a huge cut in your principal, then it would be rational for everyone with negative equity to simply quit making their mortgage payments, even if they were able to make the payments.
That’s the doomsday scenario for the banking system.
There would be no cost to not making your mortgage payments. In fact, you would be richly rewarded for not making your mortgage payments.
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ks 12.19.08 at 12:30 pm
If this is truly an issue of solvency -and it sure looks that way- then there is no simple fix. There is more owed than can be paid. The issue is now: who bears the cost. The entity that is insolvent can not bear the full cost. This is the deffinition of insolvent.
If I owed 1 billion dollars, I would be insolvent. It would not matter how you restructured the loan. I would not pay back anywhere near the amount owed. The person who loaned me the money would have to bear the cost unless someone else stepped in and took some of the burden. There is no easy fix.
Lately, the government is taking up some of the burden. This is a fancy way of saying that our children and grandchildren are paying for some of this mess. The Fed is going to do everything possible to keep the interest rates low to help mitigate the effects of option ARM recasts. This will eventualy lead to problems that will then have to be “fixed”.
Trying to figure out some magical way out of this mess is silly and expensive. The quickest way to “fix” this mess is to hyper-inflate to extent that the 2005-2006 house prices are reasonable. This type of “fix” has the potential to destroy our economy. It would be good for everyone to stop trying to “fix” this.
Brian 12.20.08 at 10:04 am
Apathy is not the answer. THAT is the easy fix to any problem: do nothing.
Of all the suggestions made by Sanders, the one that does not reward bad behavior is the one I like best. The banks should co-own the house that is in default (they do anyway as the mortgagor) in return for a principal reduction. When the house is eventually sold, the profit above the mortgage balance should be split 50/50. This gives the homeowner a 50% stake and a reason to continue maintaining the house and making payments. The bank doesn’t have to deal with the costs of foreclosure and a floor on housing prices will be established if this is done across the board.
The government could also get a cut on this if the forgiven balance and resulting profit at time of sale were subject to capital gains tax. And it should be. This is found money by the homeowner. They did nothing to deserve the profit but are the beneficiaries of a terrible crisis. We do not need to create any more moral hazard. There is enough already.
I think this is the model for all these “bailouts”. Any one who wants government (that is taxpayer) money should give up a proportionate ownership interest to the taxpayer. This has already happened in a very unplanned and uneven way. We taxpayers do now own a good portion of AIG, Citigroup and the assets (through TARP) of many other banks. We should have owned Chrysler and GM in return for their bailout (which exceeded the value of their equity), but they were able to take advantage of the Presidential vaccuum that now exists.
I think our children and grandchildren will end up owning most of America’s assets by the time this is all over, at least the portion not owned by China and the oil sheiks (sarcasm is intended).
ks 12.20.08 at 12:17 pm
I agree that it is entirely likely that
“…our children and grandchildren will end up owning most of America’s assets by the time this is all over”
Under this scenerio, the US becomes a socalist nation. We will probably call our selves a capitalist nation that, somehow, has most assets under state control.
The way we choose to name our economic system is not important. The result will be the same.
I prefer to do nothing. I like economic apathy. It is easy and gets the job done.
Brian 12.20.08 at 1:09 pm
“…and gets the job done” Yes, I agree that doing nothing in a market based economic system will result in correcting the excesses. But it will do so in a mindless, robotic fashion. No one will be spared and many more will lose their homes, their jobs and their reason for living. If one is a big fan of Charles Darwin, then this is the way to go: survival of the fittest. Hope you are fit.
Cbass 12.20.08 at 5:08 pm
“In reality, the root cause is falling home prices. ”
John,
The root cause of this problem was, and is not, falling home prices. There was unsustanable appreciation. There were late night infomercials and inexperienced investors thinking they could become rich without doing any work. The root cause is the American attitude, people thought they deserved something for nothing and when things went wrong expect me and the rest of the public to save them.
Cbass 12.20.08 at 5:14 pm
I am like the Honda Fit, the Fit is go. The word on the street is that apathy is all the rage these days. Like ball bearings… come on guys!!!
ks 12.20.08 at 10:16 pm
I do not want to live in a cut-throat society. We have some programs that give a small social safety net. I am fine with the idea of strengthening these programs.
I would like for the costs associated with excessive risk taking to be taken by those who took the risks. This has nothing to do with social darwinism. There are massive losses that must be realized. We are not finished with realizing these losses.
There is a good chance that AIG will require more than the 150+ Billion dollars it has taken from the government. Please give me a good reason that AIG must be saved at such high cost. The only argument that I have heard is that AIG was such a huge player in the CDS derivitive market, that the downfall of AIG would destroy the entire (unregulated) derivitives market. This is about saving rich people. This is not about saving peoples houses. There has been nearly ZERO relief for regular Americans. Nearly ZERO houses (on a percent basis) have been saved from foreclosure. This has cost many many billions of dollars and it aint over yet.
THIS is social darwinism. The fit are doing quite nicely.
ks 12.21.08 at 1:26 am
Here is something I often think about:
Recently I bought a foreclosure. The previous “owner” bought the place in 2001. I was able to buy it with about 12% down for 4 k more than the 2001 price. The PITI and HOA fees, all combined, are about the same monthly payment as a decent apartment that is about 2/3 the size. The house is very affordable, in a nice location, and I am happy with it.
Why was the house in foreclosure? The previous owner did not buy the house in an inflated market. Did the previous owner lose a job, have an extended hospital stay, or some other bad life-event?
In these crazy times I find it quite possible that the previous owner might have HELOC the hell out of his house. There are two properties on the same street, and of the same floor plan, as this property that sold in early 2006, for over two times the 2001 price. In 2005 and 2006 there would have been plenty of “equity” to extract from the property that I now have. Did the previous owner have a 150 k lifesyle on a 75 k income?
I do not know what happened to cause the foreclosure. I just have mad speculation. I do know that the original 2001 price should not have been much of a burden unless there was a very bad life event. The other alternative is that the owner made some very stupid financial decisions.
If there was stupid financial decisions made, I do not think that we as a society should have tried to save the previous owner from foreclosure. If the property was lost due to loss of job, or other bad life-event, I could pity the man for his bad luck, and hope that he is able to get back on his feet quickly.
I wish I had the details because knowledge of the circumstances are important for determining what might have been the best outcome.
The need for detailed information regarding a property owners individual circumstances is the reason that working out loan modifications is difficult. To go and try to work out blanket modifications without the detailed information is proving to not work very well.
Eventhough I do not know the details as to how my particular foreclosed property came to be that way, I do know that there were many people who used there house “equity” to supplement their income. The total amount of the income supplemented by all Americans through home equity withdraw is coming to a screeching halt. The ecomomy was used to having a large amount of this equity withdraw as GDP. Now this part of the GDP is missing.
In this 70% consumer driven economy, a slowdown in spending is going to hurt. It is going to hurt a bunch.
How do we “fix” this?
I say do not try.
The roof.
The roof.
The roof is on fire.
We don’t need no water.
Let the mo***** f***** burn.
Burn mo***** f*****.
Burn.
Brian 12.21.08 at 10:34 am
Hey, KS, I see you DO have some heart. I am gladdened by this.
No one on this post has addressed my initial point from the Sanders interview: “Of all the suggestions made by Sanders, the one that does not reward bad behavior is the one I like best. The banks should co-own the house that is in default (they do anyway as the mortgagor) in return for a principal reduction. When the house is eventually sold, the profit above the mortgage balance should be split 50/50. ”
So, what is wrong with this approach? It addresses KS and CBass’ desire to not bail out people who were “stupid” and greedy, blowing their equity appreciation on HELOCs. Unfortunately, because the national government (us) now owns the bank, this approach transfers more of our national wealth to the government, but I am resigned to this outcome already. So a little more won’t hurt. (Note: what a windfall there will be when in 2020, the Feds are able to de-nationalize all these acquired assets and sell them off to the highest bidder. There will be dancing in the streets, just like Russia in the 1990s or China the past 10 years. Maybe we can finance Social Security with all the gains from asset sales! ;o)
But, if we “do nothing” as some here are proposing, then I am not so sure that the home purchased at 2001 prices and now showing positive cash flow will continue to do so. I think we all understand that the current deflation is a downward spiral. KS, who is to say the spiral, left to its own momentum, will stop in time to save YOU? Today you are looking golden, but tomorrow, you may be a victim of this out-of-control freight train. Then will you still be happy that nothing was done?
John Wake 12.21.08 at 11:51 am
The 50/50 appreciation split is a good idea where the banks could possibly prevent a lot of foreclosures and later make money if they bought right.
However, if current history is any guide, the banks’ bureaucratic inertia would screw it up and they would lose a ton of money… and then, no doubt, the banks would want a bailout.
If banks get in the business of forgiving debt, the appreciation split is a possible way to recoup some loses in the long run (for those banks that aren’t dead). I suspect, however, the banks see anarchy if they start forgiving principal.
Brian McMorris 12.21.08 at 3:11 pm
John , I understand your point, but the banks are no longer independent. Where mortgages are concerned, the Fed now controls 95% of the market. There are very few non-conforming loans getting written, and ALL conforming loans are now the property of the American people, since none are getting packaged as securities, but instead are being held by Fannie and Freddie, which we “bought” in mid-July (80% of them, which is more than a controlling interest).
So, there really is no chance the banks will need to be bailed out. We already did that and now own them or their assets. The few that are left (BAC, Citi, Wells Fargo) aren’t anymore holding the loans, but are originating on behalf of the GSEs (if that acronym still applies).
As an American and by extenstion, an owner of the mortgage financing system, I want to see us stop the housing price decline before any more damage is done, including to my own home value.
Paul 12.21.08 at 3:20 pm
I have been arguing in my professional circle for quite awhile that the only way to slow foreclosures is to write down principal. John correctly points out that this create a massive free rider problem and incentive for everyone to default to get a principal write-down (particularly in Arizona). But there already is an incentive for consumers to walk away - Arizona’s anti-deficiency statutes protect many homeowners (not for their HELOCs however) and the 2007 Mortgage Debt Forgiveness Act relieves many homeowners from paying taxes on forgiven debt. Consumers are just starting to get wise to these laws and will increasingly walk away as they figure this out. Their credit will be repaired long before their house regained its value to the point of no longer being underwater (10 to 15 years).
One of the problems with the Hope Act is that the principal write-down requirement is to 96% of current fair market value. So if I am a homeowner and a bank gave me a write-down to below fair market value in a still falling market - I’d sell as quickly as possible. Why wait around to be quickly underwater again? So this isn’t a plan to keep homeowners in their house - it is a plan that helps people wipe their hands clean.
Any other full principal write-down to current market value creates the same incentive for many homeowners. So I would argue that principal write-down should be undertaken, but maybe only writing down about 50-75% of the deficiency. That reduces the monthly payment, gives the homeowner a little bit of hope that within 5 years (not 15), they will no longer be underwater on their loan (so they don’t walk away), and slows the free rider problem because people trying to get out of their home right away won’t be able to use it (b/c they are still underwater). Adding in the profit share for banks as Brian suggested would further give banks incentive to do the write-down and would punish the borrower (and further mitigate the free rider problem). This would slow foreclosures and stop whole neighborhoods from experiencing the devaluation dominoes we are seeing.
Now there are still many people who would be tempted to try to take advantage of a program like this who don’t necessarily need it. Banks would have to put guidelines in place that closely look at a homeowner’s income, savings, etc. If you can still pay, you don’t qualify. In such tough economic times, I doubt too many people will quit their jobs just to qualify. Some people will figure out the loophole to qualify, but this is still much better than continuing the massive downward slide we are seeing in home values in Arizona. Banks come out much better taking this tact as John mentions.
Now the real reason banks don’t want to do this - besides the free rider problem - is that writing down principal forces them to write down their asset values and affects their solvency. Banks are holding lots and lots of illiquid assets (particularly CMBS) that they are permitted to value much higher than their market value. If they were forced to mark these assets to market - the bank would likely fail. That is another reason banks are starting to stall on processing foreclosures - they call it a foreclosure “holiday” - they don’t want to have to write down the asset value. But that’s another topic altogether…
Finally, the biggest threat to exacerbate our Arizona foreclosure problem is massive job loss. We are in a nasty cycle right now where we are going to see increasing unemployment for at least the next 6 months. People without jobs can’t pay their mortgage.
-Paul
http://www.desertlawblog.com
John Wake 12.21.08 at 4:20 pm
Paul,
That would be a very attractive combination, “only writing down about 50-75% of the deficiency” plus banks taking an equity interest in future appreciation.
Very interesting!
I wonder how many underwater homeowners would go for it?
Paul 12.21.08 at 6:54 pm
Another reason I failed to mention that banks are reluctant to write-down principal is the loans they “hold” often are not really theirs. They are in fact servicers for the pools of loans that have been securitized and sold to investors. Under the master agreements that govern these bundles of loans, the servicers often have very little discretion to modify loans without consent of the investors who purchased the mortgage backed securities. So the banks’ hands are often tied when dealing with homeowners and they have a fiduciary duty to try to preserve as much of the value of the mortgage as possible. What investors in these securities have to come to grips with is that often writing down principal and keeping a homeowner in the home may be a better decision to preserve asset value versus foreclosure. Therefore, in cases where the loans have been securitized, the investors need to collectively approve loan modifications that would allow principal write-downs. With these securities cut so many different ways, I expect it can be a difficult process to get all investors to agree on terms.
In fact, a few early lawsuits have been filed against servicers by investors (most recently Countrywide) for doing loan modifications without complying with the master agreements. Here is the NYTimes article on the lawsuit. It’s a difficult situation and perhaps the only thing that will resolve it is if things keep getting worse and people come to their senses. My feeling is that everyone is sitting around waiting for the federal government to step in and buy assets and bail them out.
-Paul
http://www.desertlawblog.com
Brian McMorris 12.21.08 at 9:46 pm
“…Banks are holding lots and lots of illiquid assets (particularly CMBS) that they are permitted to value much higher than their market value. If they were forced to mark these assets to market - the bank would likely fail.”
Bernanke has promised the Fed will take care of this problem by buying up as much of the RMBS and CMBS assets as is needed to protect the banking system and encourage new lending. Unlike the Treasury which must have Congressional approval to do this type of acquisition, apparently the Fed has the power to use its “Open Market” actions to acquire any type of financial asset (at least as Bernanke now interprets the Fed mandate). RMBS and CMBS might be some of the asset types the Fed purchases from banks. This will provide two benefits: it removes questionable (marked down) and illiquid assets from a banks balance sheets and the transaction increases the capital base of the bank, thereby allowing for additional lending.
ks 12.22.08 at 12:27 am
As stated by Brian McMorris
“…the Fed will take care of this problem by buying up as much of the RMBS and CMBS assets as is needed to protect the banking system and encourage new lending”
Am I the only person that thinks this is a scary idea? The fed is upset about being in a liquidity trap and now is pulling out the big guns.
I have been working under the assumption that the government would act in an irresponsible and short term manner. Because of this assumption, I take the Fed at it’s word.
Try and think of just a few things that could possibly go wrong if the Fed does not time the credit expansion and then the credit contraction very very well. Ask your self if the Fed has shown that it is good with respect to bubbles.
At what point do we hit the final mother-of-all-bubbles. How nasty will the grand finale be?
Could a treasury market dislocation pop the next bubble? That is a fun thing to imagine.
ks 12.22.08 at 12:58 am
By the way, here is my list of bubbles:
Tech bubble -> This one at least came with an increase in productivity
Housing bubble -> Is hurting more people than the tech bubble
Commodities bubble -> hurt more people than the housing bubble. This one caused there to be rice shortages in poor countries.
Treasuries bubble -> Lord only knows how this one ends. Have you seen the yields on treasuries since the Fed anouncement?
Next bubble -> Is it possible to find another one?
At some point there will be an end to the final bubble. It will not be any fun at all. This is not a joke.
Brian McMorris 12.22.08 at 7:22 am
KS….an investor’s job is not to try and tell the markets and government what to do, but to anticipate their actions and invest accordingly.
I am not a fan of government intervention. From what I read on this blog, no one who posts here is. We can all see the government screws up a lot.
The emotions of politics interfere with rational business decisions. But, if interfere is what they will do, the question should be, “what will I do about it?” I think Bernanke was very clear in his message last week that he intends for the Fed to blow a new bubble. This will be a reflation bubble based on making cash less dear and equities more dear. Because any move to “Reflate” will at some point pass to “Inflate”, I think it would be wise for investors to position their portfolios accordingly. RE and commodities, i.e. Hard Assets, will benefit from this move.
As I get older, I hopefully get wiser. One thing I have learned is there are no absolute truths, only relative truths. Even though philosophically I like the idea of “free markets”, I can’t really make the case that truly free markets (completely without regulation) are good. A completely free market is just as dangerous as total central planning (ala USSR). The relative truth moves on a line between these two points. Right now, the relative truth favors more government intervention since deregulation allowed too much excess (greed to damage the market).
Brian McMorris 12.22.08 at 8:29 am
Blog Posters: I find the subject of “financial relativity” so interesting that I went looking for some substantiation to my ideas. I did find a couple of posts that you might also find interesting.
Let me provide a macro example to my point. Suppose we in America have through our history, created total national assets (in public and private hands) that were valued at $50 Trillion USD in 2006. I did not check to see if this was accurate, but it is in the ballpark. And I am just trying to make a point, so forgive me my lack of research.
I have noticed that through history, wealth is not destroyed but transferred, unless physically through acts of war. Egypt, Rome, Spain, France, England, have all controlled global wealth at some point in history. But wars destroyed that wealth. In the case of physical destruction of assets a deflation is warranted as there is less asset (utility) value than before.
But, now, in late 2008 after two years of continuous revaluing of our national assets, the same asset base is untouched, but is valued at $40 Trillion (due primarily to the huge reduction in RE values) rather than $50T. The question: where did $10 Trillion go? My answer: it is still right there. We still have all the same assets. They still provide all the same utility. The value to us as a nation, or as a world, should not change if man were perfectly rational. This goes to the point that “money” is imaginary. The value on money is what we collectively want it to be. The value of money is “relative” to the assets it represents and alternative uses for that money. (P.S. Goldbugs: this is also true for Gold, which has NO inherent value).
What is very interesting in this current deflation, is that it is global in nature. This is a first to my knowledge. In past deflations and inflations, the phenomena of money relativity been limited to national borders. This has allowed for comparisons between the economic performance of different countries. So, in the 1970s, we (in America) could all look at Argentina as a bad actor with their hyper-inflation, or in the 1990s at Japan, with their financial deflation. Their citizens had the option of converting Argentine peso to dollars to hold value or loan yen for dollars and other currency in the case of Japan (thereby funding the “carry trade). But if the entire world deflates at the same time, was there ever really a deflation? Or, did we all collectively just decide to use a different currency factor to value all assets? (If a tree falls in the forest, and there is no one nearby to hear it, does it really make a sound?)
There is no obvious alternative for the money coming out of assets. It is flowing to cash and getting stuck there in the form of US Treasuries, for Americans, but also for people around the world. This is not rational and will not last. At some point, the cash will flow back to assets. And it looks as though our Fed intends to help that process along.
If the theory of economic (money) relativity holds true, then creating money to expand back to $50T should not be inflationary. It just gets us back to where we were with the same asset base. Something to think about.
Here is a simple personal example of money relativity:
http://www.spring.org.uk/2008/04/avoid-relativity-trap-how-thinking.php
ks 12.22.08 at 11:49 pm
The idea that true value is uncoupled to monetary value is absolutely true. The true value of things do not depend on some arbitrary monetary unit. The true economy is made up of the goods and services that are of any true value. The unit of money is an efficient way to trade the goods and services. Nothing more. Nothing less.
Playing games with the monetary supply does not produce anything of value. Playing games with monetary supply only leads to wealth redistribution and inefficiencies. Inefficiencies act as wealth destruction for the whole of society. Our society will not become richer by playing money games.
mags 12.25.08 at 2:40 pm
I have properties I bought years ago at decent values and have always been able to make my payments because of my planning. Why don’t I get a principal reduction!? I did not paticipate in all the real estate shenanigans and yet those who did are going to get a better deal than me??!!
Brian McMorris 12.26.08 at 9:19 am
I think it is more important for those of us who are responsible and have maintained a positive net worth, not to lose any more of our net worth to asset price declines. Why would anyone with real estate or stock holdings adovacte for those to keep going down? Rather than watch them drown, I would rather throw a rescue line to the idiots who took too many chances and save myself by saving them.
If the goal is to wipe out everyone who has any kind of debt, then we will have a REAL problem. If you are looking for the ultimate bottom, that would be it. The credit crisis will be corrected, absolutely, when there is no longer any debt. Anyone with debt will be underwater and assets will find their bottom. We will ALL be wiped out.
D 12.26.08 at 3:38 pm
I was thinking about this, and it seems to me that the answer is a conversion to a 30 yr fixed with a balloon payment at the end for the difference. The monthly payment could be reduced by 1/3 of the principal. This covers everyone. The banks do not have to lose money, and the home owner (would be defaulter) gets to stay in the home if they can make the reduced payments. We all know that eventually home prices will recover. At some point in the next 30 years this person will sell or refinance. If they sell, the bank gets their money, and if they get to a better place in life where they can refinance, then great. As a home owner myself, I would not be enticed in the slightest to default on my payments to have a free conversion to this type of loan.
The question could be asked “What if they sell the home in the next 3 years and it is not enough to cover their loan”. As the article mentions, there is great cost to the banks to go through the foreclosure process, so it will be better for banks than foreclosing a year or 2 earlier. At minimum it might save at least half of these homes and spread the rest of the losses over time. As for the homeowners I think that they should either be charged the capital gains tax on the short-fall, or they could choose to buy their new home with a roll-over conversion from the same lender. This would transfer the debt to the new location in the form of a 30 yr fixed. They might have to buy a house of lesser value to accommodate the difference
All of this might sound like a bad deal for the borrower, but if they are responsible, they can make the comeback. If they wait until home prices recover, then sell, they will get out of debt, and actually make money. The main point is that if the borrowers that are in trouble cannot afford a 1/3 reduction and be responsible then there probably is not much that can be done for them anyway short of flat out giving them the home.
John Wake 12.26.08 at 3:59 pm
D, that’s a pretty interesting idea!