I’ve been noodling this post for a week and finally decided to buckle down and write it. Not because modifications and foreclosure moratoriums have become politically correct, but simply because there aren’t any compelling reasons that I’ve seen advanced so far that convince me that it will do anything substantive to change the current economic environment.
Let me say up front that if the owner of a mortgage decides it in their best interest to modify a loan, then more power to them. My objection runs to efforts by the government to coerce modifications from the private sector or to use public funds to induce private holders of mortgage securities to modify when foreclosure might be the more rational business decision.
So here, in no particular order, are ten reasons why I hate the mortgage modification concept.
- It Won’t Work: The loan modification process has rarely been successful on any sort of scale. Life changing events (illness, divorce, death of a breadwinner, etc.) from which one can recover are usually the circumstances that allow for a successful modification. The expectation that mass modifications of mortgages for those who never had a chance of properly servicing their debt in the first place is a pipe dream.
- The Next Generation of Homebuyers Gets Disenfranchised: A decline in the price of housing is viewed as something akin to the plague while declines in other goods, say crude oil or its derivative, gasoline, is applauded. In fact, the decline in the price of housing is opening up opportunities for the next generation of buyers. Arresting the decline punishes them unjustly.
- No Price Discovery: Price discovery will occur no matter how long it may be deferred. Modifications on a mass scale will inevitably experience a high degree of failure, prolonging the search for a bottom.
- Mortgage Rates Soar: Abrogating contracts either through the use of the bankruptcy courts to cram down principle or jawboning servicers will destroy investor confidence in mortgages as an investment vehicle. The attendant risk premium that will be attached to home loans will drive interest rates to credit card levels.
- Valuation Becomes a Guessing Game: Principal write-downs will inevitably become a matter of privacy and the market will have no mechanism to establish the relative worth of similar properties. Absent good public information, the ability to determine value will become impossible. Buyers are likely to be highly reticent to buy in such a market.
- Distortion of Market Relationships: If home prices are artificially supported via modifications the relationship among different levels of housing is going to be distorted. There is a natural economic relationship that is market driven. Alter the relationship artificially and the move-up market evaporates.
- Picking Winners and Losers: Government decides who wins and losers in this one. Don’t expect the rules to be written objectively.
- Where’s the Fairness?: How do you explain to the homeowner who didn’t lie about his income, who has been making his payment despite being under water and who hasn’t engaged in serial refinancing that his tax dollars are going to be used to bail out the miscreant who did one or all of the above?
- Moral Hazard: Maybe we should just retire this phrase. But if we do intend to maintain a market economy then the sense of personal responsibility and consequences for foolish actions has to be left intact.
- Gaming the System: The American people have become quite adept at gaming the system. If indeed mass modifications are to be the rule then count on them to do the math and figure out if quitting a job or missing a few payments might make good economic sense. This is a nation that figured out” liar loans” pretty quickly. Don’t bet against them to get the best of the government.
Feel free to add your own ideas to this list.