Apr092012
Principal reduction transfers the pain from lenders and loan owners to everyone else
I have two strongly held views on foreclosure and principal reduction that are completely at odds with the drivel in the mainstream media.
First, foreclosures are not a problem. In fact, foreclosures are essential to the economic recovery. All efforts to avoid or delay foreclosures are counterproductive.
Second, principal forgiveness is the worst policy option. The clamor from the left to give away my tax dollars to loan owners is getting louder and louder. It’s simply bad public policy, and it should not be embraced by policymakers.
Sharing the Pain and Gain in the Housing Market
… The big question before lenders, investors, and policymakers today is how to avoid another wave of costly and economy-crushing foreclosures.
While this issue is being pushed onto policymakers by pandering politicians on the left, this discourse is loaded with false assumptions. First, the erroneous idea that avoiding foreclosures is good for the economy. It’s simply not true. Our economic malaise is largely caused by the unresolved foreclosures and mountains of overhanging bad debt. The debt is the problem. The foreclosures are a cure. Second, the wave of foreclosures is only costly to the banks. The rest of us are being asked to preserve the wealth of bankers and investors in banking stocks and bonds. That isn’t right.
There are several ways to lower an at-risk borrower’s monthly payments and increase the chance of repayment: refinancing to today’s historically low interest rates, extending the loan’s terms, modifying the interest rate, deferring payments, or lowering the amount the borrower actually owes on the loan—so-called “principal reduction.” In most cases the lender or mortgage investor responsible for the loan considers all of these options when deciding which intervention is best for the specific borrower.
That is, unless the loan is owned or guaranteed by Fannie Mae or Freddie Mac, the country’s two biggest mortgage finance companies. Fannie and Freddie have yet to embrace one option—principal reduction—as a viable foreclosure mitigation tool.
In fact the two mortgage giants, which are now operating under government conservatorship, are forbidden from lowering principal on any mortgages they own or guarantee by their regulator, the Federal Housing Finance Agency, or FHFA. That’s the case despite a growing consensus among economists, investors, academics, and consumer advocates that principal reduction is often the most cost-effective way to avoid unnecessary foreclosure for certain groups of borrowers.
The “growing consensus” meme is complete bullshit. A chorus of left-wing panderers are cranking up the volume, they the only people they are persuading this is a viable policy are the loan owners who mistakenly believe this will help them and perhaps the lenders who see the false hope of principal reduction as helpful to keep loan owners making payments.
Principal reductions are particularly effective for deeply underwater borrowers that are facing long-term economic hardships, such as a permanent reduction in wages or long-term increases in unavoidable spending.
If loan owners are facing long-term economic hardship, why aren’t they short-selling their homes and downsizing? If I am suddenly unable to pay my rent, I am expected to vacate the property and move into something more affordable. Why aren’t loan owners expected to do the same?
What they are proposing is to keep people into houses they can’t afford and have no business being in. This crowds out those who can legitimately afford the property and makes them either pay more or settle for less — and they are being asked to subsidize the people crowding them out and occupying what should be their home.
These families are at high risk of default and often cannot see the long-term upside from making expensive monthly payments into a bad investment.
That’s because there is no downside, and these people should strategically default.
With more equity in their home, these borrowers would be more likely to stick it out in tough economic times by making deep cuts to savings or other areas of spending.
Now we get to the real agenda — keep borrowers in perpetual servitude. People who should strategically default may not if given a small dose of false hope.
These are homeowners worth helping.
Why? How is keeping them in servitude to lenders helping them? That sentence should read, “these are lenders worth helping” because that’s what they are really proposing.
Foreclosure is often the worst-case scenario for everyone involved, but especially for underwater borrowers who boast close ties to their communities and prefer to stay in their homes.
Bullshit. People can rent a home and stay in their community. Further, if they want to exercise their preference to stay in their home, they should pay for it.
.. And each foreclosure in the neighborhood decreases the value of everyone else’s home, which is a drag on the local housing market.
As a renter, I can honestly say I don’t give a crap about the neighborhood resale values. I care a great deal about my money being used to prop these values up artificially.
Reducing principal is the only way to rebuild an underwater borrower’s equity while permanently lowering monthly mortgage payments. … But FHFA is not convinced principal reduction is ever the best option for Fannie or Freddie.
To be fair that position may make sense if the goal of the agency is to protect the short-term interests of Fannie and Freddie. Principal reductions require the lender to take a hit on their books today in order to save more money tomorrow by reducing defaults and foreclosures. In the case of Fannie and Freddie, that may mean billions of more dollars in temporary support from taxpayers, who have already invested $150 billion in the companies since 2008.
That’s exactly why it shouldn’t be done. It will cost more now, and there is no real evidence it reduces losses going forward. The only way this policy reduces losses is if it prevents loan owners from strategically defaulting by giving false hope of future equity. That’s a difficult policy to embrace.
But it’s important to realize that over the long run, the goverment-sponsored enterprises are projected to lose even more money if they don’t act today. …
To maximize returns to Fannie and Freddie, we propose a pilot program that reduces principal—often by as little as 5 percent or 10 percent—without creating skewed incentives for borrowers. Through so-called “shared appreciation” modifications, Fannie or Freddie agrees to write down a portion of the principal on deeply underwater loans in exchange for a portion of the future appreciation on the home. The borrower has a reason to keep paying, while the lender benefits when home prices eventually stabilize and rebound.
False hope in exchange for tangible future benefits? Any borrower who does this should sell the moment they are no longer underwater. Why share equity when they don’t have to? They can sell the house subject to a shared equity agreement and get into one where they don’t have to share anything.
… And by phasing in the principal reduction—say, over the course of three years contingent on meeting every monthly payment—the borrower has additional incentive to stay current on their mortgage. Both of these program rules deter borrowers from defaulting on their loan just to get a reduction in principal, what some critics call the “moral hazard” problem.
The dangling carrot of false hope. This is a clear attempt to get people to keep paying who would benefit more from strategic default.
That said, we fully understand that principal reductions should not be available to everyone. As is the case with any loan modification, the principal reduction must be in the best interest of both the borrower and the lender, or in many cases the mortgage investor that owns the loan. This consideration must be done on a loan-by-loan basis.
Consideration on a loan-by-loan basis is code for “we have no idea how to make this work as a general rule.” People who propose policies they can’t make work shouldn’t be taken seriously.
At this point, we don’t have enough data to determine when exactly principal reduction is the best option for Fannie and Freddie compared to other modifications such as interest rate modifications or principal deferral. Indeed, that’s the main reason for a targeted pilot.
So if we throw several billion dollars at the problem, we might be able to figure out how to make it work? Give me a break.
For now we recommend Fannie and Freddie focus on borrowers that are most likely to benefit from a reduction, specifically borrowers that:
- Have a mortgage that’s worth at least 115 percent of the home’s current value
- Are either delinquent on their mortgage payments or at imminent risk of default
- Face a long-term economic hardship, such as a non-temporary decrease in income or a permanent increase in unavoidable spending
- Do not have private mortgage insurance or a second lien, such as a home equity loan
If you focus this program on those who can’t afford their underwater mortgage, who benefits? If the owner had equity and couldn’t make the payments, they would be forced to sell, and nobody would care. Since they are underwater, this benefits a lender who would otherwise have to take a loss when the borrower sold the property to move into something affordable.
The appearance versus the reality
Joe Six-pack loan owner favors principal reduction because he believes his lender is going to reduce his mortgage balance to fair market value with no strings attached. Joe further believes he will get to keep all the upside once prices bottom. In other words, a typical loan owner believes free money is on the way. That isn’t going to happen. The cost is simply too large. Loan owners as a group are $3.7 trillion underwater. There is no way the government can afford to make all of them whole, and I would be leading the rebellion if they tried.
Any principal reduction program would actually benefit a very small fraction of underwater loan owners, and those the receive principal reduction will likely see their balance reduced by a small amount so they are slightly less underwater.
The reality of principal reduction is that many will hope for some benefit, and very few will obtain it. The real purposes are twofold: (1) pandering politicians get to look like they did something — just like the robo-signer deal, if you recall — and (2) loan owners will gain some false hope to keep them making a few more payments before they implode — also just like the robo-signer deal.
Do any of you see it differently? Am I too cynical, or do I see reality through the spin?
Under a financial repression regime, the business owner can close it down and walk away. The wage earner can relocate and the consumer can reduce consumption at-will to lower the burden of sales taxes. But, the property owner is the ultimate tax donkey because they remain trapped in a suburban money-pit while federal, state and local govts collect usury fees ad-infinitum, and transaction costs of selling become more punitive as time passes.
Loan owners don’t recognize the trap they are in. They get drained of resources at every turn, and their only hope is the fading dream of future equity.
Indeed. Ironically, whatever the future equity may be (aka: forced savings) it will be trapped in-tandem because the capital will NOT be deployable.
Funny, California is becoming a State where it’s OK to be a debt serf to your house. I don’t think it was even this bad 15 years ago, where at least homeowners tried to pay down their loans. People in other states we get mortgages, but not base their whole life on their property. It’s so bad in this State, to get a home even to the extent of under funding retirement and savings. FYI, you house is not an investment, it’s a consumption item.
Most people in California view their house as a cashflow investment that will fund their retirement.
They viewed it as an investment because for many years it was, and it generated better returns than stocks, with a potential for tax-free mortgage equity withdrawal. People in FL were similar to CA, but I think those deepest underwater have already given up.
Banks are now insulated from further litigation, and politicians are touting the benefits to loan owners. Disgusting.
National $25B Mortgage Settlement Approved by Federal Judge
The $25 billion settlement received approval from a federal judge Wednesday, but the announcement was not made public until Thursday, according to a Reuters’ article published Thursday evening.
U.S. District Judge Rosemary Collyer approved the national, historical settlement, which was brought on by federal officials and 49 state attorneys general against the top five largest servicers – Bank of America, Citigroup, JPMorgan Chase, Wells Fargo, and Ally Financial.
The investigations revolving around the settlement involved issues with foreclosure abuses and servicing problems such as robo-signing, lost paperwork, and problematic modifications. The settlement was filed in federal court in March, and the agreement was reached in February after more than a year of negotiations.
Oklahoma was the only state to opt out of the agreement, with the state’s Attorney General Scott Pruitt deciding to seek out a separate settlement leading to $18.6 million.
Pruitt said in a statement that the settlement he sought would provide for Oklahomans who were victims of misconduct “while not exceeding the appropriate role and authority of state attorneys general.”
Calling the approval “a victory for American homeowners,” HUD Secretary Shaun Donovan in a statement said, “we know that now the real work begins to hold these servicers accountable and ensure that the nearly 2 million homeowners who are expected to receive help and relief actually get it.”
Of the $25 billion, $20 billion in relief will be designated to help homeowners through principal reduction, refinancing for underwater homes, principal forbearance for unemployed borrowers, short sales assistance, and additional benefits for service members. An additional $5 billion will go to government officials.
The settlement will also require new servicing standards for foreclosure prevention. Aside from banning practices such as robo-signing, servicers will no longer be able to foreclose on a borrower being considered for a loan modification and are required to assign a single point of contact for borrowers.
I agree with IR’s take on principal reduction. However, if it is going to be done, the reduction should be phased-in rather than creating a shared-appreciation plan.
e.g. A $200K FMV house with a $250K mortgage might get $10K reduced immediately in conjunction with modifying the rate & term; and $5K annually thereafter subject to an annual automated appraisal to ensure the FMV hasn’t surpassed the mortgage. This dangles the carrot long enough.
I still don’t know how you decide who’s entitled to a principal reduction? It would seem the most appropriate borrowers would be those who you want to discourage from strategic default (those able, and currently willing, payers), but that wouldn’t make the Left very happy.
I think we should simply restore law and order and force banks to take significant writedowns on their mortgages. I know, shocking, to let balance sheets reflect the true value of the assets.
Then the banks will be incentivized to do principal reductions themselves since it won’t be such a loss vs what is on their books. They will also have a much stronger incentive to push thru foreclosures at a higer pace for the same reason.
Never gonna happen. We are all Japanese now. If you want to plan for the future, just look at where Japan has been going for the past decades.
Unfortunately, I agree with both your assessments. The banks should be forced to recognize their losses and act appropriately without the added complication of late recognition of losses. This policy is exactly what Japan did, and despite how much we criticized them at the time, we are doing the same thing. We are in for several more years of debt deflation and asset price declines.
CAR to the rescue!
California lawmakers align opposition to FHFA REO program
By Justin T. Hilley April 9, 2012 • 3:41pm
Nearly 20 members of California’s congressional delegation sent a letter last week to FHFA Acting Director Edward DeMarco urging him to refrain from implementing the agency’s REO pilot program in the state.
California Congressman Gary Miller, R-Brea, along with 18 other members of California’s congressional delegation, said the program would negatively impact the state’s housing market and raise costs for taxpayers.
“We are concerned that including California counties in this initiative is in direct conflict with your duty as conservator to preserve and conserve the Company’s asset,” the letter states.
“In California, there is no question that disposing properties through bulk sales will yield a lower return for the government-sponsored enterprisess and taxpayers than through traditional disposition methods,” the letter continues. “This means that such a program will increase losses to the taxpayer and GSEs.”
The Federal Housing Finance Agency began the program in February to more efficiently sell bulk real estate-owned property held by Fannie Mae and Freddie Mac to investors. The program calls for the sale of more than 600 Fannie Mae-owned foreclosed homes in Los Angeles and Riverside counties to institutional investors.
The California Association of Realtors applauds the letter. The organization believes the REO program is detrimental to the state’s housing market because housing inventory is extremely low and demand is high.
However, more than 23% of the Fannie Mae REO inventory is located in California, the most of any other state at the end of 2011. The next closest is Florida, at 11.5%.
Homebuyers in most of California’s markets are experiencing multiple offers, CAR points out, including for distressed and foreclosed properties. According to the association, sales of bank-owned homes are closing in an average of less than 60 days — and often above the list price — without government intervention.
CAR: “homes are closing in an average of less than 60 days without government intervention”
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LMFAO
CAr doesn’t want to acknowledge that the only reason for the temporary furvor at the low end of the housing market is because the banks are withholding all the product, partly because they expect to sell some in bulk as rentals. If these properties are pushed through as CAr ostensibly wants, prices will crater, then you will hear CAr whine about the flood of REO killing prices.
Charts That Should Give Chills To US Housing Bulls
No doubt, people have been screaming about “affordability” all the way down.
http://www.businessinsider.com/japanwse-home-price-to-income-and-rent-2012-4
What does sample average mean?
Principal reductions are just smoke and mirrors to delay writting down of the asset and transferring liabilities to the taxpayers for chump change of a few thousand (5,000 to 20,000) dollars for each bad loan.
In my book, vapor income loans and vapor appraisials are indications of defective underwritting and product. With modifications and principals reductions, the income and appraisials will be corrected, verified and approved. The underwritting will no longer be defective and liability will be transferred to the taxpayers. Great deal for the banks and short-end of the stick for the taxpayers. Even greater deal for the banks when the govt allows the reduction to be funded by the prior “fines” and “settlement” money. That would be no further out-of-pocket expenses for the banks and the govt would not be collecting money from the bank.
this is just another corporate-govt program to reward the guilty and punish the innocent.