Housing fixes fall short
New focus should be on write-downs, negative equity
By Jack Guttentag, Monday, February 2, 2009.
Flickr photo by Thomas Ott.The government's efforts to combat the worst financial crisis since the 1930s can be divided into three phases. Phase one, executed in good part in catch-as-catch-can fashion, was directed toward shoring up financial firms that were undercapitalized and had lost the confidence of their creditors. The goal was to prevent their failure, which would have made the crisis worse -- far worse.
Phase one is still far from over, new flare-ups continue to arise, and new approaches for recapitalizing banks are being considered. But the threat of major failures that would further destabilize the system has largely receded.
Phase two, executed in much more deliberate fashion, was to reduce interest rates to mortgage borrowers. Where phase one had the highest priority, phase two is low priority, adopted largely because it is easy to implement and helps some homeowners, even if not those who most need it.
Lower rates have generated a refinance boom in the midst of a growing recession, like an oasis in the desert. The impact is limited because access is restricted to homeowners who qualify for loans that can be purchased by Fannie Mae or Freddie Mac, or insured by FHA. To lower their rates, borrowers must have equity in their property and good credit -- the thirstiest homeowners can't drink from this oasis.
Phase three has yet to be defined, but the focus has to be on shrinking the foreclosure rate. The financial crisis started in the housing market and will not end until home prices stop declining and foreclosed homes stop flooding the market.
None of the existing programs, including loan programs (Hope for Homeowners and FHA Secure), counseling programs (Hope Hotline) and foreclosure moratoriums, have made a significant dent in the foreclosure rate. The same will be the case if bankruptcy laws are amended to allow judges to modify mortgage contracts, a proposal currently under discussion.
To make major inroads into the foreclosure rate, we need a marked increase in contract modifications of mortgages on the path to foreclosure, returning these loans to good standing and keeping them there. The private sector has made efforts in this direction, but the loans they have modified are too few and the modifications too small to make a substantial difference. In particular, very few modifications reduce the loan balance, which is why about half of them re-default within six months.
Another important objective of phase three is to begin the process of restoring confidence in the quality of financial assets, which the crisis has undermined. With the loss of confidence has come the loss of ascertainable values and marketability. This is the major reason why borrowers today who need loans larger than those that can be sold to Fannie Mae or Freddie Mac have to pay a rate premium of about 2 percent, which is about eight times larger than it was before the crisis.
The following are the main features of a plan directed to these objectives that a colleague and I submitted to the U.S. Treasury. A detailed version is on my Web site (see "Breaking the Back of the Financial Crisis").
Government will encourage servicers/investors to mark down loan balances to 90 percent of current market value by contributing to the markdowns, and by guaranteeing timely payment of principal and interest on modified loans. Eliminating negative equity on modified loans will lower payments and incent borrowers to remain in their homes, which will reduce the incidence of re-defaults.
The government outlays required to support balance write-downs will be large, but will be secured by second liens, which borrowers will be obliged to repay in the future. In this way, the government will be able to recover some (if not all) of the outlays.
Government will encourage private mortgage insurers (PMIs) to underwrite and provide payment insurance on modified loans by offering to share losses with the PMIs. In addition, the payment insurance would carry full faith and credit back-up insurance by the Government National Mortgage Association (GNMA), which will make it highly desirable to investors.
Payment insurance supported by GNMA will make modified loans marketable, and shift some of the workload in processing modifications from understaffed servicers to PMIs. GNMA will receive a piece of the insurance premiums, which should make this part of the program self-supporting or even profitable for the government.
For space reasons, I have left out such topics as how the interest rate will be set on modified loans, and the terms imposed on borrowers for repayment of the advances made by government. I have also left out the long-run role of mortgage payment insurance in stabilizing the housing finance system of the future. These topics are discussed in the Web version.
The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. He is indebted to Igor Roitburg for helpful suggestions. Comments and questions can be left at www.mtgprofessor.com.
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Submitted by Robert A. Hulme on February 2, 2009 - 5:26am.
As was stated throughout this article, more programs need to be put in place to help those borrowers who truly need the help. Just what will really be effective only time will tell.
Creating and maintaining jobs and helping borrowers with the ability to repay should be the major focus of our recovery efforts.
Robert A. Hulme
Realtor, GRI, e-PRO
Prudential Utah Real Estate
Loan Officer
Envision Lending Group, Inc.
www.UtahCountyRealEstate.us
www.UtahHomesForSale.ws
801-885-2586
Submitted by Peter J. Pike on February 2, 2009 - 5:28am.
"None of the existing programs, including loan programs (Hope for Homeowners and FHA Secure), counseling programs (Hope Hotline) and foreclosure moratoriums, have made a significant dent in the foreclosure rate. The same will be the case if bankruptcy laws are amended to allow judges to modify mortgage contracts, a proposal currently under discussion."
While I agree that none of the existing programs have made a significant dent in the foreclosure rate, I believe it is precisely because there was no change in the bankruptcy laws to allow judges to modify mortgages. None of the existing programs offers any reason (either carrot or stick) to lenders, to cause them to modify loans to the point that make sense. We need both the stick (the threat of bankruptcy judges modifying the mortgages unilaterally) and a carrot (give the banks a 150% write off, and share in the money that borrowers would have to pay under the HOPE program) to get things under control.
Peter J. Pike, Esq.
McNeese Title, LLC
Destin, Florida
Submitted by Sean OToole on February 2, 2009 - 9:07am.
"Phase three has yet to be defined, but the focus has to be on shrinking the foreclosure rate. The financial crisis started in the housing market and will not end until home prices stop declining and foreclosed homes stop flooding the market."
This is one of the most ridiculous fallacies of this whole debacle. Counter to popular belief foreclosures are NOT driving prices down. Prices are dropping because most of the gains since 2000 relied on loan programs that no longer exist. As we return to traditional lending programs, prices MUST drop to levels supported by area incomes. Foreclosures make up the majority of sales because lenders are the only willing sellers at CURRENT MARKET prices. Take two seconds to think about the home prices you could qualify your average buyer for today vs. 2 years ago, and you'll instantly know this to be true.
The fundamental problem is that we have roughly $4 Trillion in mortgage debt that simply can't be supported based on reasonable valuations given current incomes. Foreclosure is the ONLY "fix" that is currently working as it is the only solution so far that is actually eliminating this bad debt. Principal balance reduction loan mods and bankruptcy cram downs would also work, though I worry about the unintended consequences of allowing judges to modify secured loans.
The elephant in the room is the simple fact that the U.S. can't back stop $4 Trillion in bad debt without putting the dollar in serious jeopardy; financial institutions are already failing so they clearly can't do it; putting the burden on the pension funds, foreign government and others that invested in it won't end well; and the idea that borrowers would be able to repay it was always a fantasy.
What will work is the spreading of risk and resulting loss among all the parties. The government should take on some share of the loss, say $1 Trillion, by offsetting a portion of losses for those financial institutions and mortgage debt investors who modify loans to supportable valuations for those borrowers who would reasonably qualify for the revised loan amount. Lenders/investors not willing to modify loans to those levels in a reasonable time frame, or who made loans to borrowers who would never have reasonably qualified should be barred from all bail outs and left to fail.
Until then foreclosure remains the only tool for eliminating this mountain of bad mortgage debt. Those pushing for foreclosure moratoriums should know that moratoriums will NOT bring back prices, but will delay our return to a healthy housing market.
Sean O'Toole
Founder / CEO
ForeclosureRadar.com
ForeclosureTruth.com
Submitted by Steve Hicks on February 2, 2009 - 9:11am.
Simple assumption is still the best method of slowing repos and getting our market back on track. The lenders took this away years ago to make sure they were involved in every real estate transaction anywhere. Now righting the market helps lenders more than generating new mortgages. Lenders are not currently calling due on sale clauses anyway, so legalize it and let the REALTORS close resale tranactions with a simple no qualifing assumption. This will save 4 to 6 percent in closing cost making marginal listings sell.
Submitted by William Metzker on February 2, 2009 - 9:15am.
I'm glad more people are starting to say what Mr. Guttentag is offering here--a focus on mitigating foreclosures and significant write downs of loan balances with mechanisms for (a) the government to get its money back, and (b) the lenders keep a semblance of capitalization.
However, I don't believe a 90% workout is enough. I don't know exactly where the floor is, but I'm guessing it could be as low as 75%, in some cases. Such a writedown will, in a lot of cases, lead to zeroing out of bank shareholders' equities and maybe even partial or temporary bank nationalization. The sooner we get there, the better.
I'm uncomfortable with BK judges being able to order writedowns. The concept is ok, but I've seen a few judges who ought not be given this authority.
Submitted by Jerzy (George) Szkup on February 2, 2009 - 10:46am.
George Szkup
www.DestinationTucson.biz
All these good opinions and suggestions!
Here is one more - Re: foreclosures.
Foreclosures are a major problem and are one of the items that is driving prices down (ask any real estate practitioner).
Probably 50% of them cannot be helped but the other 50% (converts itself to over 1 million homes) could be helped if bankruptcy laws are amended to allow judges to modify mortgage contracts. This law, when and if enacted, would provide needed incentive to lenders to engage in serious, proper loan modifications.
Not a cure-all but it would reduce the problem somewhat.
George Szkup Designated Broker
Tucson Home Advisor LLC
Submitted by Rick Fine on February 2, 2009 - 1:44pm.
Loan modifications for people facing foreclosure is not the answer to stopping the decline in values unless of course America wants to become the newest communist nation.
Bailing out or backstopping financial institutions will not stop the downward spiral of the housing market either.
To keep financial institutions who made poor choices on life support instead of letting them fail as they should are the actions of an immature and selfish people.
America seems to be fleeing from the concept of personal responsibility and accountability for our choices.
Worse yet, those of us who continue to make payments on time are being penalized for doing the right thing- that is, working longer and harder to make up the difference needed to pay the bills.
Guess what, I owe too much on my home too.
That sucks.
Oh well, I guess that means I need to work harder to make enough to pay the bills.
If I fail to, I lose the house.
That's the way it is supposed to work.
If you bought a home or financed away all your equity during the madness now known as the real estate bubble, you are smart enough to have known that there was a risk in leveraging real estate during a boom. To pretend that a person was too stupid and un-sophisticated to understand their actions is a cop-out.
Requiring those that continue to work and make their payments to pay for your refusal to accept the consequences are the actions of a coward who is not fit to own property in the first place.
This is like giving a drunk lite beer instead of grain alchohol, while it may provide some immediate relief, the problem will only continue to escalate until the bottom is found. Only then can we begin to 'Hope For Change'....
Submitted by Jeff Manson on February 2, 2009 - 5:23pm.
Not sure if forcing banks to rewrite loans for consumers that can not make payments will help things. Just prolong the process and make interest rates go up in the long run.
If the Government really wanted to help with the dropping housing prices they would get rid of the capitol gains tax and you would see investors start buying up all these foreclosures therefore stabilizing prices. They could get rid of the tax for anyone that bought within 18 months.
Now that would truly stimulate the economy, create jobs and stabilize the housing market.
The Politian’s will not go for that because it is too simple and does not involve spending money on special interest group projects. Not sure they truly want to help the economy, just the people who give them money to get elected.
Obama preached change during the election, but is doing the same thing as the last president did. Trying to rush a stimulus package through congress using the same old fear tactics. Some things never change :-(
Jeff Manson
American Dream Realty Hawaii
Hawaiis
Submitted by Jose Lopez on February 2, 2009 - 6:50pm.
Today I just read that the Republicans are putting together a deal to help homeowners with their mortgages. They are trying to get the rate down to 4.5% and guarantee Fannie to purchase the note from the bank. Lets see if it happens.
Sarasota Florida Foreclosures
Bradenton Foreclosures
www.fl-repos.com
Submitted by Steve Hicks on February 4, 2009 - 2:33pm.
Deregulate the assmption policies with theses loans! Make them all assumable with no qualifying again. The free market would take over and we would see an insant drop in foreclosures. Stop throwing billions at the problem only to have the bankers intercept the funds for other purposes. We REALTORS will sell the existing inventory befor it hits the repo market.