Intelligent Loan Mods & Foreclosure Abatement

Today at 12:15 am, we shall learn of the Obama administration’s new housing plan. I suspect it will have many of the same doomed features as all the other misguided housing plans floating around.

Before getting to those specifics, let’s revisit and recognize several truths:

• Home prices remain elevated;

• Artificially propping up prices is counter-productive;

• Home owers (No equity, 100%+ debt) who are in houses they cannot afford are going to have to move to homes or apartments they can afford;

• Foreclosures/REOs are often costly to banks; The lenders that made these bad loans to unqualified borrowers will suffer write-downs;

• It is not the responsibility of Taxpayers to bailout borrowers who are in over their heads, or lenders that made bad loans.

What are we likely to see from the White House today? I expect to see an over emphasis at stopping foreclosures; a reliance on foreclosure moratoriums; Involuntary loan modifications a/k/a cramdowns; and last, Interest rate deductions;

We would be much better off if we did 3 things:

  1. Recognize that falling prices will help return the Housing market and the economy back to normalcy. On the basis of either median income to median home price, or Housing value as a percentage of GDP, homes remains significantly overpriced, and need to continue come down in cost;
  2. Identify those people who cannot afford to be in their houses (Underwater, overpriced, too little income) and help them move into more affordable housing (rental or purchased); Keeping people in homes they cannot afford is counter-productive
  3. Identify those people who can afford to stay in their homes with a modicum of loan mods/work out. These are the best targets for legitimate foreclosure avoidance.

If they could, banks would prefer to avoid foreclosure. Its an expensive, time consuming process; The REOs are a messy, money losing headache. Any intelligent proposal to reasonably avoid preventable foreclosures would give the banks a big incentive to voluntary participate in loans mods. I believe this is just such a plan.

As we first noted last year in our Housing Proposal (Fixing Housing & Finance: 30/20/10 Proposal), there is a simple way to provide incentive to banks to modify loans: The “30/20/10″ solution:

  • 30: Takes up to 30% of any qualifying delinquent mortgage and separate it from the “main” mortgage; it becomes a 2nd, interest free-balloon mortgage. It stays on the books of the present mortgage holder;
  • 20: Save 20% of the current delinquent and potential foreclosure properties; Of the 5 million homes that are late in making payments, (the first step along the road to delinquency, default and foreclosure) the process should make 20%, or 1 million homes eligible;
  • 10: The Balloon payment comes due in 10 years, and will be treated as a 2nd mortgage, with interest charges only accruing as of October 1, 2018; it can be refinanced or paid off in full.

A few government actions are needed: Make the interest-free balloon loans tax free also; Allow the lenders to set aside these loans without taking any markdown immediately. If it defaults in 10 years, then that is when they take the hit.

This plan will allow housing market prices to normalize, keep those loans that are savable from going into default, avoids Moral Hazard, and does not require any taxpayer money. (Which likely means it has no chance whatsoever of being considered).

The mad attempts to avoid any and all foreclosures is counter-productive. The foreclosure process is how an over-priced market returns back to normalcy. That is what is now happening, and excess interference will only slow down the eventual return to a healthy economy.

Previously: Fixing Housing & Finance: 30/20/10 Proposal (September 22nd, 2008) http://www.ritholtz.com/blog/2008/09/fixing-housing-finance-302010-proposal/


Originally published at The Big Picture blog and reproduced here with the author’s permission.