An Angry Banker's Foreclosure Solution

It is no secret that the Foreclosure Prevention Act of 2008 has not lived up to expectations in terms of keeping families in their homes, slowing down the rate of default on mortgage loans and stabilising the housing market. Why? Because after all is said and done, many people are still living in homes that they cannot afford, and never should have bought in the first place.

The solution is not to throw money at the problem in a desperate attempt to “keep families in their homes”, particularly when it comes to rewarding people who made bad borrowing decisions by rescuing them from their mortgages and forcing lenders to write down the balance of outstanding loans. No, the solution is to get people back to living within their means.

I have said from day one of this crisis that the responsibility for the problem is shared among all of us. No, I don’t mean all of us bankers. I mean all of us. “Us” includes bankers, brokers, investors, Congress, the regulators, and like it or not the borrowers who speculated in the housing market and happily accepted easy loans that were being offered them.

So to solve the problem created by all of us, I propose that we assign specific accountability to each guilty party and then implement corrective actions that will rectify any damage done to a party beyond what they were directly accountable for. Without further ado, here is my is plan for helping those families who can no longer afford to live in their homes.

Borrowers who can no longer afford their mortgage payment, but were in fact responsible borrowers:

If a borrower can demonstrate that he/she borrowed responsibly (within his ability to pay and was not speculating in the housing market), then I assign very little blame to him/her and believe he is deserving of maximum support. However, foreclosure should still take place (but with protections outlined later).

How does a borrower demonstrate he borrowed responsibly? Easy:

• Can the borrower prove he had the ability to pay (proof of stable income at the time of borrowing)?
• Was the LTV (loan-to-value) 80% or less?
• Was the borrower’s debt-to-income ratio after obtaining the loan less than 30%?

If the answer to all these questions is “Yes,” I believe the borrower most likely behaved in a responsible manner and that his current situation is most likely not his fault. Therefore the borrower would be eligible for the following benefits:

• Upon foreclosure, government assistance of a few thousand dollars (or a tax credit) to help with expenses to move to a less expensive house or apartment should be provided.
• The borrower’s default should not be recorded in the credit bureau, thus enabling the borrower to obtain a new loan when his financial situation improves.

What about borrowers who were gambling?

If the customer fails the “responsible borrower” tests above, I am still not yet prepared to assign full responsibility to him though. The reason is that I believe banks have a fiduciary responsibility to their depositors to ensure they do not extend credit on excessively risky terms (in other words, it’s the depositor’s money at risk, not the lender’s). Therefore, for failure to answer “yes” to any of the three questions above, here is how I propose we rectify the wrongdoing:

• The lender should be fined for failure to lend in a responsible manner and the full amount of the fine should be applied to the outstanding balance of the borrower’s loan. The amount of the fine should be calculated as the difference between the value of the loan the borrower could have legitimately afforded and the amount of loan that was actually made.
• If the loan can be refinanced now with lower payments that the borrower can afford, problem solved.
• Otherwise, proceed with foreclosure, but with the new lower balance as the recoverable amount for the bank.

Note that the program above should only be applied to loans on primary residences. If people have two houses, but lose one of them, they still have a place to live and will probably have better cash flow once their second house is foreclosed.

Why the “Angry Banker’s Foreclosure Solution” Will Work

Allowing the foreclosure process to proceed naturally – but with relocation support and no negative credit bureau impact for responsible borrowers – will be almost like pressing the “reset” button for millions of borrowers who legitimately became victims of an unprecedented economic downturn. They will have improved personal cash flow after foreclosure and still be able to obtain loans in the future. With their improved cash flow, they may also be able to go ahead and more easily service their credit card debts, helping to avert the next major credit crisis for the banking industry.

For banks, fining them for irresponsible lending practices and applying the fines to the loans themselves, forces the banks to accept financial responsibility for their bad business decision to allow no-doc liar’s loans at imprudent LTV’s. But for those banks that made responsible loans (those made to customers passing the “responsible borrowers” test above), the bank should rightly be able to recover their losses through sale of the collateral just like in a normal economy.

For the economy, we will see excess supply in the housing market as foreclosures increase in the short term. This will drive down the prices of homes, which will spur people to start buying. When people buy used homes, they will naturally renovate and improve them, meaning they will be spending money again. This will drive domestic consumption and motivate companies to hire again, resulting in reduced unemployment, and so the positive feedback loop begins.

Now I recognize that there are many ways to further improve this plan. But the fundamentals are sound. Don’t reward bad business decisions (either by banks or borrowers), but do give a helping hand to those people who were legitimate victims of the global economic meltdown.

I welcome your comments.

Disclosure: Long C, XLF

Comments

[NEH:]

Your definition of responsible is too narrow.

Jul 30 08:38 AM

[sailor1012:]

Absurd suggestion, this could never work, too vague and who will decide? Absurdly stupid!

Jul 30 10:10 AM

[Jim Dwyer:]

Mortgage guidelines:

1) Everybody pays THEIR OWN mortgage.
2) Those who can't pay, or don't feel like paying their own mortgage can RENT.
3) Banks and speculators who lent money to people who can't pay, or don't feel like paying their mortgage, are out of luck. They lose.

Jul 30 10:14 AM

[mr subprime:]

Here's my suggestion: The borrower should file a lawsuit against their lender for the inflated appraisal, the falsified asset statements, the falsified income statements, and all the other bad behavior that the banksters engaged in. Expose the FASB 140 violations, the AB1122 violations, the SEC violations, and call your State AG (since the Supreme Court has said they can now PROSECUTE for violating the state banking and lending laws). Get your mortgage extinguished and hold them up for damages.
And then throw the bankers in jail.

Jul 30 10:50 AM

[Swashbuckler:]

While I don't agree with your suggestions for dealing with the mortgage problems, for many reasons including those cited here by other posters, I admire your effort at addressing a very complex, nasty problem. If Washington had made an effort early on, the situation might be much less severe today.

Jul 30 11:02 AM

[LKofEnglish:]

personally i'm all for mr. subprime. still, this is the best picture. if only it was on the hood of my semi while i drive down the interstate...as for a "solution" trust me the government has already come up with one. tis true that it does involve clowns, too!

Jul 30 01:02 PM

[john s. gordon:]

nice in theory but unlikely to ever be implemented.
> jack

Jul 30 01:23 PM

[Tony Petroski:]

Curious that nobody, not even the Angry Banker could suggest that we let the market work, allow the foreclosures to proceed apace and get on with life.

Fiddling with records like foreclosing but then not allowing financial institutions to record the foreclosure is like the insurance laws in which states mandate that insurers have to look the other way and ignore the first three speeding tickets. Let the market work without all the mandated fiddling. In the insurance business, specialist companies exist to price the risk of "substandard" insureds. The can distinguish between a good driver who made one mistake vs. the chronically bad driver that is also a bad risk. Banks can figure out the difference between a "responsible" borrower that lost his job in the Great Depression II vs. the chronic non-payer of bills. Let the market work and get out of the way. Recovery will be so much quicker.

Jul 30 01:45 PM

[jackooo:]

Throw money around...it has to land somewhere....

Jul 30 03:25 PM

[jazzman:]

You can bail out these worthless banks and such who made bad decisions and ripped people off and continue to do so, but you can't help people who want to keep their homes..How ironic. and Narrow Minded..The incompetence of corporate America goes way beyond whet consumers have done!

Jul 30 05:08 PM

[rockerchic:]

What about the first criminal in line: the mortgage broker? They knew the ins-and-outs of the loans and spoke right to the person advising them of their situation and what they could afford. They're the ones who need to be in the unemployment lines and fined for each loan they sharked.

And the regulators? Also fired for not doing their job.

Just a dream of course, like some of the things listed in the article... but it would be nice to see some justice served.

Jul 30 05:14 PM

[Mr. Ed, Jr.:]

I think this is insane.

Attempting to determine who was or was not a " responsible borrower" is a giant step toward national lunacy. (We have already turned onto that road, though). If you want to play that game-- and I can guarantee you it will be a game-- let's take a look at all of the defaulter's spending habits...

Did they run up big bills at the mall, buy an Escalade with DVD players, take too many cruises ?...and on and on. Financial responsibility is not just about the mortgage.

If someone actually did borrow responsibly in this mess, with at least 20% down and a real job with the income they claimed (In which case there should probably be some sort of national award ceremony held for them on the White House lawn.), they are probably still ok unless they have lost their job. But losing a job is possible at any time-- even in times of general prosperity.

When the homeowner stops paying the mortgage, he is living rent-free in most states-- certainly in the states where there are the most problems. (Coincidence ?) There is no need to then hand over taxpayer funds to help them default.

We have massive fraud and misrepresentation on all sides of this housing mess. Fitch examined a batch of mortgages and found fraud in every one of them.

Lying on a mortgage application is illegal. Those who did it should be prosecuted. Maybe the plea bargain could include restitution to the government for the foreclosure losses caused by falsifying a mortgage application.

Banks should be closed for their role in this, not bailed out. There are plenty of bankers and Wall Street scammers who need to learn firsthand what a "frog-march" is.

There was massive fraud involving real estate agents and appraisers, yet only a handfull of cases have been prosecuted.

Let's not pile any more bailouts or schemes on top of this mess.

Jul 30 06:32 PM

[snagglesnarf:]

Let's just kill the bankers; it's less complicated.

Jul 30 06:54 PM

[dcb:]

I have a solution. give this money (our money) to the taxpayer instead of his greedy banke friends.
From A Former Goldman Managing Director: How You Finance Goldman Sachs’ Profits
Submitted by Tyler Durden on 07/30/2009 17:10 -0500

Alan Grayson Bank of America Bankruptcy Banks Ben Bernanke Bonuses Cash CEO Commercial Paper Compensation Comptroller of the Currency Credit Debt Derivatives Earnings FDIC FED Federal Deposit Insurance Corporation Federal Reserve Federal Reserve System Goldman Sachs Jamie Dimon Lehman Brothers Liquidity Merrill Lynch Money Morgan Stanley New York Times Office of the Comptroller of the Currency SEC Speculation TARP Toxic assets Trade VaR


By Nomi Prins, via Mother Jones

July 28, 2009 -- This is perhaps the most important thing I learned over my years working on Wall Street, including as a managing director at Goldman Sachs: Numbers lie. In a normal time, the fact that the numbers generated by the nation's biggest banks can't be trusted might not matter very much to the rest of us. But since the record bank profits we're now hearing about are essentially created by massive federal funding, perhaps it behooves us to dig beneath their data. On July 27, 10 congressmen, led by Rep. Alan Grayson (D-Fla.), did just that, writing a letter to Federal Reserve Chairman Ben Bernanke questioning the Fed's role in Goldman's rapid return to the top of Wall Street.

To understand this particular giveaway, look back to September 21, 2008. It was a frenzied night for Goldman Sachs and the only other remaining major investment bank, Morgan Stanley. Their three main competitors were gone. Bear Stearns had been taken over by JPMorgan Chase in March, 2008, Lehman Brothers had just declared bankruptcy due to lack of capital, and Bank of America had been pushed to acquire Merrill Lynch because the firm didn't have enough cash to survive on its own. Anxious to avoid a similar fate, hat in hand, they came to the Fed for access to desperately needed capital. All they had to do was become bank holding companies to get it. So, without so much as clearing the standard five-day antitrust waiting period for such a change, the Fed granted their wish.

Bank holding companies (which all the biggest financial firms now are) come under the regulatory purview of the Fed, the Office of the Comptroller of the Currency, and the FDIC. The capital they keep in reserve in case of emergency (like, say, toxic assets hemorrhaging on their books, or credit derivatives trades not being paid) is supposed to be greater than investment banks'. That's the trade-off. You get access to federal assistance, you pony up more capital, and you take less risk.

Goldman didn't like the last part. It makes most of its money speculating, or trading. So it asked the Fed to be exempt from what's called the Market Risk Rules that bank holding companies adhere to when computing their risk.

Keep in mind that by virtue of becoming a bank holding company, Goldman received a total of $63.6 billion in federal subsidies (that we know about—probably more if the Fed were ever forced to disclose its $7.6 trillion of borrower details). There was the $10 billion it got from TARP (which it repaid), the $12.9 billion it grabbed from AIG's spoils—even though Goldman had stated beforehand that it was protected from losses incurred by AIG's free fall, and if that were the case, would not have needed that money, let alone deserved it. Then, there's the $29.7 billion it's used so far out of the $35 billion it has available, backed by the FDIC's Temporary Liquidity Guarantee Program, and finally, there's the $11 billion available under the Fed's Commercial Paper Funding Facility.

Tactically, after bagging this bounty, Goldman asked the Fed, its new regulator, if it could use its old risk model to determine capital reserves. It wanted to use the model that its old investment bank regulator, the SEC, was fine with, called VaR, or value at risk. VaR pretty much allows banks to plug in their own parameters, and based on these, calculate how much risk they have, and thus how much capital they need to hold against it. VaR was the same lax SEC-approved risk model that investment banks such as Bear Stearns and Lehman Brothers used, with the aforementioned results.

On February 5, 2009, the Fed granted Goldman's request. This meant that not only was Goldman getting big federal subsidies, but also that it could keep betting big without saving aside as much capital as the other banks. Using VaR gave Goldman more leeway to, well, accentuate the positive. Yes, Goldman is a more risk-prone firm now than it was before it got to play with our money.

Which brings us back to these recent quarterly earnings. Goldman posted record profits of $3.4 billion on revenues of $13.76 billion. More than 78 precent of those revenues came from its most risky division, the one that requires the most capital to operate, Trading and Principal Investments. Of those, the Fixed Income, Currency and Commodities (FICC) area within that division brought in a record $6.8 billion in revenues. That's the division, by the way, that I worked in and that Lloyd Blankfein managed on his way up the Goldman totem pole. (It's also the division that would stand to gain the most if Waxman's cap-and-trade bill passes.)

Since Goldman is trading big with our money, why not also use it to pay big bonuses? It's not like there are any strings attached. For the first half of 2009, Goldman set aside $11.4 billion for compensation—34 percent more than for the first half of 2008, keeping them on target for a record bonus year—even though they still owe the federal government $53.6 billion, a sum more than four times that bonus amount.

But capital is still key. Capital is the lifeblood that pumps through a financial organization. You can't trade without it. As of June 26, 2009, Goldman's total capital was $254 billion, but that included $191 billion in unsecured long-term borrowing (meaning money it had borrowed without putting up any collateral for it). On November 28, 2008 (4Q 2008), it had only $168 billion in unsecured long-term borrowing. Thus, its long-term unsecured debt jumped 14 percent. Though Goldman doesn't disclose exactly where all this debt comes from, given the $23 billion jump, we can only wonder whether some of it has come from government subsidies or the Fed's secret facilities.

Not only that, by virtue of how it's set up, most of Goldman's unsecured funding comes in through its parent company, Group Inc. (Think the top point of an umbrella with each spoke being a subsidiary.) This parent parcels that money out to Goldman's subsidiaries, some of which are regulated, some of which aren't. This means that even though Goldman is supposed to be regulated by the Fed and other agencies, it has unregulated elements receiving unsecured funding—just like before the crisis, but with more of our money involved.

As for JPMorgan Chase, its profit of $2.7 billion was up 36 percent for the second quarter of 2009 vs. the same quarter last year, but a lot of that also came from trading revenues, meaning its speculative endeavors are driving its profits. Over on the consumer side, the firm had to set aside nearly $30 billion in reserve for credit-related losses. Riding on its trading laurels, when its consumer business is still in deterioration mode, is not a recipe for stability, no matter how much cheering JPMorgan Chase's results got from Wall Street. Betting is betting.

Let's pause for some reflection: The bank "stars" made most of their money on speculation, got nearly $124 billion in government guarantees and subsidies between them over the past year and a half, yet saw continued losses in the credit products most affected by consumer credit problems. Both are setting aside top-dollar bonuses. JPMorgan Chase CEO Jamie Dimon mentioned that he's concerned about attracting talent, a translation for wanting to pay investment bankers big bucks—because, after all, they suffered so terribly last year, and he needs to stay competitive with his friends at Goldman. This doesn't add up to a really healthy scenario. It's more like bad déjà vu.

As a recent New York Times article (and many other publications in different words) said, "For the most part, the worst of the financial crisis seems to be over." Sure, the crisis may appear to be over because the major banks of Wall Street are speculating well with government subsidies. But that's a dangerous conclusion. It doesn't mean that finance firms could thrive without the artificial, public-funded assistance. And it certainly doesn't mean that consumers are any better off than they were before the crisis emerged. It's just that they didn't get the same generous subsidies.

Additional research by Clark Merrefield.

Article From Mother Jones, h/t amsterdamtrader

Jul 30 08:41 PM

[dcb:]

As a form of protet all americans should stop paying their mortgage. Lets see what happens then. Our founding fathers fought a revolution on the orinciple of taxation without representation. Are you being represented by our government. If the answer is yes you are a banker, but other wise it is no. Are they going to throw everyone in jail. imagine 100 milllion americans with ruined credit ratings. well they can't make anymoney if they don't let us borrow. they can't do shit!!

Jul 30 08:46 PM

[maryanne:]

US is one of the few countries with NON-recourse mortgages - ie, those deatbeats can walk away anytime. This should only be allowed by bankruptcy course otherwise otherwise they should be forced to pay back the loan even if it takes the rest of their lives (garnish all wages and income)

Jul 31 02:17 PM

[bexe:]

Good start by re-qualifying borrowers. But even qualified borrowers are in trouble because the diminution of the value of the property would have stripped of the entire equity. The only way to overcome that apart from a fresh injection of cash, is to rent.
Banks be made to buy back the property and lease back the home to the defaulting but re-qualified occupant at the punitive rate equal to the original low mortgage payment before the spike. Lease payments reduces the outstanding value of the "loan". Lesee are given the option to re-purchase the properties.
[e-mail]

Jul 31 02:42 PM

[Ricard:]

This is an excellent solution with some fatal flaws, none of which have to do with banking.

1) This involves politicians getting involved and writing a bill that will not only anger their donors (finance industry), but also alienates their constituency. I'm of the opinion that everyone knows someone that either has recently undergone a foreclosure, gift-to-bank, or is generally underwater. You will have lots of angry people who will vote their local Congressperson out of office. In essence, your bill is a political impossibility, and exposes a fatal flaw in democratic models of government.

Right now we are seeing democracy in rare form. Political scapegoating has targeted the financial industry, with the caveat that the industry will take the abuse as long as they get whatever they want in legislation. This keeps the mobs from voting them out of office, and keeps the money flowing from their donors. Will anything truly worthy get done? More than likely not - we will more than likely reach this crossroads again in the future, with even harder choices to make. Why? Because we CHOSE as an electorate to keep people in office that will acquiesce to any of our demands, as unreasonable as they may be. We may all end up going the road of California's government and pretend we're not insolvent.

2) A few thousand dollars to compensate for 20% down payment may fly in Toledo, but a 20% down payment in California usually was close to a 6-figure number. Considering that outside of Detroit, the West coast is probably where most of the foreclosures are originating (prices are still dropping here unlike New England or the Midwest), your suggestion for maximum support will fall very far short of providing any meaningful support for West coast homeowners who fall under your criteria of 'responsible'.

Example: Responsible first-time homebuyers who purchased their first home for $500,000 would have bought a nice 1500 sq ft home with a 4000 sq ft lot and put down at least $100,000 down, for a home now worth probably less than $400,000 (IMHO should be worth $350,000 max, even though a house like that in Detroit would probably not even be worth six figures) - these people are underwater, and a couple thousand dollars will probably feel like a band-aid for a gunshot wound.

3) Your punishment to the lender will probably destroy a good number of institutions. As opposed to filling in the value gap, a wrist-slapping of charging points back to either the customer or the federal government will probably be all we can expect. After all, the lender will still be saddled with a POS property...that's usually punishment enough. Again, the reasoning behind this is that for your typical year 2005 purchase of a 1500 sq ft home, the value gap is probably a 6-figure number compared to today's prices, at least out here in California. That is not only an outlandish fine, it will cripple banks even without the detriment of ridding themselves of foreclosure properties. Financial system collapses, Great Depression II begins.

Anyway, ex the finer details, your proposal has quite a bit of merit. However, I think the possibility of seeing such legislation actually enacted amounts to zero.

Aug 04 03:24 AM

[Angry Banker:]

Thank you Ricard for commenting in the spirit of the article, which was intended to spark discussion and not the typical sarcastic vitriol that many commenters on SA tend to write. Much appreciated!

Aug 05 09:11 AM

[Ricard:]

Yeah, a lot of people on SA are long on opinion and short on support. I fall into that camp too sometimes, but I know the point is to add constructive dialogue whenever possible. Cheers.

Aug 05 11:44 PM