Debt Destruction through Principal Reduction

From time to time, I’ve been told that I ramble on too much, or that I’m a little too wordy, longwinded, tedious, etc…  In an effort to be a bit more concise, I’ll get to my point!  (HA…  yeah right!   Buckle up!)

You can’t save the economy, without saving its most important part!  The GENERAL PUBLIC (the consumer, producer, service provider).  In a nutshell, the problems we face are:  Too much Debt, Too little credit, and no transparency between the two.  (In order to further break that down, we have to look at the way this affects the following 2 groups:  Wall St and Main St.  …and how the problem is addressed by The Powers That Be and the dollar that was.  …but we’ll get to that later.)

Plain and simple, the average person is in over their heads.  …and we have to throw out our grandparent’s book on what needs to be done.  We are in unique times.  Deflationary trends will rear their heads in the world of excess, but inflationary trends will emerge in the world of necessities.  With the cost of living, surviving, and thriving becoming so expensive, those without “SHOULD” drive the cost of everything down.  …but the levels of debt owed are far too vast to be absorbed by the overburdened system.  Since the consumer, wall st, and the government are already so overspent, they no longer have the buffer of existing credit to meet our current obligations.

Faced with this catastrophe, the options that have to immediately be addressed are to add credit and destroy debt.  The Powers That Be (TPTB – The Government, Fed, Treasury, SEC, FASB, etc…) have gone to great lengths to save the Monoliners, Banks, Credit, Financial Firms, Insurers, Auto, etc… in grand socialist fashion.  In short, where they had too much debt, TPTB eased the burden of debt obligations by taking debt off the hands of Corporate America.  Where they had too little credit, TPTB provided liquidity in every conceivable way and slashed interbank rates to keep markets from freezing.  …and where transparency issues existed, TPTB absorbed the toxic mess, and placed it in the vortex of Unknown Financial Obligations (UFO’s), where they will disappear from existence, but someday, magically reappear as a long term gain. (…while looking and smelling like freshly printed dollars which no one will question 10/20/30 years from now.)

By saving Wall St, we have temporarily saved the arms and legs of our economy…  Now it is time to save the body.  Main St!

Principal Reduction:  (aimed at primary residence)

To immediately address the needs of Main St, debt must be destroyed.  Obviously, the overspent consumer can no longer spend without availability of, or access to, credit and current debt obligations.  The subsequent obligatory pullback by the consumer will directly feed the deflationary spiral, which then can only be absorbed through inflationary printing by TPTP.  (more quantitative easing via ) 0% rate, and T-buy backs)

The most direct way to avoid this death spiral and put money back in the pockets of the consumer, while at the same time, reducing debt obligations, is through principal reductions of debt.  Time is of the essence as every day that this is not done exacerbates the speed and depth at which our economy will fall.  There is a multiplier affect, which requires immediate action to put the necessary floor down.  Currently, the “wait and see” reactionary approach by TPTB, have us trying to save those already in trouble, rather then taking the proactive approach of saving those who will inevitably be in trouble.  (I’m not saying those who are in trouble are not a top concern, but rather they need to be tended to in a manor that addresses the future problems first.  Like on an burning airplane, you put the oxygen mask on yourself first….  Then you can help other.  Otherwise, you’re just compounding the problem.)

Perhaps a better analogy is, when addressing the Tsunami of debt that our country is in, you don’t put up a wall to block the tidal wave that already came in!  You put up a wall to block all the future waves that will be coming!!!  For the wave that already came in, you sift through the wreckage and repair what you can.  In an effort to help the public, TPTB have spent a great deal of time and money working on providing aid for those already in foreclosure.  Unfortunately, they have failed to build the wall that is needed to stop the next tidal waves of foreclosures and bankruptcies!  The compounding of losses as the concept of waiting for someone to go into  foreclosure/bankruptcy is far too late in the process to help.

How Principal Reduction Works?

If you bailout every bankrupt person, then responsible people will choose not to pay. You can NOT create fail/reward system. A balanced approach is needed.  With that said, to stem further risk of escalating bankruptcy/foreclosures a mathematically modeled approach needs to be taken where the percentage of money owed on primary residences can be reduced by a factor greater then the next projected overall net loss within the spectrum of the consumer’s reduction of spending + obligations.

In a prior article, (http://www.rgemonitor.com/globalmacro-monitor/254144/friends_romans_countrymen_lend_me_your_ears) I used hypothetical 10% and 20% reductions to draw how this works.  What I stated was that many of the underlying secondary market securities have already been written down this much or more already.  (many by up to 80%)  By reducing the principal value of these assets even further, it would seem to that this would cause these securities to take additional hits.  …but this is not the case.  A “less is more” approach will actually raise the amortized value of the securities, as their likelihood of being repaid increases.

At the same time, when Main St feels the “rolling stimulus” of reduced the monthly bills, the immediate capital/credit inflow will flow to the following places:

1. Pay off debt

2. Saving

3. Spending

4. Under the mattress.

For the first 3 scenarios, you have cash flowing back into the system, thus feeding the “less is more” concept.  “Debt repayment” will help aid putting a floor under default or the confidence/fear of default by investors. “Savings” will immediately recapitalize the banks, thus helping start an upward cycle.  And “Spending” will start to resume when fear resides and credit exists.  Unfortunately, “under the mattress” will have to be addressed. (this can be done through increased bank rates and raising of FDIC caps or restoration of confidence in the fact that the first 3 scenarios are once again working.)

For the portion of written down principal, TPTB would create “open receivables” in equal amounts.  (TPTB could even securitize these severely distressed assets, much like the Tobacco Bond Debt.  I wouldn’t be in favor of more securitization…  but at least the perverse incentive would be in aiding the economy to recover to the point where even the open receivables were potentially paid off.  Investing here would be a true investment in the future/confidence of the net worth of the economy.  That’s far better then requiring people to smoke, just so debt can be repaid!!!)

VOLUNTARY!!!   Not MANDATORY!

The concept of this stimulus plan is voluntary but equal.  For those who do not want to participate (for fear of reducing the “principal value” of their home further) they do not have to participate.  Alternative stimulus should be provided for their responsible behaviors of spending within their means.  (Unfortunately, they will eventually come to the realization that their asset isn’t worth what they paid for it or what they felt it should be worth, as the market currently dictates.  Their prudence through “potential” house price recovery could pay off, if the market was to return.  (which is most likely through a “less is more” theory/reality))  For example, those whom have paid off their MTG debt, or choose not to write down their principal:  a tax break can be created to reward them annually (similar to a STAR reduction).

For all those that choose to reduce principal, an open receivable is kept on the books for the length of ownership of the home. If the housing market was to recover and you were to see a windfall, the open receivable would have to be paid prior to seeing a profit.

For example, You have a $200,000 mortgage. TPTB writes down 10%.

* TPTB creates an open receivable for $20,000.  (which TPTB could then securitize as skin in the game for aiding a recovery focused on the broad US economy)

* The homeowner now has a $1,140 monthly payment as opposed to a $1,266 payment, saving them $126 per month which gets infused back into the financial system (This is your “rolling stimulus plan”.   For a typical $417,000 conforming loan, the savings would be $264 per month.)

To look further down the road, if the housing market were to recover, this is what would happen. You sell your $200,000 home (which you were only paying on $180,000) for $230,000. Instead of walking away with a $50,000 profit (230k – 180k = 50k) you would have to pay off your open receivable first. So you’d walk away with $30k (or maybe less if interest is added???)

In the event, that the market continued to stay depressed, the likelihood of you selling your house at a loss (or flat) versus just filing for bankruptcy/foreclosure would be significantly diminished by the parallel difference between the equity owed versus the current market price.  Let’s say, you were somewhat responsible, and put 15% down on the purchase of your home.  ($200,000 price, $30,000 equity, $170,000 debt.)  In addition, let’s say the market dropped by 40%.  Your house would be valued at $120,000.  In order to keep the homeowner’s skin in the game, rather then walk away from the negative equity, TPTB will need to lessen the 30% difference of $170,000 owed versus the $120,000 value.  If say a 15% Principal Reduction was set, owing $145,000 on a house that you paid $200,000 for, would leave less of a risk of homeowners walking away, and promote potential sales.  At the same time, that homeowner would see their monthly debt burden reduced by nearly $150.00 a month.  That’s $150, this month, next month, the month after that, and so on.  That’s your “rolling stimulus”.  When 150,000,000 homeowners see this reduction of debt, it pans out to over $250,000,000,000.00 billion in new liquidity, and destroyed debt per year.  (which like I said earlier, will be printed regardless, as a necessity for replacing the fictional monopoly money (of finance) that has already left the system.  (The “monopoly money” will be further explained in the future post on “The Financial Industry’s overgrowth”.  – still in pre-production)

Which ever way the market goes, the issue of “transparency” where homeowners are holding “illiquid assets” (their house) is addressed as their debt is less, their credit is more, and the glut of unsold houses reverses course due to the momentum in price discovery of a bottom.  (this bottom is unattainable right now as people cannot come to grips with the reality of where the current market prices are at versus their equity owned)

***Interest Rate Reductions for Homeowners***

TPTB have already floated around the concept of mass interest rate reductions for homeowners.  In theory, and mathematically, this concept looks the same as Principal Reduction, but is flawed.  It lacks Incentive!  It does NOT put equity in the homeowners hands in relation to their debts.  In sum, it only addresses the credit side of the problem.

Quantitative Easing:    By taking the drastic measures they have, TPTB have played a high risk game of chicken with the value of the Dollar.  When our financial system started to systemically implode, the dollar and all financial companies based in dollars fell with it.  The markets dropped as the fear struck the players and well informed financial communities.  Eventually, when that fear became reality, and losses started to be felt around the world, the losses around the world balanced out.  The subsequent flight to safety saved the US Government, and its entire economy.

The current confidence boost in the power of the dollar has given our current financial decision makers a false sense of confidence.  Now that economics has taken over the mainstream media and further educated the masses on large parts of the existing problems, the general public has grown tense.  Already gripped with fear, and having seen the value of their general investments cut in half, the public is now too well informed to a blatant devaluing of the dollar.  If the government is serious enough to take the next steps in “Quantitative Easing”, I believe they run a serious risk of sliding down a slippery slope of trust and good faith in the value of the currency in relation to easing our country’s financial burden by inflating our way out of the debt.

The precedent of printing credit without parallel debt destruction becomes cyclical, and hyperinflationary.  (Since all solvency issues with the government will be averted through printing)  The “ground level fear” of “what has value” that exists on the street will no longer just pit the USD versus import/export products like oil, foreign currency, cheap labor.  The reality is:  “what has value” will be revised from financial engineering to putting food on your plate.  This is reality.  Right now, in the current environment, this potential risk is significantly upped if Quantitative easing takes place.  We saw oil rise to $147, (when it is currently at $45), which begs the question:  Will food be next?  Why not?  Why is oil capable of inflating by over 200% of its current value, while rice is not? Especially, when hoarding is much easier of food products by the general public.

Playing with the confidence in the value of the dollar is NOT a healthy risk right now!!!  Quantitative easing could work if the core (the body and head) of our economy was stable.  Currently, the backstop of our economy only owns debt and illiquid assets.  As the net redemptions, expenses, losses, etc… continue to grow, the more bad news and debt reality hits.  This will cause more obligations, larger bailouts and greater outflows.  (Take a moment to work through the logic.) This is a doomed process through liquidity injections alone as the only reasonable solutions would require so much liquidity that hyperinflation would be a guarantee. The time is now.  Debt Destruction.  It’s time for the public to call upon TPTB and demand it for our economic salvation.  Without this, and fast, I fear what’s around the corner.  The second the general public is saved, I will be prepared to start giving real investment advice.  Until then, our economy is walking blindfolded through a nuclear minefield!

Thanks for listening…  now it’s your turn to talk.

All the best, Miss America – Rich Hartmann

p.s.  If you believe…  Then do you part and spread the word!

34 Responses to "Debt Destruction through Principal Reduction"

  1. OuterBeltway   December 12, 2008 at 9:35 am

    MA:Your focus on Main Street is spot on. Your point that household disposable income is the key to the economy’s salvation is also correct.We need to think long and hard about the household and its relation to the global economy. How do we earn money in tomorrow’s economy?What do we invest in? What do we spend money on? What are the actions that we take as individuals to move our Main Street economy back onto a solid foundation?Keep the spotlight right where you’ve got it, MA.What do we need to do to enhance the earning power of the household, and to shift (not reduce, but shift) the expenditures the household makes so that those expenditures contribute to our future economic security?The mortgage debt re-scheduling mechanism you posit would be a great step in the right direction. If we can spend $700B to bail out what is now an essentially irrelevant industry (investment banking), we can spend $700B to stabilize our nation’s households, which actually IS our economy.Tangentially, I hope you’ll remember to make fun of your congressperson if they voted for the Wall Street Bailout. They are either really misinformed, or they’re cynical crooks. In no way can they be described as fit for office.Sorry, Congress, but you got caught out in the sunshine. You were very, very ugly to behold.

    • MA   December 12, 2008 at 10:39 am

      Hey OB,I can talk to the RGE folk about the vacancy of LB, and if they’d like to fill it.Would you be interested?MA

      • OuterBeltway   December 12, 2008 at 3:08 pm

        MA:It would make sense to have a spot to run the BrainTrust thread from. That would really help the whole gang.Ask if they’d consider it, OK?Tks.

        • amacfly   December 13, 2008 at 6:45 pm

          I’ve been trying to find your oft spoken about BrainTrust thread, but the search here hasn’t worked for me in turning it up, so if this gets you on the masthead then count a vote from me too.

      • Average Jane   December 12, 2008 at 4:41 pm

        A capital idea! ;) One vote from me!

  2. Octavio Richetta   December 12, 2008 at 9:56 am

    MA, IMHO, you are being too smart and too early.IMO, inflation and USD cliff-diving may happen but it is way too early to get ready for that. You will have plenty of time to move if that comes. You sound to me like Bill Gross latest early move: Corporate bonds (his previous early move was out of treasuries and into agency paper).Early in the year I got out of TLT, IEF, SHY and the equivalent Fidelity Spartan index treasury bond funds to let Bill Gross do the driving for me, navigate the turbulent waters while manging to make an extra buck. What a stupid move:-)I think he should go back to counting cards in Vegas for a while see if he gets the golden touch back. In the mean time, beating against PIMCO’s views, or at the very least ignoring them, may be a money maker.

    • OR   December 12, 2008 at 10:04 am

      Late edit: “You remind me of Bill Gross’ latest early move….

      • MA   December 12, 2008 at 10:37 am

        OR,I am well hedged in occupations. My Wife2k is a bankruptsy lawyer, me a banker.We’re on opposite ends.My fear isn’t for self preservation, but rather my neighbors.On the jitters meter, I am at all time highs.

    • artichoke   December 13, 2008 at 6:10 pm

      If I understand Rich’s comment, things would be even worse if we have deflation next. Then the debts would become unpayable at light-speed and our entire society would, in my opinion, be kaput.Try foreclosing and evicting 50% of mortgage holders in states where gun ownership is legal? I don’t think it would happen.Rich is saying that even if we have the necessary inflation, that’s not enough. We need debt writeoffs to lower the size of those debts relative to other prices in the economy.

  3. Free Tibet   December 12, 2008 at 10:11 am

    It appears TPTB feel debt destruction is more equitably achieved through currency debasement – which is hardly news. And perhaps savings can be leveraged 80:1, as has been shown. But eventually comes a tipping point in which savers get wise.

    • MA   December 12, 2008 at 10:34 am

      Thanks FT,My problem right now is that the Principal Reduction is on TPTB’s plate. They are aware of it… yet they are hesitating to pull the trigger.They are kings. …and we are debt servants. They are pushing until the last possible moment to go through with this, as it takes the focus away from Wall St. (which is where their castle are) These people are of a different mindset! They really feel as if we put another wing on the castle, that will save the people. (you’ve gotta understand the bull/broker/leaders mindset.) These people believe in their own importance! …it not that they’re not looking out for you. …it’s that they feel the way to save you, is by enhancing themselves, so they can have the ability to throw you more crumbs.Things are set to get worse very fast, and spiral far out of their control if they don’t revise their immediate vision. It’s not that they don’t understand this… …it’s just arrogance and a true belief in “top down”. …but to quote Crammerica “they have no idea how bad it is out there! NO IDEA!Their disconnect is epic.I watch downward spiral every day on my daily walk through Times Square ton and from the office. At the crossroads of America, I see it on the faces, and I feel in the air!Miss America

      • Free Tibet   December 12, 2008 at 2:52 pm

        I believe that TPTB believe they are already addressing it. It must be something they read – maybe about the GD – or maybe just something they’re smoking, that has convinced them that they Kings, world sovereign, and fundamental to all enlightenment. Seems disconnected to me too.But my problem, right now, it that I think it is unlikely to help – building that castle on a foundation of debt – and will make things even worse. Providing all of this liquidity in a deflationary environment assumes it can be mopped up before it turns inflationary. I doubt it. Experience shows that these things turn suddenly. Currency collapse.If the momentary strength of the $ is due to the repatriation of funds to make margin calls on US obligations, ask yourself at what point it’s better to just jingle mail those keys?

      • Guest   December 13, 2008 at 6:18 pm

        I don’t think the financial leadership thinks of common people as being important. They have a system, the system is important, the common people will have to conform to the system.Building the incentives of that system is like designing a maze for experimental rats. If you build the maze right, you can get the rats to run the way you want. This process is called “microeconomics”!They even invented a weird version of macroeconomics (macro not micro) called “growth theory” where all that matters is economic growth. Welfare, leisure, all those old concepts from intro econ are oddly absent from the calculations of growth theory.Let’s be realistic. It’s not a matter of convincing these people to care about the common man, or what the best way to help them truly is. They do not and will not care! It’s going to be a very blunt confrontation to resolve this, exciting to watch.

      • amacfly   December 13, 2008 at 7:02 pm

        Wow, it gives me chills to hear you say that here. This is what I’ve learnt Mullins, Griffin, Estulin, Russo, Ron Paul and others, but somehow hoped wasn’t really true. Your comment here on RGE, the place I’ve found the most clarity over the last couple of years, underscores the reality we are all in living, as their debt slaves.Thank you as always for your great and clear comments. I wish I could offer more than thanks, but I do not work in finance, I’m merely trying to learn how to save what I have in a very stormy sea.

  4. Anonymous   December 12, 2008 at 12:44 pm

    Dear Miss America,I appreciate your humanity and your foresight. Your analogy scares me though; Let’s all put on oxygen masks near a huge source of fire – I believe your readers understand the unavoidable conclusion. Your proposal sounds more like lowering the plane to a sustainable level then having the passengers parachuted off the doomed vessel. I pray you are correct as Paulson and his boys are turning up the O2 as we speak and the fire is getting damned hot!

  5. Tom   December 12, 2008 at 12:53 pm

    I sold my house in early 2008 because I didn’t really like the area and could see the drop in prices worsening. I didn’t lose or make any money on the deal. Now I rent and would like to buy a home but I can’t figure out how to price a house and the sellers in the area (western MA) don’t seem to believe prices have fallen at all (even though none of the houses in the 400+ range have sold in months). I recognize I am most likely in the minority right now in that I have cash, only small and easily serviceable debt, and a seemingly highly stable job (ER doctor). I am in an ideal position to buy a house but I can’t see going ahead with it if prices will drop another 20% (does this include deflationary effects as well). I can’t see investing in anything else right now, is a house a bad idea? If people like me won’t buy a house, who on earth will?

  6. 2cents   December 12, 2008 at 2:23 pm

    @MAI too agree, that there has been too little focus on the general public.I find it difficult to agree with your plan however. Oh, I follow the logic and it certainly seams feasible, but it like the current Wall St. “funding” is ultimately what I call Absolute Value Time Immortal accounting and it is not conductive to a better future.We of course now practice current value accounting coupled with future value investing. We tend to base everything on current values by either forecasting present value of future fund flows or normalizing past fund flows to their present value. Of course, there are assumptions used to perform either calculation, but the point is that we are trying to make logical, understandable comparisons. The smoothed variable that invariably results is that volatility (detail) is linearized or at most bounded. It’s kind of like the difference between driving from LA to NY and flying from LA to NY. The former will be generally more tortuous and adventuresome while the latter will be rather predictable and uneventful.Under what I call Absolute Value Time Immortal accounting, we are effectively putting a lien on all assets this freezes the volatility and bounds gains or losses in opposite directions from reality! If a mortgagee agrees to a principal reduction he gets the immediate benefit of staying in his home. If the home value continues to go down then he may be in the exact same position again in 6 months. If his home value goes up he will have to remit those gains up to the value delta of the principle reduction. It turns into a mind set of if things get worse I’m no worse off and if things get better I’m not going to be any better off. Why would anyone invest current funds into maintenance and upkeep when the foreseeable upside is nil! Better to pay the “rent” mortgage and wait till things stabilize enough and then dump the house into the market and let the lender realize the net loss of the recovery amount.What happens here is that the asset becomes bracketed I Asset I as an absolute value regardless of what actually happens elsewhere and the time value of it is frozen. It’s future value is bastardized until the bracket is breached. Look for a ripe market in bracketology to take hold should such a plan ever be implemented. You’ve essentially converted a fixed rate mortgage to a mortgage with lower monthly payments followed by a balloon payment of a size and timing largely chosen by the borrower. Look for serious manipulation of these parameters in the future! The kicker is that the lender will be able to continue to realize the full value of the loan on its books as an asset! Talk about zombie banks!This same Absolute Value accounting is the same structure that is taking place on Wall St. except it is working with the present value instead. While your mortgage plan captures or brackets a future fund flow, Wall St. is capturing a present fund flow! They can use this money in the real sense right now to do whatever it is that they feel most compelled to do with it while there assets are bracketed in level 3 accounting. If or when these funding mechanisms are unwound and the FED/Treasury are made whole who do you think will be paying the supposed interest on those funds? While those funds are debts of the US who do you think is paying the interest to the bondholders? If or when housing stabilizes who will be paying back the principle reduction amounts and interest?Quite frankly, we the taxpayer, investor, consumer and homeowner are and will pay the full cost of these maneuvers. Your plan coupled with current alphabet funding schemes mean that financial institutions get cash now and can bracket their assets (level 3) to forgo any realization of losses but capture any upside however unimaginable at this point. On the other hand their current receivables get dinged a little by reduced mortgage payments but that is better than the alternative of many receivables going to zero! In return for the mortgagee getting to lower his payments and help the lender at least maintain a modicum of flow of receivables, the bank gets to continue to book the entire value of the original loan while the mortgagee inherits a balloon payment!To me it would be a much more transparent and efficient to just get people into homes that they can afford period. Just realize the losses and move on. People will counter that no sane person will take a mortgage or write one on another house that may also decline in value. Exactly, prices are still going to decline further from here. It has to start somewhere though, and once enough people are actually needing a house and enough lenders see that upside for loans now exists there will be a rapid consolidation to supportable loans and housing values. It’s unfortunate that there is indeed pain either way, but anyone who thinks that we can solve this problem without pain is delusional! The government’s assistance should be to limited providing temporary and compassionate support for food, shelter, and clothing.

    • FARNORTH 5   December 12, 2008 at 6:19 pm

      RE ;THE MORTGAGE DEALIn my neck of the woods real pain was caused by One Industry towns having the One Industry shut downThe “SOLUTION”for the mortgage company was to take the $300,000.Mortgage on the now $200,000 house and split it into two parts.(1) A $200,000 !ST MORTGAGE AT CURRENT RATES PLUS.(2) A $100,000 LIEN DUE ONLY AT THE TIME OF RESALE.ANY ASSET APPRECIATION SPLIT 50/50 BETWEEN THE PARTIES.Worked like a charm !!!!

  7. MA   December 12, 2008 at 2:57 pm

    Thanks $0.02.Very well constructed argument. Unfortunately, I believe differently because of some work I’m doing on the concept that the financial system has grown too large for itself (I keep stating that it’s in pre-production)In theory (abridged version), true production and services created value. Credit was provided in return, and spend and consume followed. (Finance, always skimmed off of this as a service for tracking/etc…) That skim, has always been monopoly money since no “real” production was born from it. It was always hidden, because future inflow would mask the outflow.…but the “skim” has grown large (and compounding), and 10x worse, the non-servicing world of “finance” (advisors/investors/brokers/etc…) had become the market. There is no way to cover their skim.401ks (which are the people’s new savings accounts) began to float the new massive skim… but not enough incoming money had been added to keep the “skim” sustainable.…and now that the outflow had begun, and the “skim” continues, TPTB’s inability to add credit on par with what’s been extracted is exposing the shell of monopoly money game. That production less cash that was extracted needs replacement by real production. …since the old game hiding the “skim” is not working because future inflow can no longer mask the outflow size.Bad things are afoot.Debt needs to be destroyed ASAP as “current values” (time immortal accounting?) might technically look like DOW -32,000.Miss America

    • MA   December 12, 2008 at 3:00 pm

      p.s. $0.02regardless of my stance, your post forced me to think a little more, and strenghthen my research.I’m glad you stop in.MA

    • 2cents   December 13, 2008 at 7:30 pm

      @ MAI totally agree with your above “skim” story as we both discussed earlier with what OB called my asynchronous thesis. Yes, this is a pretty complicated jumble of $&^@ and absolutely nothing is going to be cleanly resolved.I respect your disagreement with my mortgage synopsis above. As I stated, I do think that your plan will generally obtain the results you are expecting. Your solution provides for an accountment of the debt write downs whereas mine pretty much says its gone, it ain’t coming back anytime soon and don’t even think about keeping it on your books.

  8. Guest   December 12, 2008 at 3:15 pm

    MA,Your solution should not be limited to the US economy but must be extended to the world economy and world debt. There has been a lot of talk of “forgiving” the debt of African economies (for example). Of course, some Africans would take umbrage at the use of the word “forgiving”.

  9. Average Jane   December 12, 2008 at 4:46 pm

    Hi, MA. Great post.We need to get back to price-to-income ratio. When my parents bought their home back in 1970s, that D2I ratio was 1-1/2. Now of course that’s laughable.Rest assured I am constantly calling my Congresswoman, who voted for the TARP, with my message: “How’s that workin’ for ya?”And this article will be e-mailed to my family and friends. Thank you.

  10. Michael   December 12, 2008 at 6:15 pm

    Why does everybody come up with the most complicated possible avenues to address a completely garden variety credit contraction (read your history since the 17th Century)?The total of all the loans, guarantees, swaps, purchases, etc, in the various bailouts of the Fed and Treasury to date is $8 trillion. With the boutique wars in Iraq and Afganistan and the coming fiscal stimulus package, we’re committed to well over $10 trillion in “Quick, save somebody!” money.Rather than arguing about who deserves which piece of the pie, and fighting over what knd of fruit should be baked in, all we need to do to rocket the country out of any deflation/recession/mortgage problems/etc is cancel all the Rube Goldberg bailout programs and the unnecesary wars and send a check for $33,333.00 to every citizen.Problema Resuelto!!

  11. TA   December 12, 2008 at 11:35 pm

    MA,Another great Friday contribution! But I thought the public has received the same attention as Wall Street (wink, wink). They had their own special Congressional hearings chaired by Chrm. Frank and Dodd, and have their very own relief plans (wasn’t Project Hope announced about a year ago?).I’ve studied several housing relief plans floated this year, and found all to be shamefully disingenuous. Each used the human suffering associated with foreclosure to advance their proposal which typically incorporated either an interest rate reduction or a “principal reduction set aside” to achieve more affordable mortgage payments.Folks, here’s the rub; the fly in the ointment isn’t foreclosures, its short sales. There are far more borrowers underwater than in foreclosure (or going into foreclosure).What’s gummed up local real estate markets isn’t the rising number of foreclosures, it’s lenders unwilling to accept a short sale. Without a release from their lender(s) (whereby the lender(s) assumes the loss), sellers are forced to make up the loss (difference) from savings (?), retirement funds (??), or most likely, are unable to close on the sale. Some skip, but at least for now, most are resigned to making monthly rent (mortgage) payments, hoping for a better day.IMHO, mandatory principal reduction is the only viable solution. If it’s that simple, why hasn’t it happened already? Lenders will only agree to mortgage modifications that are in their best interest, and borrowers aren’t organized; they simply don’t have the clout of the banking lobby, and as a result, they have no voice.By the end of 2009, a plan will be adopted which unilaterally reduces the current principal balance on all mortgages originated between 20XX and 20XX. The lender’s quid pro quo will be an extension of the tax code’s (net operating loss) “carry back” provision from 2 to X years to offset losses associated with the principal reduction. I anticipate a major policy speech announcing this approach in 1Q09.Although the cat fights over its details will be entertaining (i.e. “moral hazard”, flat rate reductions or tie them to an index – but which one?), the plan won’t be derailed. Why? 70% of our GDP is tied to consumption and homes have become the primary catalyst for that consumption.Watch for the resuscitation of this phrase in 2009, “desperate times call for desperate measures”. Without an approach this drastic, it could take a generation for the housing market to unwind and function smoothly again. And we don’t have six months, let alone a generation.

  12. Guest   December 13, 2008 at 4:06 am

    How is going to pay? There is always a pricetag and this one is going to be huge.Your suggestion is just another way to print money and there will be a severe price for this.

    • TA   December 13, 2008 at 9:14 am

      Guest,I’m assuming your post was directed to me.The cost associated with unilateral principal reduction could be +/- $1 trillion.Although unilateral principal reduction may seem like radical surgery to some, it succinctly addresses the two main obstacles associated with achieving any semblance of short-term economic normalcy; the recapitalization of lenders and borrowers (lenders via NOL carry backs and borrowers via the reduction/elimination of negative equity & lower mortgage payments) and the normalization of local real estate markets (reduce over under borrowers and foreclosures).To your point, will there be collateral issues associated with achieving those ends (printing money)? Of course. However, IMHO, they won’t trump achieving those ends. What’s an additional $1 trillion on top of the $5 – 7 trillion already pledged, if it reignites the primary catalyst in our economy?Undoubtedly Capital Hill servers and switch boards will melt from the deafening shrill of “moral hazard”, “socialism”, “un-American”, etc. Hey, this may actually result in the merging of blogosphere and MSM opinion (at least for a while), but in the end, “desperate times call for desperate measures”.All will be right by the 2010 spring selling season…hopefully.

  13. Michelle   December 13, 2008 at 10:14 am

    If a “safety net” is provided to underwater homeowners through principal reduction, won’t this create a moral hazard and drive home prices even lower? Let’s say that I’m looking to purchase an existing home and know TPTB have reduced the principal balance on said home, I will offer far less for the home knowing the seller is no longer upside down and can accept a lower sales price. In this case, principal reduction only exacerbates the downward spiral in home prices. TPTB can require that anyone accepting principal reduction program assistance must pay a recapture if their home sells within a certain time frame, but then this opens up a whole new can of worms as to whether homeowners accept assistance or just walk away. With strings attached that resembles a noose rather than a lifeline, these homeowners may rather just return their keys than accept a deal that may ultimately drive home prices down further.

  14. Sean   December 15, 2008 at 12:30 pm

    Rich, as you posted on Roubini’s latest blog that you were literally “scared” right now. May I ask specifically what were you scared? About stock equity?Thanks for sharing.Sean===========================”As I stated on my thread… My jitters are at all time highs. (remember, my write ups were started before much of this new news had come out. I’m literally “scared” right now.)”

    • pa   December 16, 2008 at 7:02 pm

      ice as the principle is reduced who will be underwater next?2 trillion tonnes of Arctic ice melted since 2003: NASACTV.ca News StaffMeasurements of ice collected by NASA’s GRACE satellite suggests that most of the land ice lost over the past five years has been in Greenland, with significant losses also occurring in Alaska and the Antarctic. Scientists say the Greenland melt shows no signs of slowing down and, instead, it appears to be accelerating.

  15. amacfly   December 17, 2008 at 5:28 pm

    Just for fun I divided 700Bn by 400Mm, to see what every man woman and child in the USA would get if this bankster fraud was not funneled back to the scam artists who perpetrated this massive Madoff on the American people.700Bn spread across 400Mm is $1,750,000 per head – now that would solve a lot!

  16. Guest   December 20, 2008 at 9:58 am

    MA,when will you be posting your next contribution? I’m eagerly waiting to read.

  17. David   February 7, 2009 at 1:17 am

    I see chase bank is taking a customer’s payment as a Principal Reduction, as shown in monthly statment. Say, a payment of $1000 is splited into 3 parts:$90 for paying the interest$820 for paying the principal$90 Principal Reductionso, total is $1000 of the paymentWhat does this Principal Reductin really mean?

  18. the sacraficing one   February 24, 2009 at 1:54 pm

    I am all for helping people that are hurting, but this fix is hurting everyone. Several of my neighbors have recently received up to 250000 in principle reductions on their homes. 250000 A quarter of a million dollars. Forgiven…gone. How am I ever going to make money on my home now. Are these folks struggling? NO. They are still driving beamers and lincolns and their kids are still in all their clubs and they are vacationing in exotic parts of the world. We bought used cars and my child had to go to community college instead of a university so we could make our house payments. How is this right? How can this possibly be right?