Barack Obama's "Help For Homeowners" Proposal

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Today, the President announced "a plan" to theoretically aid homeowners. Unfortunately, judging from the information available, it looks more like a Wish List than a Plan.

People may be eligible to refinance if their loan to value ratio is 105% or less. Respectfully, Mr. President, that's not going to help a lot of people, who bought for zero down and have seen values slide thirty percent. You do the math: If values slid thirty percent, how much did they have to put down for this to help them?

While we're at it, what proportion of the homeowners at risk have mortgages through Fannie and Freddie? Very small. Even if they do have Fannie and Freddie first mortgages, what about the "piggyback" second loans with other lenders that enabled these folks to buy with zero or five or ten percent down?

They give three examples of refinancing, but are completely silent upon the likelihood of getting second mortgage holders to subordinate.

Second mortgage holders might be willing to subordinate if there are no costs added to the balance of the first mortgage. In other words, homeowner pays everything out of pocket. It is the rational thing to do. But second mortgage holders are not going to agree to go even more underwater than they are.

From the Q&A

Do I need to be behind on my mortgage payments to be eligible for a modification? No. Borrowers who are struggling to stay current on their mortgage payments may be eligible if their income is not sufficient to continue to make their mortgage payments and they are at risk of imminent default. This may be due to several factors, such as a loss of income, a significant increase in expenses, or an interest rate that will reset to an unaffordable level.

This is false. Imminent risk of default is defined as being within thirty days of default. In California, you've got to be 120 days late to be in default. Therefore, in California you have be be three months late on your mortgage in order to be at imminent risk of default.

How do I know if I qualify for a payment reduction under the Homeowner Affordability and Stability Plan? In general, you may qualify for a mortgage modification if (a) you occupy your house as your primary residence; (b) your monthly mortgage payment is greater than 31% of your monthly gross income; and (c) your loan is not large enough to exceed current Fannie Mae and Freddie Mac loan limits. Final eligibility will be determined by your mortgage lender based on your financial situation and detailed guidelines that will be available on March 4, 2009.

Um, this is what those lenders doing now. And by the way, Fannie Mae and Freddie Mac standards are (and have been for many years) 45% back end debt to income ratio. If you have no debts when you get your mortgage, this means up to 45% of your income for housing.

7. I owe more than my house is worth. Will the Homeowner Affordability and Stability Plan reduce what I owe? The primary objective of the Homeowner Affordability and Stability Plan is to help borrowers avoid foreclosure by modifying troubled loans to achieve a payment the borrower can afford. Lenders are likely to lower payments mainly by reducing loan interest rates. However, the program offers incentives for principal reductions and at your lender's discretion modifications may include upfront reductions of loan principal.

Note the words "at your lender's discretion". Lenders don't want to modify principal, for many excellent reasons I went into in Mortgage Loan Modification. Incentives for them to do this are going to cause them to be willing to write down principal on a dollar for dollar basis with those incentives. Basic microeconomics. Since the incentives seem to be in the range of $1000 per loan, that's what you can expect.

10. Is my lender required to modify my loan? No. Mortgage lenders participate in the program on a voluntary basis and loans are evaluated for modification on a case-by-case basis. But the government is offering substantial incentives and it is expected that most major lenders will participate.

Once again, this is different from what lenders are doing now in what way? Oh, I'm sure that $1000 government incentive is going to make the critical difference in how much they are cutting the rates to avoid losing their entire investment of several hundreds of times that amount.

14. My loan is scheduled for foreclosure soon. What should I do? Contact your mortgage servicer or credit counselor. Many mortgage lenders have expressed their intention to postpone foreclosure sales on all mortgages that may qualify for the modification in order to allow sufficient time to evaluate the borrower's eligibility. We support this effort.

The Fact sheet has one provision that is sure to be popular, but is also certain to completely destroy the mortgage market down the line,

From the bullet points on page two:

Allowing Judicial Modifications of Home Mortgages During Bankruptcy When A Borrower Has No Other Options

This is a taking of private property without appropriate compensation, which violates the Fifth Amendment to the Constitution. It's been on a wish list of socialists and trial lawyers for decades, but until now, the government has been smart enough to see what happens next.

1. People can now keep their homes by declaring bankruptcy.

2. Amazingly enough, people who are in danger of foreclosure declare bankruptcy

3. Courts modify the indebtedness. Lenders don't get money, are stuck with a non-performing loan, and don't have any benefit from the security interest (that is, the property) given in the mortgage.

4. Lenders start treating real estate loans in accordance with all other loans and indebtedness of similar quality - in other words, mortgage rates go into double digits at a minimum, probably into the twenties. Down payment requirements increase.

5. Keeping in mind that The Mortgage Loan Market Controls the Real Estate Market, real estate markets suffer a crash that makes everything that has happened to date look like a mild accidental scratch.

And if we have this much trouble with losing 30% of value, what do you think happens when we lose 90% of what's left? In a circumstance like that, I would consider walking away from my mortgage.

I see no criteria for qualification, other than the basic "conforming loan limit". It's not clear whether this includes "super conforming" loans in high cost areas like mine.

Two months ago, I wrote that the previous president's plan wasn't really going to help much in The Hope (Dashed) For Homeowners Program. Absent that one killer condition of judicially modifying mortgages through bankruptcy, this plan would be no better but no worse, except for spending $75 billion dollars of taxpayer money for things the lenders are already doing.

But if the "judicial modification" of mortgages item is still in whatever bill makes it through Congress, that will do more damage to our economy than anything else I can think of that our government might possibly do, and that includes the $1.2 Trillion Congress and the President just agreed to waste a few days ago.

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2 Comments

Ravi said:

I really don't agree with your comments about mortgage cram-downs. I think, in practice, their positive effect in terms of motivating lenders to actually do modifications (as opposed to putting their heads in the sand and hoping that somehow the situation gets better) and in encouraging lenders to not make clearly stupid loans in the first place (if the loan can be crammed down in bankruptcy a lender is going to be more careful about checking if a borrower can really afford it). Both of these effects should lead to a more stable housing market overall (since there will be less reason for house prices to overshoot in booms and undershoot in busts) and, in my opinion, outweigh any marginal impact on mortgage rates.

And I really think both straightforward economic reasoning and historical evidence show that the impact on mortgage rates will be marginal. I'll present the economic case first.

Look at the presumed situation:
- the borrower is insolvent and declaring bankruptcy
- the principal value of the mortgage is greater than the current market value of the house

What should a mortgage lender expect to recover in that scenario? Well, what do they have economically? They have a secured debt up to the current market value of the house. Beyond that, they have an unsecured debt, so the value of that depends on what resources the borrower has to devote to that debt. Given that the borrower is declaring bankruptcy (and that most people get in way over their heads before finally reaching that point) I think it is reasonable to assume that the unsecured portion is worth "not much". So their realistic upper bound that they can extract from the borrower is the current market value of the house.

What is their alternative (if they weren't forced into the cram-down)? Well, they could modify the mortgage voluntarily (but this is practically difficult given mortgage securitization) or they could foreclose. What are they going to get in foreclosure? Well, they're going to get the current market value of the house... less the costs of foreclosure. And the only way a mortgage lender could do better than that is if borrowers (in bankruptcy so their credit is already ruined) make the irrational decision to stay in a house where they are underwater rather than walking away.

Now maybe borrowers are irrational but consider this: the current bankruptcy law requires borrowers to get credit counseling before declaring bankruptcy. If mortgages can't be crammed down and borrowers owe more than the house it worth you could easily argue that it would border on malpractice for a credit counselor NOT to suggest walking away from the mortage. At the end of the day, you can't get blood from a stone no matter how much mortgage lenders want to pretend you can.

A second spin on the economic argument is to look at the mortgage rates on investment property - which are subject to cram-downs, as I understand. They're higher than residences, agreed... but not to the tune of 20% or more (as you suggest might happen). I remember reading about a study that said the effective rate difference was closer to a quarter or half a percent. Not nothing, but not the end of the world either.

Now for the historical argument. As has been documented on blogs like Calculated Risk and Credit Slips banning cram-downs in bankruptcy is the result of a relatively recent (early 1990s, IIRC) Supreme Court decision. Prior to that, everyone assumed that mortgage cram-downs were permitted. And people have done historical analysis of mortgage rates pre and post that decision (correlating them to prevailing interest rates) and have see only a tiny or nonexistent impact on mortgage rates.

Dan Melson Author Profile Page said:

>I think, in practice, their positive effect in terms of motivating lenders to actually do modifications (as opposed to putting their heads in the sand and hoping that somehow the situation gets better)

Open your eyes. Lenders are doing this now, and have been since last summer. They're not in denial, they're looking for a way to manage their losses and make them as minimal as possible.

>encouraging lenders to not make clearly stupid loans in the first place

Wouldn't have happened without the government essentially mandating that they make stupid loans, as I have documented any number of times in the last few months, and because lenders were judged by how many stupid loans they made in comparison to other lenders, it became a competition to make stupid loans. The government even tried to sue a couple of lenders that decided they were going to exit the madness and limit themselves to high quality loans.

>I'll present the economic case first. Look at the presumed situation: - the borrower is insolvent and declaring bankruptcy - the principal value of the mortgage is greater than the current market value of the house What should a mortgage lender expect to recover in that scenario?

The value of the house, and maybe (depending upon the loan) the ability to have recourse upon the borrower's other assets, including if they come into more money within a few years.

Lenders know they lose money in a default situation. That's why arguing that they should make the loan because there's a lot of equity is a losing argument (at least with regulated lenders. Hard Money is a different story). Always has been, even during the height of the insanity. There always had to be at least a believable pretense of the buyer being able to afford the loan.

>Given that the borrower is declaring bankruptcy (and that most people get in way over their heads before finally reaching that point)

You are getting things precisely backward. The problem is that they're going to declare bankruptcy in order to keep the property. This happens now, and costs lenders huge amounts of money because the people can pay a lawyer a small amount of money and delay the inevitable for 18 to 24 months, perhaps longer (and it hurts them much worse in the end) . But if you effectively take away the ability to eventually partition the property off from the rest of the bankruptcy and foreclose, exactly what is that secured interest really worth to the lender? People are going to be hiding assets and declaring bankruptcy simply to get their mortgage written down, and the hiding of assets can be done.

>Well, they could modify the mortgage voluntarily (but this is practically difficult given mortgage securitization)

It happens. It always has happened. It is a difficult process, but then it should be a difficult process.

>If mortgages can't be crammed down and borrowers owe more than the house it worth you could easily argue that it would border on malpractice for a credit counselor NOT to suggest walking away from the mortage.

No. There are reasons why you shouldn't walk away. I wrote an article explaining why here Why You Should Not Walk Away From Upside-Down Real Estate. A competent (as opposed to agenda driven) credit counselor should know this. Foreclosure is the worst of all worlds for a lender, except for judicially mandating they lose even more money while being stuck with the loan and a possible iteration of precisely the same thing in a few more years. At least with foreclosure, they get to stop the damage.

>banning cram-downs in bankruptcy is the result of a relatively recent (early 1990s, IIRC) Supreme Court decision. Prior to that, everyone assumed that mortgage cram-downs were permitted.

That's because prior to that, bankruptcy judges were mindful of a secured interest. They would negotiate with the lender for a settlement that made sense given the context. The lender ended up as happy as possible with less expense. Then judges started simply mandating whatever met their fancy, lenders sued, and (predictably) won due to the takings clause in the Fifth Amendment. If the government is going to start doing this, they'll have to pay the lender involved. Depending upon how it all shakes out, it may become a gold mine for the lenders in today's bad situation. But in the meantime, lenders have a requirement (SEC and FRB mandated) to consider the practical effects of effectively losing security, a thing that has never happened before (ask your grandmother what happened to people who tried to declare bankruptcy to save their house? She'll answer "they still lost it")

Compare the reaction to the phenomenon of "Buy and Bail", a much smaller and more contained phenomenon. First, they essentially banned loans for people trying to buy another property in the same area. Then they essentially mandated no loans for anyone with less than thirty percent equity on any investment property anywhere. If you don't think this is hurting the market, I have news for you: Nearly forty percent of all pending transactions fell out of escrow when Fannie and Freddie instituted this requirement last month because the buyers suddenly couldn't qualify for loans, and if more than five percent of the ones who couldn't were intending "buy and bail" I'll give the Communist Party $50. You think that's not going to cause a further fall in prices, I got news for you. Supply and demand. What happens when demand falls?

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This page contains a single entry by Dan Melson published on February 18, 2009 3:45 PM.

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