The FDIC is proposing a test program of principle reduction for negative equity homeowners.
But why is the FDIC required? An intriguing private sector solution would be a negotiated principle reduction between borrower and lender — no government intervention is needed.
Let’s begin exploring this idea by looking at a Washington Post article from today (FDIC to test principal reduction for underwater borrowers):
“The Federal Deposit Insurance Corp. is developing a program to test whether cutting the mortgage balances of distressed borrowers who owe significantly more than their homes are worth is an effective method for saving homeowners from foreclosure.
The program would be aimed at a growing population of homeowners who are underwater on their loans, estimated at more than 20 percent of borrowers, or 11 million homeowners. Economists consider these borrowers among the most vulnerable to foreclosure, and some industry officials worry that more of them will simply walk away from their mortgages, or “strategically default,” rather than spend a decade or more trying to regain positive equity.
Under the FDIC program, borrowers would be eligible for a reduction in their mortgage balances if they kept up their payments on the mortgage over a long period. The performance of those borrowers would be compared with borrowers given more traditional mortgage relief packages, such as those that cut the interest rate on loans.”
It only requires basic math skills for all parties to recognize that it is in the banks interest to avoid foreclosures. Underwater borrower with this knowledge — and the cojones — should let the bank know they understand simple math: Foreclosures = 50% bank loss.
They can then “engage in an arm’s length, Wall Street style negotiation.” Not precisely a threat, but simply laying out clearly what the mortgagee’s options are.
Imagine if a negative equity home-ower said to their lender:
“The fact is you lose ~50% (40-60%) on a foreclosure sale of a 2004-08 vintage mortgage.Since Morgan Stanley and other who have defaulted and walked away from money losing commercial real estate transactions they could not renegotiate, I am going to do the same: Unless you cut a substantial percentage of the principal (~20-30%) owed, then I will choose to strategically default (walk-away).”
I suggest bypassing the FDIC and going straight to your lender. Where the FDIC could be of assistance would be to prod the lender to consider the alternative to foreclosure.
My guesstimate is that of the 5 million probable future foreclosures, this mod would be applicable to about 20% of them. Note that a recent report from the Office of the Comptroller of the Currency implies that banks have figured this out: In Q3 of 2009, 13% of loan mods included a principal reduction, up from 10% in Q2 ‘09.
Of course, if Congress didn’t force FASB tio eliminate mark-to-market on holdings, the banks wouldn’t be able to, Japanese style, wait the whole mess out over the next decade or two.
There are additional elements involved.
The HAMP approach (which isn’t working very well):
“Lenders have been reluctant to cut the principal balance owed by distressed borrowers, arguing that it would encourage homeowners to become delinquent even if they can afford their mortgage. Instead, the industry has focused on providing mortgage relief by lowering a borrower’s interest rate or extending the terms of a mortgage to 40 years.
We know borrowers do not benefit much from these mods – a 1% lower, 40 year mortgage still makes most of these homes too expensive. It does little for the ability of the underwater borrower to carry the property. And these HAMPS fall into default at a very high rate — 60-80%, depending upon circumstances.
Final point:
“In some cases, a portion of the principal balance is put into a second mortgage that does not have to be paid off until the borrower sells the home or refinances.”
That was my 30-20-10 proposal some time ago. That is a good fall back proposal — move 30% of my mortgage into a 10 year, interest free 2nd mortgage.
A straight up principle reduction is the way to go, with a balloon mod an alternative option.
>
Previously: Fixing Housing & Finance: 30/20/10 Proposal (September 22nd, 2008)http://www.ritholtz.com/blog/2008/09/fixing-housing-finance-302010-proposal/
Strategic Defaults in Florida (October 28th, 2009) http://www.ritholtz.com/blog/2009/10/strategic-defaults-in-florida/
Coming Soon: 5 Million More Foreclosures (February 16th, 2010)http://www.ritholtz.com/blog/2010/02/coming-soon-more-foreclosures/
Source: FDIC to test principal reduction for underwater borrowers Renae Merle Washington Post, February 26, 2010; A20http://www.washingtonpost.com/wp-dyn/content/article/2010/02/25/AR2010022505817.html
Attached is a very entertaining story of a family that was going to be foreclosed on, and how in spite of the fact that it was in no way in the bank’s best interest to foreclose on them, it was insanely difficult for their young lawyer to prevent it (and it would have been impossible for them to prevent it without a lawyer).
Warning: Profanity. Not Safe For Work. NSFW. http://www.mcsweeneys.net/links/panoramaexcerpts/Ali.html
I really, really doubt that the same banks that were stupid enough to make these loans in the first place are going to be smart enough to see their own self-interest in reducing the principal on them.
I agree that in theory, a borrower with balls should be able to make this happen: issue a credible threat, and the bank should react to cut its losses and protect its interests. But the problem is you’re dealing with entities that have already proven themselves extremely irrational. They allowed a total collapse of lending standards! They made loans to people they knew couldn’t pay them back!
This is like a cop pulling a gun on an insane person. Yes, the rational thing they should do is put their hands up. But crazy people are operating in a totally different reality. They are following rules that are very clear to them, but which are totally disconnected from the reality of the situation they’re actually in. And as a corporate entity, so are banks.
Too bad residential mortgages are not like CRE financing. People should not be held hostage to the ‘moral obligation’ propaganda to pay at any cost. Also should let losses from the sale or RS be written off, Cap and eventually eliminate the interest expense write-off and do away with the over 55 exemption privilege.
let’s be honest, it’s another save the banks ass program,
flour big boys in construction, going forward, ie, upcoming bids, not so good, construction can layoff in a heartbeat, and it goes downhill quickly to sub-contractors, who then become competitors and drive the prices down in what little work there is
there’s sayin in construction, u got a pick-up truck and a shovel and ur in bizz
First, to “constant normal”: It’s a pun. “Home-owers” You know like in OWE the bank.
Now the serious stuff. The bankstas have FASB to allow them to continue the charade.
Time for some reality: Mark-to Market. Negotiate or go home ( $200 billion writedown). Too big NOT to fail( A trillion dollars of worthless paper) Lose your jet and the house in the Hamptons. Priceless!
As the powerpoint man, says, spell cheek your stuff. Redlined hed, ooops.
~~~
BR: Its a PUN — Home OWERS they are not home owners, they have negative equity, and they own nothing.
Get it?
(See, I told ya guys I was nuanced!)
What about inverting the amortization table for a year or two?
This is all such a TERRIBLE idea.
1. Americans need to LEARN to be frugal and make smart financial decisions. We can’t just bail out 20 million people and peg home prices at such and such a level. All those that screwed up will have learned nothing and run out and get into debt once again (which is what Ben wants).
2. It’s ridiculously unfair to those that did NOT chase the bubble. RIDICULOUSLY SO.
3. You encourage a society of ‘everyone for themselves’. Take what you can from .gov. Instead of there being amazing concepts like ‘justice’, ‘fairness’ and ‘equality’ – we have – “YOU 50 million people must give money to THOSE 50 million people.”
Nice.
I’ve so far stopped most of my disposable spending. I will eradicate what’s left as I’m a saver and have been saving for a house for 2 years now. Let things collapse the way they should and I’ll be there with cash in hand.
Read Full Article »