Hitting the Reset Button On Home Mortgages

Alan Blinder, Princeton economics professor and former Vice Chair of the Fed, has a piece in Monday's NY Times business section on how to restructure the mortgages that are in trouble and are causing so much heartburn in our financial markets. He is mostly commenting on the "Dodd-Frank" proposal for the government insuring troubled mortgages.

I think this is basically a good idea. If the government is going to bail out the people trading with Bear Stearns (BSC) in an effort to calm the markets, then they might as well go right to the source of the poison and clean up the mortgage mess. But, it has to be done right. And I think that insuring the mortgages instead of buying them, as was done in the depression, is an idea with some merit.

But there are a bunch of things about the Dodd-Frank proposal and Blinder's additional thoughts that concern me.

As I understand the Dodd-Frank proposal, the lenders will take a write-down on the non-performing loans instead of foreclosing on the loans. The lenders will then trade the non-performing loans for new federally insured loans and realize a loss on the old non-performing loan.

All of that makes sense to me. These loans are not worth 100 cents on the dollar because not only are they non-performing, but the collateral has fallen in value as well. It makes sense to realize the losses and convert the bad paper into good paper. And, it makes sense that the government is going to have to do something to comfort the market. Insuring the loans is an idea that at least ought to be explored, even though we are talking about putting taxpayer money at risk.

But here are my questions/concerns:

1. Who sets the value of the new loan? If the government is going to insure it, how can the market really price it? The best approach would be to have the market price the value of the loan based on a non-insured deal, then have the government insure it. That way the taxpayers are only insuring a market deal.

2. How do you avoid giving the homeowner a total bailout in the process? Let's say I bought a home for $250,000, put no money down, and have monthly mortgage payments of $1,500 a month. Let's say the home has dropped in value to $200,000 and I can really only afford to pay $1,200 a month. The market value of that loan is probably in the range of $175,000. The current owner should take a $75,000 loss, and let it trade to a new holder (or keep it), get federal insurance, and get paid $1,200 per month for the remainder of the loan.
   All of that makes sense to me. But do I (as the homeowner) only have to pay off $175,000 or $250,000? If the deal is I only have to pay $175,000, then that's a great deal for the homeowner, and should we be doing that?

I think we need to look at what would happen if the government didn't step in, and then work from there. If the government doesn't step in, the holder of the loan is going to foreclose on the loan, take the home, sell it (in my example for $200,000 less transaction costs), and take a loss. That loss is going to be between $50,000 and $75,000.

The homeowner is going to lose his home, but since he didn't have any money down, he doesn't have any financial losses. He does have to give up a home that he and his family may have come to love.

If the government can come up with a scheme to get the mortgage holders basically what they would be getting in a foreclosure situation (the market price of the collateral less transaction costs) and allow the homeowners to stay in their homes and have a high probability of staying current on the loan going forward, then we will have achieved a number of good things.

We will avoid a glut of foreclosed homes from coming on the market, further depressing home prices. We will convert bad loans to good loans. And, we will keep people as homeowners who have a vested interest in maintaining and improving their homes instead of putting them back into the rental market.

So let's go back to Blinders's piece in the Times. As to my first question about how these loans get priced, he suggests:

My suggestion is that the Super F.H.A. categorize the mortgages it might refinance into, say, “high,” “medium” and “low” qualities and, based on its best guesses of fair market value, post initial buying prices for each type.

I don't like that idea. There's not enough of a market at work for my taste. I think they should just do a new appraisal on the property and price the loan at 90% of the appraised value. Then, apply federal insurance and reset the payment plan so that the homeowner pays off the new appraised value plus a market interest rate in 30 years. That should do the trick.

As to my second question about how you avoid giving the homeowner a windfall, Blinder says:

The proposal would make homeowners relinquish part of any price appreciation on their houses for as long as their Super F.H.A. mortgages remain in effect. Good idea. But I’d go further, by also making beneficiaries of the plan forfeit the right to take out second mortgages or home equity loans.

There is some sound thinking in this part. First, a homeowner who has a federally insured loan should not be able to borrow against the home as long as that loan is outstanding, period. As to who captures the "discount," it makes sense to me that the homeowner and the federal agency which insures the mortgage should share in the appreciation of the home between the new loan value and the old loan value.

You don't want to give the entire discount to the homeowner because that's just a huge gift, possibly at taxpayer expense. But you do want the homeowner to continue to have an interest in making the home better and seeing it appreciate. You also want the the federal agency to get some of this appreciation to offset the risk it is taking. As to what the percentage should be, I say 20% to the homeowner and 80% to the federal agency.

These are my thoughts on the proposal. As I said, I think it's basically a good idea. This mortgage mess should be cleaned up, and using the traditional method of foreclosure and resale is not a great idea in a time of crisis like we are currently in. Let's hit the reset button and put the government in the mix, but do it in a way that reflects the market values and doesn't give the homeowners a huge windfall.

Comments

[daffy:]

I think that everything you are writing is fine and dandy as far as a bailout for homeowners go, but there seems to be one thing that people are increasingly willing to ignore.

A good percentage of people who are in danger of foreclosure shouldn't have been in the home in the first place.

I have been on my block for about 5 years now. In the last 8 months there have been 4 foreclosures (I live in Miineapolis). Of those foreclosures, one was a cut to pieces mansion for rental units that I have offered the value of the land minus tear down costs (after foreclosure). It really is that bad. Two of the home are valued higher but are really the least valuable homes on the block (they are like track homes in a neighborhood of turn of the century architecture). The final home is a traditional home symbolic of the neighborhood.

OK, now onto the "owners". The first home was occupied by some young partier who threw outrageous parties with sword fighting and the likes at all hours. Foreclosed, I am sure failure to make payments. The second two were occupied by people who had migrated home to home as renters and were always evicted (either by the city (condemnation) or the landlord). The fourth one was occupied by a couple who took out an arm loan and invested all of thier savings into a restaraunt in 2007. A start up restaraunt.

Ok, if you ask me, the only people who should have been in their home are the restauranteers. The other three occupiers did not belong in the position of having a mortgage to be responsible for. They couldn't even handle a lease for god's sake.

So, as far as I can see, at best 75% of the people in this bad debt situation should have never been there in the first place. So, no we should NOT bail them out. If the government wants to step in, well, let them help the couple who made a mistake in their mortgage choices and the choices of their business start up. At least they were willing to risk what they had to possibly provide a better life for themselves and others as well as provide for a larger tax base.

Seriously folks, you are not going to entrust your Maserati Quattroporte Executive GT to an alcoholic with a BAC of 0.33%. Just the same as you are not going to entrust your retirement porfolio to the homeless guy on the park bench.

Let's stop with the broad sweeping regulatory changes. Pretty soon home ownership will be a right, and the governemnt will be bailing out everyone. Driving is a priviledge, and so IS HOME OWNERSHIP. THESE ARE PRIVILEDGES YOU HAVE TO TAKLE SERIOUSLY AND BE RESPONSIBLE FOR.

2008 Mar 31 08:36 AM

[Cerebus:]

Right on Daffy. I get pretty agravated every time I hear about the possibility of out tax dollars going to bail out homeowners who never should have gotten a loan in the first place. There is a reason why people have sub-prime credit scores, it's because they don't pay their bills...

2008 Mar 31 09:22 AM

[Andy Singleton:]

To motivate anyone to participate in this scheme, the government has to pick up some part of the losses. Almost certainly, the process will be "captured" by either the homeowners or the banks and milked for additional subsidies. Personally, I think this is a bad idea. However, from a political point of view, as a nation, we don't have a problem subsidizing either of those two groups. The problem that I see is the cross-regional subsidies. Most of the subprime problem is in inflated California and Florida markets. A huge amount of money will be transferred from "responsible" buyers in the midwest living in $200K homes to Californians living in $600K homes. This is obviously unfair, in a way that even politicians can see, because there are politicians that actually live in the Midwest.

2008 Mar 31 10:04 AM

[mikeylikesit:]

Hmmm... so the plan is to reduce the principal of the loan to the subprime borrower. Did I summarize that correctly?

Hey, what about me? I bought a home for $251,900 in 2005. I paid down $52,000 already. Yep, I got extra money and expected the stock market to tank someday soon... So, I kept making big lump sum payments to my mortgage figuring 5.875% return on those payments were better than the market beating I'd take soon.

So I guess I wasted my money. The government would have regulated my home to a principal balance of $200k without any help from me.

Man, do I feel stupid for being responsible.

No... seriously... I feel really really really stupid.

2008 Mar 31 10:17 AM

[HangingOnBy...:]

Maybe it's not too late. I could still rush out and buy a house right on the brink of what I can qualify for, then wait for the price to drop and the government to bail me out along with the rest. Wonder if I can get them to compensate me for buying a large SUV that's surely going to depreciate as well. Hmmmm. What about other investments. Surely I can come up with more. No sense being responsible. Social security won't be there anyway. Might as well get the rest of the country to finance my bad decisions as well. I love this country. Especially in elecition years.

2008 Mar 31 10:45 AM

[bearfund:]

The greatest danger lies not in the handing out money aspect; the government does that all the time. Much worse is the fact that such a bailout actively punishes those of us who (a) didn't feel comfortable gearing up 40x on real estate, (b) recognised that the market was significantly overvalued, and thus (c) preferred to save our money so that we could take advantage of the coming correction. We've already taken it in the shorts from negative real interest rates - our savings not only aren't growing any longer, inflation is eating away at their value. Now you also want to deny us proper pricing? To hell with that; I might as well just quit my job and go live in the park. Why participate in a heavily manipulated economic system that seeks primarily to punish prudence?

2008 Mar 31 10:58 AM

[mikeylikesit:]

Let's all be honest also... like the author, I can't wait for some folks in my neighborhood to be foreclosed on. Hoodlums that should have never been able to move here.

I've been saving money just to buy their foreclosed properties and now it won't happen.

2008 Mar 31 11:01 AM

[User 48501:]

nobody is responsable for anything! its all bushes fault! vote for hilbama! they will go after the greedy corps. that give us our jobs!

2008 Mar 31 11:10 AM

[vboring:]

it sounds like anger is starting to build up on all sides. hopefully there will be enough anger that the gov't will be forced to roll some heads.

some white men in expensive suits need to go to jail for this mess.

as for the bailout proposals, they need to differentiate between home investors and home owners, because investors shouldn't be bailed out. maybe some witless owners should. how to tell the difference?

if you can sustainably afford your original loan, you are an owner. if you can't, you're an investor. any bailout should only help people who can afford their loans, but who are now incentivised to abandon them because of negative equity.

2008 Mar 31 11:17 AM

[ThomasB653:]

With all of the different plans for the "bailout", how about this one. What if the Fed provided home loans for a low interest, let's say 3%, available to everyone, for the existing, outstanding loan value, and/or new purchase loan value. Cash out refi's would not be available. The application would be linked to the IRS to verify that the borrower has income able to support the loan amount (payments), and pays income taxes. The relationship of the loan to the IRS is that it would be funded and/or guaranteed by the fed.
There would be other requirements such as it must be owner occupied and a limit of one such loan per taxpayer. There may also be a time limit window of maybe two years for this program. It would be imperative that Borrower Fraud regarding this loan would not be tolerated and immediate repossession, mandatory jail time and fines would be imposed.
Bottom line is that if you can't afford a low interest home loan on your verifiable, taxable income, then maybe you overbought and/or mis-stated your income and home ownership may not be for you.

2008 Mar 31 11:29 AM

[deaverb:]

Don't forget that ARMs of normal payers are going down down down since the cuts. My wife's mortgage went down $621 in March, no small number. It will reset again in March next year and save her another $400 plus. Don't forget that Ben is helping a lot of people current on their mortgages. This is not just a "bailout."

2008 Mar 31 12:01 PM

[gordon:]

Did you know the gov't has hired it's OWN APPRAISERS? Get ready for the collusion, corruption, and sweetheart deals by politicians and their families or those elites well-connected to get their investment properties' loan amounts lowered! What date to value, when every week they are dropping? What recourse do people like me have with our lender? WE ARE FACING HARD TIMES TOO! Self-employed, 20% down, played by the rules, EVERYONE should have the right to protest to our lenders, right? Will these gov't appraisers work in secrecy, not divulging to neighbors of these properties how much the appraised vale was dropped? Think about the ramifications.

2008 Mar 31 12:20 PM

[mallarde:]

Sounds sort of like giving citizenship to those that gamed the system by running across the border, just like these borrowers gamed the system by taking loans they knew they could not afford unless the housing market went their way.

We already subsidized their real estate speculation by giving them tax deductions on their mortgage interest. Now we have to take their losses, too? Outrageous.

2008 Mar 31 12:46 PM

[User 170674:]

"We will avoid a glut of foreclosed homes from coming on the market, further depressing home prices."

This is not the problem, it is the solution. The problem is that houses are overpriced. The markets are seized because home owners won't sell their home at what the market values it at. We need to accept this, allow prices to fall, and move on.

We also need to stop acting as if "homeowner" is a sacred class. I did not think buying a home in 2005 made financial sence. I chose to continue renting. People looking for a bail out now should never have bought and will merely go back to renting as they should have all along. Let's stop acting as if this is an injustice.

2008 Mar 31 02:18 PM

[HangingOnBy...:]

Low interest rates are certainly a good thing. But low interest rates to purchase a declining asset isn't going to incent a tremendous amount of people. A real estate correction is necessary. Any move by the government to prop up prices through any means would equate to fraud in the real markets. And to "vboring", not all bankers and mortgage brokers are white.

2008 Mar 31 04:08 PM

[freddie:]

I don't want to sound cold, but judging by the TV interviews of folk being forclosed or walking, and the few I know here in California that were speculating with no money down deals, I have no sympathy.

The majority went in with eyes open hoping for the bubble to continue and to get out in two to five years with tax advantaged big capital gains. They gambled and lost, tough luck and good luck next time. In any case, the bailout is for the lenders, and if interest rates continue to be lowered, maybe another bubble down the road. I lived in Argentina, a nation in almost perpetual stagflation, and every time the housing bubble busted, it revived again a few years later when other speculative outlets dried up. The Argentines were flipping years before the US bubble. But all you stock market fanatics should look to property price recoveries and rents for the long term (think in 10 year periods) by getting started now. I bought residential and a little industrial in the early 1990s downturn in CA and would be a sad sack today if I had just depended on my gambling in equities for my retirement.

2008 Mar 31 05:08 PM

[buckwheat:]

Oh paleeze - we're where we are for ONE REASON - greedy bankers. Greedy mortgage companies, who's startup numbers we in the 10's of thousands in every state. Every greedy real-estate jerk became a mortgage broker.

These start-up mortgage types skimmed billions off the top of YOUR money, and fed their insatiable appetite by "giving" loans to their maids, gardeners, plumbers, firemen, mayors, policemen and anyone else stupid enough to jump on their greedy-train.

Lenders were glad to throw cash at these mortgage punks. Hey - the gov't backed it up with insurance. The Mortgage Bankers Association threw billions into Congress for new yachts, beach homes, airplanes and the like. As long as their congress-person made foreclosure laws favorable to the lenders. As long as they made laws that fully protected their mortgage investments.

NOOOO - as normal citizens we don't get OUR investments fully 100% insured do we? But they do! They wanted their investments fully funded and they paid the gov't to pass the laws.

They've got their billions, new beachfront villa in the Portugal Algarve, new G5 jet to get around. They bought, manipulated and raped the system. And you paid for it.

"GET OUT! You're a month late" [yahoooo, let's cash in and buy the cigarette boat]

2008 Mar 31 07:47 PM

[wcoastjosh:]

I agree with pretty much most of you guys commenting, and the author of this article is an idiot.... So if we all stop paying on our mortgages, why doesn't the government give us all free equity in our homes? I mean hey its free money right? Whats another $3trillion or so? We are rewarding the financially irresponsible, shouldn't we award the responsible too? Or does government money actually come from somewhere? ITS NOT FREE MONEY PEOPLE!

2008 Apr 01 03:19 AM

[AKJ:]

Everyone gets up in arms about bailouts and the unfair treatment of irresponsible buyers until they start looking at what a wave of foreclosures does to their own property value. Just look at California - that state has more Jumbo mortgages than every other state combined. Very responsible buyers have to finance $500-750k on their first home purchase to get a reasonable home in most cities. If you collectively let everyone in California foreclose who is currently or soon will be in default or delinquent on their mortgage, you will wipe out hundreds of billions of dollars of property value. Whole towns will be abandoned as home values drop below mortgage balances and owners have no incentive to stay current on their loans. Property tax revenue will plummet. Consumer spending will grind to a halt. Personal bankruptcies will skyrocket. City and county governments will start defaulting on their bonds. Insurance companies (mortgage, bond and property) will go under as claims exceed reserves. This is why the Fed is fine bailing out "irresponsible" borrowers - because it saves the system for the rest of us. So boo hoo - you may not get the break your neighbor got. Irresponsible people get government help all the time - the US is fairly frugal on this compared to most Western countries. This would be the least wasteful assistance ever offered. Your home is most likely your most valuable asset - to see it marked down 20-30% in one year because your neighbors went into foreclosure will not make up for the fact that everyone got a fair deal and the US Government spent a few billion less than they could have.

2008 Apr 01 10:47 AM

[ACT:]

We have to understand some basic principals that homes were sold for a 10+ years into the future value in most cases, people had to state an income somewhat of the 10-20 years into the future as well, therefore now we have a Problem. Pay option plans were helping with the so called values to move them up. Unfortunately a $55,000/ year median income doesn't pay a $500,000 median home price with a minimum payment option for very long time. Many homes were financed with pay option type of loans at 100% CLTV and now those people owe way more than what they can afford. Now it is no longer the Subprime issue, the lenders and investors need to face reality. Most of the time the Account Executives suggested we state enough income to get the people qualified, some of my clients wannabe's just turned to someone else who put them into the home they dreamed of just couldn't afford in reality and now those folks are begging me to help them overcome the hardship they face today with the payments. Solutions for this crisis is cutting principal value by 20% on all loans, not considering actual value, not considering where the client will raise the money to pay for the mortgage, and do graduated payment plans over a period of maybe 5 years, starting at 3% below final resting rate, and settle on a fixed rate for the rest of the term. Put some clauses in the loan program calculating for the windfall effect. This may help keep those values higher for times to come. Investors wanted to cash in on the ideas, but the consumers had the lack of education to understand what they actually signed for. Most my clients in trouble today had no understanding or had a hope to be able to refinance and bail out of the kind of loans they've got into. Consumer EDUCATION, EDUCATION, EDUCATION is the answer to most of our problem today. Unfortunately the weak is dragging the rest of them down. I had a prime loan and now my home is worth $250,000 minus because of the bad apples. God Bless Us!

2008 Apr 01 01:07 PM

[Jan:]

That's the largest bunch of blather that I've heard in this whole mess. We are a free market society, that prices risk to determine value. And Yes, we who were good at math and finance will be footing the bill for this rediculas bailout. I for one once lost a home and it taught me a lesson that I'll never forget, don't become over leveraged. They have to loose to learn and this "idea" would keep the much needed lesson from them! NO BAILOUT

2008 Apr 01 01:18 PM

[John Q. Public:]

Most of these comments are good and some others go to show you that knowledge and reason and owning a computer do not go hand-in-hand. Like a friend of mine says, opinions are like a--holes, everybody has one.
Anyway, I retired after 40 years of working, at the end of 2004, the same year I purchased a new house and doubled my mortgage payments. I intend to pay for it with my pension and with my savings and investments. If I fail to do so, I do not expect the government to bail me out. It is a risk that I took upon myself and if I come to the point where I cannot may the payment to keep the house, I will sell it and purchase something smaller that I can afford or rent if I have to. My point is, these are my choices, made with the backing of my money and no one elses. I certainly do not expect the government to step in and bail me out with TAXPAYER money. What is wrong with people? You make the decisions, you reap the benefits........or the disaster. Take responsibility!

2008 Apr 01 01:43 PM

[Hyman:]

This entire idea is just totally absurd. All that is needed here is for the government to compel lenders to extended their initial teaser rate monthly mortgage payments for another 5 years or so. By that time the market will have improved and the homeowners will have a lot more options. This approach would automatically weed out all the speculators and the owners who could not afford to buy and live in these homes to begin with.

2008 Apr 01 02:37 PM

[John Q. Public:]

Hymans idea is the best one that I have heard yet, both personal and from the expert pundits!!

2008 Apr 01 04:08 PM

[Still Renting:]

If I owned a home on which I owed $500k and it had dropped in value to $400k (and the market will be going down for another two to three years, I'm betting), even if my credit rating was over 800, last months payment would be the last one I would make. I would live in it rent free for as long as possible and simply move to a rental when necessary.

I would invest the monthly savings in gold - that I can hold in my hand - and it would be in a safe deposit box. That would be the only gold portion of my portfolio.

Which is worse, bad credit for a relatively short time, or spending the rest of my life paying off a home I could never get out from under? The home loan is a secured loan. The bank gets their "security" in the end.

2008 Apr 01 05:58 PM

[pharma:]

Just because someone Does NOT Want or Can Not make mortgage payments, the loan should be reduced or forgiven? Hell no!

Otherwise, NOBODY in his/her sound state of mind will make any mortgage payment. Just live in a house or a mansion and pay nothing. Foreclosure? What foreclosure? Hillary, Obama and the rest will just outlaw foreclosure.

Do you expect anybody will build a single new house? No way!
Do you think anybody will work? No, what for?
Do you think there will be any food in supermarkets? No.
Will such society last for long? No.

A historical note:
Back in 1917, similar "forgiveness"/anarchy situation took place in Russia. It did not last long. It led to the Bolshevik coup, the civil war, and dictatorship. 25%+ of the entire population were slaughtered and/or starved to death.

2008 Apr 01 11:30 PM

[pharma:]

AKJ,
the only reason why housing prices are going down is because these houses are overpriced regardless of foreclosures or no foreclosures.

If a house is foreclosed and the house is auctioned then someone will buy it for the right/market price.

Do you get it? Or do you think the government must support housing prices? If yes, at what level?

2008 Apr 01 11:58 PM

[FreeMkgGuy:]

NO Bailout. Period. What about responsible individuals who did NOT take out such stupid mortgages? Why punish them? What about people who put 20% down? Do they get a break?

Once prices drop to fair value, there will be buyers. Prices were just unsustainable and it is just prudent to let it take its own course. The government should not get into this. Where were these guys when there was rampant fraud and manipulation going on? 750k mortgage for a strawberry picker with 15k annual income? Do you want to bail them out with your tax dollars?

2008 Apr 03 12:30 AM

[LISTENHERE:]

BUCKWHEAT IS SOOOOO RIGHT ! RICH PEOPLE GETTING RICHER,I DO AGREE THOUGH IF YOU PUT 20% DOWN PAID ON TIME, KEPT ONE PROPERTY,GOOD CREDIT THOSE SHOULD NOT BE PUNISHED WITH THE CRAPPY RATES AND DOWN PAYMENTS NOW IF YOU CAN AFFORD TO HAVE IT.I'M IN VEGAS AND CAN'T BEGIN TO TELL YOU THE STORIES I HEAR. PEOPLE OWNING 7 OR 8 HOMES AND MORE , THEYVE ALREADY FILED BANKRUPTCY SO THEY CAN BE READY FOR ROUND 2 IN TWO YEARS! YOU ALL KNOW ITS GOING TO HAPPEN, IT MIGHT NOT BE FAIR,BUT THE SAME FOLKS THAT MADE THE LOANS,AND MADE UP THESE LOANS WILL MAKE MONEY OVER AND OVER AGAIN ,THE RICH GET RICHER, BELIEVE ME IF THE GOVERMENT BAILS OUT THE LITTLE PEOPLE,IT JUST MEANS SOMETHING EXTRA GREAT FOR THE RICH PEOPLE TO COME. YOU CAN BET THE HOUSE ON THAT!!

2008 Apr 06 11:27 PM

[Luis R:]

I think that the solution is to stop resetting the loans. That is how this hold melt down started. Banks qualified buyers at starting rates either 2/27, 3/27 or 5 year arms. Borrowers in 95% of the cases with the exception of option arms were making at least interest only payments. So the investors are not going to make 9% on the loans and instead they settle for what they originally qualified the borrower lets say 6%. I think that would be a win win situation for all parties involved. The tide of foreclosures would slow down and we could see people stay in their homes. Thanks

2008 Sep 29 03:34 AM