Stopping Counter-Productive Mortgage Mods and Foreclosure Abatements

“The choice we appear to be making is trying to modify our way out of this, which has the effect of lengthening the crisis. We have simply slowed the foreclosure pipeline, with people staying in houses they are ultimately not going to be able to afford anyway.”

-Kevin Katari, managing member of Watershed Asset Management, a San Francisco-based hedge fund

I have some good news and some bad news for you:

The bad news is the $75 billion HAMP program to protect homeowners from foreclosure has been widely pronounced a disappointment. The good news is that more than a few mainstream economists — and even some policy makers — are slowly being recognizing that it has only delayed the inevitable. We may end up with something more functional as a result.

Some of this is discussed in a front page NYT article. It echos what I have been writing for 2 years now — that the mortgage modifications and foreclosure abatements programs are counter-productive.

The $75 billion program Making Home Affordable:

“has lowered mortgage payments on a trial basis for hundreds of thousands of people but has largely failed to provide permanent relief. Critics increasingly argue that the program has raised false hopes among people who simply cannot afford their homes.

As a result, desperate homeowners have sent payments to banks in often-futile efforts to keep their homes, which some see as wasting dollars they could have saved in preparation for moving to cheaper rental residences. Some borrowers have seen their credit tarnished while falsely assuming that loan modifications involved no negative reports to credit agencies.

Some experts argue the program has impeded economic recovery by delaying a wrenching yet cleansing process through which borrowers give up unaffordable homes and banks fully reckon with their disastrous bets on real estate, enabling money to flow more freely through the financial system.

Mr. Katari contends that banks have been using temporary loan modifications under the Obama plan as justification to avoid an honest accounting of the mortgage losses still on their books. Only after banks are forced to acknowledge losses and the real estate market absorbs a now pent-up surge of foreclosed properties will housing prices drop to levels at which enough Americans can afford to buy, he argues.” (emphasis added)

That sums up the situation perfectly. I am a “rip-off-the-band-aid-quickly” kinda guy, and what we are doing instead is peeling it off as slowly as possible, lengthening the pain, while only delaying the inevitable.

As we have long argued, national home prices remain too elevated for a healthy real estate market; The cheaper properties — primarily distressed units, foreclosures and short sales — are what is driving the bulk of real estate transactions today.

Why so few get this is simply astounding.

Prices should be allow to normalize through ordinary foreclosure processes. Banks should be compelled to write down bad mortgages. Underwater borrowers should be given the option of a cram-down or a foreclosure.  I favor sharing the write-down between the borrower and lender, with a zero interest, 10 year balloon payment for a chunk of the write down (A modified version of our 30/20/10 proposal).

For more details, I have to go to chapter 21 of Bailout Nation, titled The Virtues of Foreclosure:

“It’s not that people are unwilling to buy real estate in the United States; it’s that buyers are now unwilling to over pay.

And therein lies the heart of the problem with most rescue plans. They are designed to prevent the continued downward spiral of the housing market, which unfortunately is precisely what is needed. The artificial demand of the ultralow rates and lax lending standards sent prices to unsustainable levels, and put millions of people into homes they could not afford. The markets are correcting these excesses as people trade out of those homes. It is a classic unwind of a bubble.

In much of the country, home prices remain too high, and the over priced homes are not moving. That’s reflected in the huge inventory overhang of unsold homes. (See Figure 21.4.) And the inventory data of homes for sale does not include the shadow inventory—all of the homes purchased as investments, by flippers, as second homes, or as rental units. These owners are waiting in the shadows for the opportunity to get rid of their properties. Any improvement in the real estate market is likely to bring forth this additional supply.

Until prices revert back toward historical nor ms, the excess inventory will not be removed, the foreclosures will not stop, and the total sales will remain depressed. The sooner Washington, D.C., figures this out, the better off the economy and U.S. homeowners will be.”

The healthiest thing we could do would be to:

1. Allow foreclosures to proceed normally;

2. stop subsidizing purchases at elevated prices;

3. force banks to take writedowns of bad loans;

4. do a “shared pain” cramdown where both the borrower and lender split the loss  of an underwater mortgage, replacing the old original loan with something more sustainable.

We could also bring rates to more reasonable levels — say 2% from 0% — to further stop the subsidy and normalize prices. I am less confident this is likely anytime soon.

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

$15,000 Home Buyers Credit Costs $292,000/home (October 22nd, 2009) http://www.ritholtz.com/blog/2009/10/why-expanding-home-buyers-credit-is-a-mistake/

Source: U.S. Loan Effort Is Seen as Adding to Housing Woes PETER S. GOODMAN NYT, January 1, 2010 http://www.nytimes.com/2010/01/02/business/economy/02modify.html


Originally published at The Big Picture and reproduced here with the author’s permission.
 
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2 Responses to "Stopping Counter-Productive Mortgage Mods and Foreclosure Abatements"

  1. Tom Nason   January 5, 2010 at 9:13 pm

    This notion of a “cleansing process through which borrowers give up unaffordable homes and banks fully reckon with their disastrous bets on real estate” is an overly simplistic, idealized notion of how this should or could play out. I fail to see how a foreclosure serves the stakeholders any better than a similar loan modification. Consider the following:A $100,000 home is bought with $5000 down and a $95,000 note from the bank. The home is now considered to be worth $50,000 and the home owner is underwater along with struggling with payments due to income loss. They foreclose and the bank recovers 90% of the value after expenses, recovering only $45,000 against the original loan of $95,000, for a $50,000 loss. The owner has a $5000 loss and may have no down payment to apply to a now purchase. But assuming that they are able to buy a home, essentially the same home, but at $50,000, and puts $5000 down for a note and then borrows the $45,000 that the bank recovered from the sale of the first home.But instead of foreclosing, what would happen if the loan was modified by simply writing down the principle to the current market value – $50,000? The loss is recognized by the bank just as before. The owner and the bank avoid the disruption and expenses associated with the foreclosure proceedings. This seems to be a more efficient and financially equivalent, if not better.Additionally, I think the suggestion that the bubble is the result of people getting into homes they couldn’t afford is a self-serving assumption. Of course there are those that over bought. That has always occurred. In more normal conditions that asset could be sold by the owner to get out from under the mortgage, or the bank was in a better position to recover their loan loss. But when the value of that asset has plunged, making recovery impossible by either party, the foreclosure process doesn’t produce the same results. The current price deflation also hurts home owners that can afford their payment, or could before a pay cut or job loss, but need to sell for the myriad other reasons why one might sell a home.To say that we just need to purge these loans from the system requires yet another assumption: that the foreclosure process can realistically handle the volume. This is an unprecedented global crisis. The foreclosure industry must be rebuilt after years of minimal use. It will take years to liquify all of these assets regardless of how it proceeds.In your prescription for the ills we are facing: First, as I’ve mentioned, the normal foreclosure process is currently not in a position to speed up the process in the short term. Second, are we subsidizing elevated purchase prices. Certainly the mortgage industry and investors of all stripes had been doing that for years leading up to the pop. But now in many areas prices have adjusted more closely with the long term average for rent. And as always, should the government be responsible for parsing out if an asset is over priced? I am eager to point out that any tax incentive, including the historical tax break for mortgage interest, simply elevate the price of a home and I would love to seem them phased out. But perhaps now is not the time. Third, and forth, this is more or less a loan modification, and I agree that they should be accelerated to try to stay in front of more and more odious foreclosures.