Any doubts that we are going down the Japan path of trying to shore up inflated asset value rather than letting the market find the right level, should now be over. Bloomberg tells us that the Office of Thrift Supervision is looking into a plan that will enable homeowners to refinance houses that have negative equity.
Before we get into the fact that this might be very difficult to put into effect (as Tanta alludes), this move is all about propping up the portion of the housing market where the lenders/investors have the most to lose, and correspondingly, where it is most rational for the homeowner to walk away. Consider, as Credit Slips did, that the Hope Now Alliance program was also targeted at borrowers who had very low (less than 3%) to negative equity) and as Credit Slips discussed, 75% of the interventions resulted repayment plans. These do not change the terms of the mortgage.
A different post at Credit Slips discussed the concept of “hostage value” in these loans:
A side note for the Not-Commercial-Law-Jocks: “Hostage value” in secured lending refers to the ability of a secured lender to extract a payment in excess of the value of the collateral from a borrower by threatening to repossess the collateral. The classic example was the old practice of taking a security interest in all of a family’s household goods, which might add up to a resale value of $2000, then demanding that every penny (plus interest) of a $10,000 loan be repaid before the security interest would be released. This version of the practice involving household goods is now banned by the FTC. In bankruptcy law, undersecured claims would be bifurcated into its secured ($2000) and unsecured ($8000) portions.
Rescue programs [operated by the states] limit their payouts to 100% of the value of the property, which makes sense both to protect the fund and not to reward the mortgage lenders by paying them more than they could get for the house if the family gave it back to the lender. But the mortgage lenders want more. If they don’t get it, they won’t release the mortgage–even though the lenders won’t get anything close to 100% of the value of the home if they are forced to foreclose. They hold the home hostage: Pay the amount the mortgage company wants or move out of the house. Some families will find the money to pay, and others will lose their home.
Irony of ironies, borrowers may be savvying up to the fact that it isn’t rational to let the bank threaten to make you pay more for your property than it is now worth (morality is another issue…..).
Increasingly, economists are finding that falling house prices, and not just payment stress, leads to higher default/foreclosure rates. The lending industry is no doubt alarmed that “jingle mail” is on the rise, and even some borrowers who can afford to make payments are abandoning their homes.
The last 15+ years of encouraging homeowners to view their residence as a financial asset are coming home to roost. By any rational calculus, staying in a home with negative equity, particularly if you are having trouble making the payments, is not a good bet.
Thus, it isn’t clear how much this OTS concept, even it if sees the light of day, will help. But if it does, it benefits the mortgage industry far more than the public at large. Notice it also makes an explicit subsidy of underwater houses with government resources, We have now entered explicit bailout territory.
Update 9:00 PM: I wanted to clarify the point in the paragraph above about explicit government subsidies, since most reporting on this (and the reporting is muddied, which may be due to the plan being in flux) is the idea that the old, above market mortgage balance will be validated and continued via a government guaranteed new mortgage, or perhaps merely the warrant would be guaranteed.
This proposal flies in the face of good sense. The reason home prices are falling in many markets is that they are out of line wit incomes and rental prices. This measure appears to be an attempt to stymie various proposals to enable mortgages to be restructured by writing balances down to something more consistent with current market values. One such proposal is a Democrat-sponsored bankruptcy bill, which is regularly attacked by Republicans and the mortgage industry as allowing judges to rewrite mortgages, In fact, what this does is bring practice for residential mortgages in line with bankruptcy rules for businesses. Wonder why none of these critics has a problem with judges reducing a secured loan to the value of its collateral when the borrower is a corporation.
The idea that a government guarantee is not a bailout is such a canard that it is almost beneath comment, but this Administration knows no shame.
Update 2/22, 12:50 AM: Later reports (as per the New York Times) indicate that the negative amortization certificates would be privately issued, but the underlying fixed rate mortgages could come from the FHA. Still looks sus to me (one wonders, for instance, how generous the FHA appraisals will be, since they will determine the level at which the mortgage ends and the certificate begins).
From Bloomberg:
The U.S. Treasury is “interested” in a proposal to help homeowners facing foreclosure by refinancing their mortgages on homes that have fallen in value, a department spokeswoman said.
The Office of Thrift Supervision is developing a program to prevent borrowers from abandoning homes worth less than the amount of the loan. Homeowners would be able to refinance their mortgage at the current market values, with the lender getting a “negative-equity certificate” to be redeemed once the home is sold, OTS Director John Reich said yesterday.
“Treasury certainly wants to hear all ideas on ways to help homeowners, so we are interested in learning the details of this proposal as they develop,” Treasury spokeswoman Jennifer Zuccarelli said. “We welcome innovative, market-based proposals to encourage flexibility for struggling homeowners.”
The OTS, the Treasury’s savings-and-loan regulator, joins other policy makers in suggesting ways to head off the worst housing slump in a quarter-century by limiting foreclosures. Treasury last week announced an agreement with loan servicers to place a 30-day freeze on foreclosures for borrowers meeting certain criteria.
Negative-equity certificates could help servicers limit loan losses and avoid an “avalanche of borrowers who choose to walk away from the mortgage,” Scott Polakoff, the agency’s senior deputy director, said yesterday. The Federal Housing Administration could help homeowners refinance, he said.
Earlier today, Robert Steel, the Treasury’s undersecretary for domestic finance, told Reuters that “we’re just learning about it,” adding that he had talked with Reich about the proposal last night. “They’re still working out the details too,” Reuters quoted Steel as saying.
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Foreclosures are a very visible sign of economic distress that incumbent politicians would like to prevent, or innoculate themselves against by appearing to have tried everything to stop. The problem is that businesses have changed from trying to maintain long term customers and their reputation (I’m 45 and can remember this); to trying to take every customer for all their worth at every opportunity. Americans are now well aware of this and treat each contact with a business as if they were buying a watch from a guy selling out of his trunk that they will never see again. Most borrowers will stop paying the mortgage as soon as they percieve it to be in their best interest. OTS can’t stop this.
blueskies
It keeps getting worser and worser [sic].
I think that the taxpayers who are going to foot the bill for this foolishness (that’s us), should have some kind of say in these pie-in-the-sky bailout ideas.
Government seems intent on giving away tax dollars at any cost to the mortgage industry.
Where is Lewis Carroll when we need him?
They want to make a market in warrants. I have read the article several times, and I must still pinch myself concerning the unintended consequences of this plan. We are speeding down the rabbit hole.
This is a way to turn “owners” into “renters.” The claim on profits from sale in excess of the new loan amount to compensate the prior lender eliminates owner incentive to improve or even maintain the property with an eye to higher sale price. Thus the “owner” suddenly has the mindset of a “renter.”
If the new total payment is more than comparable area rentals, the rational thing to do is get the new deal financed and immediately put the house up for sale at the newly financed amount plus sales commission and closing costs. Since the newly financed amount is based on recent appraisals the house stands a good chance of selling. This would allow walking away from the deal with an intact credit rating.
If the new payment is less the owner may decide to keep the property but will do absolutely nothing to improve it for resale. I suspect that will eliminate the majority of upgrades.
Owners who think the market hasn’t reached bottom will be highly inclined to sell and walk.
Why dont we just turn this meltdown into a casino and call a spade a spade??
Re: Economic aspects
The so-called “Monte Carlo of the Orient,” Macau’s economy relies heavily on gambling. Nowadays, the gambling industry generates over 40% of the GDP of Macau. Since the early 1960s, around 50% of Macau’s official revenue has been driven by gambling. The percentage remained steady until the late 1990s. In 1998, 44.5% of total government revenue was produced by the direct tax on gambling. Then there was a 9.1% decrease in 1999, probably due to internet gaming. After the handover of the Macau from Portugal to China, the SAR released gambling licenses to other companies in order to eliminate the monopoly played by the STDM. In 2002, the government signed concession contracts with two Macau gaming companies, Wynn Resort Ltd. and Galaxy Casino. This opened the gambling market for competition and increased government tax revenue significantly. It also attracted more tourists to Macau. At this moment, according to official statistics, gambling taxes form 70% of Macau’s government income [3].
What I propose is that the Gov likewise offer a targeted tax cut for people who remained level headed in the face of this madness and demonstrated the restraint that neither their peers or the gov’t seem familiar with.
Everyone makes out excpet the prudent. This would be a targeted 100-200K targeted tax break for 1st time buyers and the tax cut would be based on a percentage of telling price in the region. First time buyers (or those who haven;t purchased in say 4 year) would qualify – kind of like the veterans no money down option. The plan would achieve a few things: (1) it wouldn’t cost a lot; (2) it would add some semblance of balance to what has already destroyed the public trust and faith in governement; (3) it would contribute to the intractable problem of inventory overhang.
As for this bailout plan, it is absurd. This is an invitation to moral hazard. Listen to Barton Biggs – get a farm and learn sels sufficiency. At some point the American People will refuse to pay for a government that is so totally out of touch with everyday people – that day is approaching. Seriously, these are the same people/politicos who introduced the disease via the very imperfect economic policy that for decades has inspired the slow hollowing out from within. Subprime is but the first lesion – they know it, we know it and the rest of the world that vendor finance US profilgacy know it.
The US went from defining ethic to begger thy neighbr policies to handouts. Should we really be surprised by any of this. At some point a fracturing occures — when?
I’m not completely clear about the proposal. Anyway, this is how I understand it:
A borrower borrowed x from a lender on a house which is now worth y < x. The Lender is willing to take the write-down to y, but in counterparty he gets a warrant with a claim to any increase in price over y when the house resells. The government meanwhile now is on the hook for a loan worth y. If this is the case, isn’t this just like the government writing a 100% LTV loan on the house? It’s on the hook for y, when the house is worth y. If the value of the house decreases over the coming couple of years, which is possible if not likely if not a certainty, then the government is going to find itself with a big loss. Compared to it, the initial borrower comes off comparatively well, with a known downside risk (which has been minimized) and even with an upside. Surely if the house is worth y now, the government should be making a loan for 80% y at best (I’d say 70% for those areas like California or Florida which have experienced a huge run-up.) That is, somewhere the government gets a cushion of 20% between what the home is worth and what it has lent, a function usually taken up by a deposit in a prudent loan. The initial lender gets this 80% y and gets a warrant with a strike of 80 % y. This way the large part of the risk is assumed by the borrower who created the risk. In case the federal government or the banks haven’t heard of this technical term, it’s called a “haircut”. By the way, the federal government hires its own assessors, because I imagine the “y” that the lender would calculate is probably 10-15% higher than the real “y”. No bail-outs.
Agh… “Compared to it, the initial borrower” That should be lender.
“Wonder why none of these critics has a problem with judges reducing a secured loan to the value of its collateral when the borrower is a corporation.”
Could it be that these critics are beholden to corporate interests?
Nah! Not in the country where the Constitution start with the words: “We the People”
I wonder what ever happened to free markets and letting assets float to market prices.. Oh yes I forget those bets are off when it hurts the bankers… Isn’t this by definition a corrupted system/government?