Real Estate: February 2009 Archives
Megan McArdle on Obama's proposed bailout
So the plan:1. Forces the bloated and undercapitalized mortgage agencies to take on more debt without regard to creditworthiness
2. Cleans up only the least toxic loans
3. Will cost some unknowably huge amount of money
This is from a supporter.
My lunatic proposal for the day: why not make it easier to move homeowners out of homes they can't afford? Set up a streamlined foreclosure proceeding where a current or mildly delinquent homeowner can simply give the house to the bank and walk away. Do this with two legal provisos:
1. No tax on the forgiven loan
2. No black mark on the credit record. The bank marks the loan as fully satisfied.
The homeowner gets a fresh start, and the bank gets the house without the huge administrative costs that are normally associated with foreclosure. Everyone loses something, but no one loses a crippling amount, and there is no net transfer between two parties who are both in financial trouble.
I left a comment, but now let me expand on it.
We have always had Deed in Lieu of Foreclosure, which does precisely that, gets the borrower out now with only one (or one additional) black mark. However, it is not mandatory that lenders accept the offer. To give them some small amount of credit, lenders in aggregate are becoming more willing to do so. More of them are getting intelligent enough to do so. I would also strongly suggest making Deed In Lieu of Foreclosure much less of a black mark than it is. Someone who loses their job and promptly realizes the situation and takes steps to deal with it that do not result in a creditor losing money they don't have to is a responsible borrower. Someone who makes the lender go through the whole rigamarole of foreclosure is in an entirely different category. And someone who hires a lawyer to spin it out for 18 to 24 months extra while the lender keeps losing money needs to be placed in a special hell for the rest of their lives.
No tax of debt forgiveness was something we had from October 2007 through the end of 2008. I thought it was a good idea initially, but lender and market experience leads me to believe I was mistaken. It was what opened the door to more massive (temporary) increases in the available housing supply, massively lowering price equilibrium until we work through that inventory. My area (San Diego) being on the bleeding edge of this whole mess, had pretty much worked through previously existing problems and the market was ripe for a recovery and some of the data seems to suggest that one had started - and then people who were struggling got their "GET OUT OF DEBT AND TAXES FREE" card.
Complete tax forgiveness didn't work, but that doesn't mean a partial measure might not be an appropriate solution. I believe that a lessened tax rate (say 25% of normally due tax) but not complete forgiveness would be a measure worth trying, but the complete forgiveness motivated a lot of people who could have and should have seen it through to bail out, creating more problems for everyone else. By leaving a portion of the penalty intact, it motivates those who can afford their payments, but simply don't want to, to keep going. As I said in Why You Should Not Walk Away From Upside-Down Real Estate, the market is going to come back, it is only a question of when. What we need to do is have an honest dialog about what is an appropriate share of the normal tax. The idea is we don't want people bailing out if they don't have to, and we especially don't want to encourage anything like buy and bail, or "Bail and Buy" bailing out of one upside-down property so they can turn around and promptly buy another one that isn't.
Apropos of that, the second idea, no black mark on credit record, is inappropriate as well, as it encourages both "Buy and Bail" and "Bail and Buy" type planning. Even if the credit report were completely unmarked, several questions on form 1003 (The federally mandated mortgage application form) will bring it to light on any future loan applications these folks may submit. Furthermore, this amounts to deceiving the system, and will set the stage for further problems on down the line.
If, however, all the people who lost their homes due to this get the standard treatment, that's a lot of folks and a lot of potential customers that lenders are going to make up their mind that they want a year or so down the line. Just because things are paranoid now doesn't mean it's going to last forever. Lenders will create appropriate programs and demarcations and grades of treating the issue, thereby dealing with the problem and bringing these people back into the market. The ones who lose their home but otherwise take care of their credit will be fine. They may pay a slightly higher rate (or need a bit higher down payment) than people who didn't have a short sale, foreclosure, or deed in lieu, but the lenders will decide they want them as borrowers nonetheless. It's as inevitable as gravity. The ones who don't take care of their credit otherwise will suffer appropriate penalties. And once the folks who get another mortgage loan make a couple more years of on-time mortgage payments, I'll bet they get treated just the same as someone who never had a problem, and that's as it should be.
People have been trying to deal with this like it's a little problem, that we can easily solve in one fell swoop and get past, and that nobody needs to suffer any pain except maybe the lenders. None of that is true. None of that is possible. This is a major problem, but the end can be in sight if the government will allow the markets to act in their own best interests. What we need is a rational plan that doesn't repeat the causes of the problem we're trying to recover from, that enables and motivates as many people as practical to work through their problems so that the problem is no larger than it needs to be, that doesn't make the problem worse, but nonetheless encourages dealing with the problem and getting past it.
Once we do all of that, it's just a matter of time until we're back to a more normal market. If the government uses the remaining money from TARP to help stabilize the credit markets and otherwise stops trying to "help", I think that the markets will get it through the heads of the participants what they need to do in order to get out of this. Everybody knows already what they would have to do to get through it on their own, but they're putting off the reckoning because they're hoping the government will step in and save them from the bad consequences of their own bad decisions. Well, a certain amount of that is necessary simply due to politics, but the money the government spends has other ill effects, and it doesn't come out of some hyperspatial vortex. The time for the government to step back and tell people to work through things on their own has definitely arrived.
Caveat Emptor
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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