A Self-Serving Non-Solution to Negative Equity in America

Wilbur Ross, US's second largest servicer of subprime mortgages via acquiring American Home Mortgage and Option One, has a self serving non-solution to negative home equity.

Inquiring minds may wish to consider A positive solution to negative equity in America.

The US federal government has tried to stabilise residential real estate, but nationwide prices have dropped by 13 per cent in the past 12 months. Analysts have forecast that by June 30, 10.6m families will have either no equity in their homes or a negative equity.

This problem seems likely to become more severe. The solutions proposed so far have been directed mainly towards helping delinquent borrowers avoid foreclosure, but the incentives have been weak. Remedies are needed to reduce delinquent mortgages to present property values, provide lenders with possible future recovery of the amounts by which they discounted their loans, restore mortgage lender liquidity and make mortgages available for future home buyers.

My Comment: Wilbur Ross does not accurately state the problem. He only states his problem which seems to be the acquisition of American Home Mortgage and Option One. The real problem in the US is that home prices are still too high and those prices need to come down, not propped up by self serving bailouts.

Many lenders would reduce the principal amount of troubled loans to the present value of the house if they could liquefy part of the loan and share in the eventual upturn in property values. To provide some liquidity, the Federal Housing Administration, the government insurer for low-income housing, should be authorised to guarantee $1 of existing troubled mortgages on primary residences for each $1 forgiven by the lender. The lender would be able to resell the guaranteed portion of its principal amount.

The FHA would receive an insurance premium, as it already does on other mortgages, and on the first resale of the home would receive the lesser of 25 per cent of the gain or the amount it guaranteed. The total of the premiums and appreciation on some sales would more than offset losses on foreclosed homes. The FHA would require that government-approved appraisers confirm the house's market value. Also, if there were a shortfall on foreclosure and resale, the FHA would not pay a lump sum but instead make the payments when originally due. Therefore, at worst the FHA's payments would be spread over many years and the FHA's risk would decline whenever the borrower made payments.

My Comment: Ross's solution is to bailout Ross and spread the risk to taxpayers over a number of years.

Lenders would be able to sell the guaranteed portion of the loan, thereby restoring their liquidity. Lenders also would receive on the first resale of the home the lesser of 25 per cent of the gain or the amount forgiven. This would enable them to recapture some of the principal amount they forgave, thereby providing them with an incentive to restructure the mortgage rather than foreclose. Appreciation sharing would not carry over to the next owner, but qualified home purchasers would be able to assume these favourable mortgages. Thus the resale market for these properties would be largely self-financing for several years and this would stabilise or improve property values. Meanwhile the original borrower would retain 50 per cent or more of the appreciation on a property that otherwise would have been foreclosed. It would be unreasonable for home-owners to expect a totally free ride on concessions granted by lenders, but retaining half of the upside would motivate the homeowner to make monthly payments even though there initially would be no equity value.

My Comment: What's unreasonable is to expect those not in trouble to bail out those in trouble. As taxpayer I do not want to have the FHA bail out anyone. In fact, I want the FHA to be abolished before more hair brained schemes like Ross's are considered. Imagine having a $400,000 mortgage but your neighbor in the identical house down the road has a $250,000 mortgage. Guess what Ross's proposal does? It is begging for all loans to become troubled. Besides, many borrowers are better off walking away where they would have 100% of any future appreciation.

If a mortgage had been $180,000 against an original home value of $200,000 and the loan were now reduced to $160,000, the lender would have lost $20,000. If the home later were sold at its original $200,000 value, the lender would have recovered $10,000, or half of the concession. The FHA would have gained $10,000 and the homeowner would have made $20,000, thereby restoring his original equity position.

This co-operation between public and private sectors would provide both lenders and borrowers with a rational, incentivised alternative to foreclosure.

My Comment: The public sector has no business promoting housing, bailing out housing, or being involved in housing to the likes of what Ross is proposing. Such bailouts are a moral hazard and it was government meddling that created this mess in the first place. With that in mind GSEs should be abolished as well, and the "ownership society" should be put on the scrap heap of history's bad ideas.

The government's present voluntary plan of restructuring brings neither added incentives to the lender nor liquidity to the mortgage market. This FHA-based plan would do both. Lenders and borrowers would negotiate interest and repayment terms without government intervention and existing servicers would continue to service the loan. All parties would benefit from stabilisation of housing markets.

My Comment: There should not be a government plan, period. But Ross proposes a plan then states that "Lenders and borrowers would negotiate interest and repayment terms without government intervention". That is of course nonsense. The plan itself is government intervention, and as noted above encourages more people to stop paying their mortgages.

Most important, the process would be voluntary and therefore would not chill the willingness of lenders to make loans in the future. In contrast, the proposed remedies incentivise all parties to negotiate but do not create moral hazard by bailing out reckless lenders or borrowers. The lenders will write down their loans and borrowers initially will lose their original equity. Both will have a chance to recoup and substantial liquidity will be brought back to the mortgage market.

I am disgusted with this self serving bailout proposal by the person who would benefit most: Wilbur Ross. Here is the key phrase: "existing servicers would continue to service the loan." Ross is asking for a bailout of Ross. No one else wins regardless of how much he tries to sugar coat it otherwise. The plan simply has too many flaws.

Mike Morgan's Take

Mike Morgan at Morgan Florida agrees. His article is Wilbur Ross ... "Bail Me Out". Here are a few snips:

Mr. Ross proposes that the FHA guarantee dollar for dollar existing troubled mortgages on primary residences for each dollar forgiven by the lender. And the lender should be able to resell the guaranteed portion of its principal amount. This is absolutely ludicrous. He’s asking for a back-door bail out because he bought what he thought was a bargain. He is now acting no differently than the flippers that bought homes to flip. Instead of pre-construction condos, he bought pools of mortgages to service and flip. So please tell me why taxpayers should have any part in the bail out of Mr. Ross?

I love the part where Mr. Ross downplays the risk to the FHA, when he points out the FHA’s payments on losers would be spread over many years. Big deal. A loss is a loss is a loss. But here we go again trying to creatively hide the loss and give it a little coating of syrup.

Let me bring Mr. Ross around to one other issue in his proposed bail out of his reputation and wallet. His plan is for primary residences only. I get calls from people every week that are losing their primary residences because they bought a dozen condos in Florida, Arizona and Vegas. I get calls from people every week that bought primary residences they couldn’t afford in the first place. I get calls from people every week that used their primary residence like an ATM to buy third cars, vacations, ,jet skis, boats, and you name it.

What’s wrong with America? LOA - Lack Of Accountability. Mr. Ross, in all due respect, you need to take your medicine just like everyone else. C’est la vie Mr. Ross.

Comments

[notsosmart:]

this particular problem-greed & self serving,is going to end this country & capitalism.no,im not a socialist or communist but a realist.take the money &run mentality & to hell with everyone else is the prevailing theme. honest ethical people(unless already wealthy) are the losers.

2008 May 23 08:42 AM

[dectra:]

Christ, you're a hard hearted son of a bitch. Can't wait until you or a member of your family looses a job, and then their home.....

You need to realize, this isn't ALL about speculators. If you really want to start pointing fingers, start with the mortgage and banking industries that promoted these half assed loans to folks.

2008 May 23 09:34 AM

[Jon Smirl:]

Forget all of these complicated bail-out plans. If the government really wants to help a simple solution with no moral hazard is to allow the deduction of 150%-200% of interest PAID (not accrued) on pre-existing loans for a limited amount of time. This would incentivize people to continue making their payments and give the market a chance to stabilize. Several years of inflation will erase a lot of negative equity.

It is trivially simple for the government to implement a plan like this.

2008 May 23 09:38 AM

[DCM:]

Mr. Shedlock, your attitude is as self-serving as Mr. Ross’s! You don’t want to make any sacrifice for someone else’s misfortune. If someone else got screwed over, that’s their problem; they should have known better. If someone is homeless, well, they deserve to be; all they need to do is get a good job. If some child goes hungry – tough luck, their parents should be better providers. We can go on and on but at the end of the day, it’s all about the haves and the have nots.

Given this popular self-serving mentality found in America today, it comes as no surprise that any solution to this uniquely profound mess were in, will always meet resistance from the haves. To quote Shedlock, “The real problem in the US is that home prices are still too high and those prices need to come down, not propped up by self serving bailouts.” Mr. Ross’s solution may be self-serving but it may also serve the needs of millions of Americans. I think there is a better solution but to denounce it because it is self-serving is irresponsible. You would think it would be clear by now, that if a solution is not found for this unprecedented economic fiasco, the fallout is going to grow even more painful and become more protracted. Letting the market work it out and not doing anything for millions of Americans is totally irresponsible. If this market is left to work itself out, the damage is going to be a hundred times more horrific than Katrina.

Mr. Shedlock, I have for you and your ilk, the same disgust as you do for the “self-serving” Mr. Ross. You’re just as self-serving! You oppose a taxpayer bailout. “What's unreasonable is to expect those not in trouble to bail out those in trouble.” I would suggest that this country is in great economic trouble and it is affecting most Americans. All too many people have this attitude of protecting their own at the expense of all others. Since Katrina, the attitude of most in the country is that “those people” had no business building homes below sea level, and they should not expect to be bailed out because they did not have insurance to cover their loss. The attitude of it's their problem, don't look to me for help only pushes more people into economic distress which the taxpayer ultimately pays for.

I hope baby boomers nearing retirement are paying close attention to the self-serving attitudes of Mr. Shedlock and his kind. For most of you, your primary retirement nest egg is evaporating by the minute. “Analysts have forecast that by June 30, 10.6m families will have either no equity in their homes or a negative equity.” This is an alarming statistic given that about 70% of the 80 million families in America own a home and that this situation is forecasted to get much worse. We could have one in four families with no or negative equity in their homes. What about the people that lost only 50 to 100% of their equity? For those of you in your 20’s, 30’s or even 40’s, a 50% to 100% decrease in equity may seem like no big deal as there will be time to recover. However, how can you assume that prices will bounce back? Is it because they have before? Our country has never experienced an economy like today’s nor a housing bubble of this magnitude. All the circumstances that led us to this point have never been experienced before. As long as we have more homes than buyers, mortgage debt greater than home values, and an illiquid marketplace, it is hard to imagine how home values could increase across the board until these dynamics change.

Maybe Mr. Ross’s solution is the wrong one but it is not wrong because it is self-serving. The wealth in this country has never been more disproportionate. The people who benefited from the housing bubble (investors, lenders, builders, and all the ancillary real estate actors) are not being held accountable for their greedy and self-serving actions. Punishing people foolish enough to pursue the dream of homeownership and those gawd awful small time home flippers is not the answer. You keep pushing these people lower on the food chain and I promise you, the taxpayer's bill will only go up. The government needs to step in and take steps to reallocate wealth in America because our free market capitalism is darn sure not going to do it.

2008 May 23 11:21 AM

[Tom Lindmark:]

Wow you sure stirred up some people. Good job calling out Ross. Now go after Bill Gross.

2008 May 23 11:36 AM

[bill d:]

What a bunch of whiny ass cry babies. Welcome to the real world of reality, financial resposibility and common sense.
I've worked hard for everything I have - why in the hell should I be expected to bail out anyone because they were basically stupid, gullible, greedy, etc.
I never bought anything I couldn't afford and I worked until I could.
In the early days I saved until I could pay cash.
And you can bet your ass I was making a hell of a lot less money then any of you and all the "poor" idiots that that they were getting something for nothing.
If their poor kids are starving in this country I'll bet they haven't given up theri dope, booze or cars.
Let nature remove them from the gene pool - they won't be missed.
How's that for a hard hearted son of a bitch ?
And I probably donate as much or more to charity than most of you and if someone truly in need of help I don't hesitate.

2008 May 23 04:52 PM

[User 30121:]

Wow! Where do I begin. What I have to say (relevent, I think, to this article and subsequent comments) is only intended for information. If it offends any of you, so be it! Maybe you NEED to be offended.

I am one LUCKY person, because I realized JUST IN TIME that I had made a TERRIBLE mistake after I purchased my home. The lender (Countrywide) whom I have cursed every day since, did what that ilk does...prey on a well-intentioned home buyer that doesn't know ALL THERE IS TO KNOW about buying a home.

I got educated real quick when it looked like I was losing my home in WEEKS thanks to the Countrywide folks who ASSURED me I would be fine!

As I write this, my house is still mine, and things now are looking good. (Value-wise, I've lost about 120K, but that will be rectified...in time.)

What Mish says, makes ABSOLUTE sense. I didn't expect anyone to bail me out. I've lived MANY DECADES. No government, big business, rich individual ever gave me anything. Why expect it now? Hell, the only bail out that EVER occurred was for the Ross' of the world. Not Joe Citizen. The have nots are in that class for a reason. We just have to be diligent in making our way. The haves are going to be okay.


As for the sour grapes comments, well, if you KNEW BETTER and now you are HURTING, you got what you deserved! If you didn't know better, like me, you fix it by burning the midnight oil and rolling up your sleeves. Looking over your shoulder for help is NEVER the answer. Oh, it may come, but don't CURSE if it doesn't.

The government is not the answer to solve ANYTHING....never was.....never will be. I can speak from experience...41 years of it!

The LAST thing you want, is for the govenment to "help" you. Because if it does, you (or your future generations) will surely pay DEARLY for it.

F@#K Ross and his ilk. Mish you are RIGHT! You MOANERS start rolling up your sleeves!

2008 May 23 07:09 PM

[johngonole:]

DCM endorses the idea that "if its not my fault I can't pay my mortgage" then I should be entitlted to have others pay for met to stay in the house I don't own in the first place. There are way too many people like DCM who thing once they get a mortgage on a house they actually own the house. Actually the house is fractionally owned by bank and the borrower. Of course the borrower only owns the house to the extent of the downpayment etc... The loans in trouble, the loans the banks are afraid people are going to walk away from are primarily owned by those whom have no equity in their houses. The bail out schemes are an attempt to bail out the banks using taxpayer monies. Those POOOOR greeeeedy idiots who might get foreclosed on still won't have any equity in thier home. So as a taxpayer I say why should I provide funding to prop up the banks while we wait for the inevitable foreclosure. Lets just get on with it. Home prices are way to high. They will fall and thier isn't anything the government or the banks can do about it that won't in the end make things much worse.

2008 May 24 01:58 AM

[johngonole:]

DCM - I beg you to leave this country and go to one that redistributes wealth. Once we give the power to goverment to decide who is entitlted to what they sure as heck will do it. Do you really think those in power are going to give it to you. No they usually give it to political party member affiliates, the military who backs thier new found power, and just enough others to try to avoid revolution. Oh yeah and sometimes they just cut food supplies off to a subset of society to accomplish the same thing.

Also your analysis is way off. The only people that are going to end up negative equity had to have purchased a home over the last 2-3 years. Those usually are not the retired persons who got into their first homes in the 60's or 70's when homes cost like $30,000. If they are negative equity tough.

How does getting forced out of a home you don't own hurt you. Move out and rent an apartment. The rent you pay on an apartment will probably be less than on the house. You'll be better off than sucking the life out of those who are actually trying to make it honestly.

DCM arguments aren't really about helping people. The arguments are bout the idea that everyone deserves the same piece of the pie. I suppose I shouldn't have bothered getting that engineering degree. I suppose the guy around the corner busting his ass working his way through college is just waisting his time. We should all slack off, sleep through 12 years of taxpayer paid for education, and all go out and live in our cheap asbestos lined trailers. Cause if we all slack off that is all each of us in society will be able to afford.

DCM I beg you and all you types to just leave the country and go to one of those great Russian, China, or European countries where they implement the policies you seek to implement. Please leave before you and all that think like you drag the rest of us and this country down.

The truth is this country needs to stop spending all its capital on goods and services that evaporate. We need to work hard live within our means, and take advantage of the public education system. Our government has done about all in can do to allow everyone an equal shot at pursuing happiness. Anything more and we travel down the slippery slope into tyranny

2008 May 24 02:22 AM

[jjason:]

I agree with Mish. In 1974 I bought a home in CT. for $95,900.00. In 1989 the home was worth about $300,000. In 1991 the home was worth $222,000 ( so said the town's assessor for tax purposes). I appraised the house myself for $180,000 in June of 1991.

As a certified general appraiser I worked for the FDIC and appraised foreclosed real estate for three years (1990 to 1993). There were a lot of people and businesses who lost a lot of money in real estate. (Remember the S&L crisis?).

Here is what I learned from my experience:

1. Don't loan more than 80% of the fair market value of the home.
2. Ask the lender for the appraisal. Then read the appraisal. If you do not understand the appraisal then find someone who does.
3. If the appraisal was properly done then READ THE LOAN DOCUMENTS BEFORE YOU SIGN THE MORTGAGE PAPERS. If the mortgage is not clear, and if terms were changed WALK AWAY FROM THE SALE.
4. NEVER,NEVER,NEVER take out a 2nd mortgage or 3rd mortgage or home equity loan. Don't take on more debt than you can afford.
5. Everyone who does 1 through 4 ends up paying for those who do not follow 1 through 4.

Some folks will pay more than others. It's called inflation, higher taxes, more national debt, more expensive financing (if you can get it), and a decreased standard of living for the middle class.

Finally, from about 1990 to 1993 those folks with cash who could read an appraisal or who could place a value on real property themselves ( like lawyers or real estate brokers) bought real estate cheap. Just like they are doing now in certain markets like FL., AZ, NV or Ca.

2008 May 26 08:50 AM

[jjason:]

I agree with Mish. In 1974 I bought a home in CT. for $95,900.00. In 1989 the home was worth about $300,000. In 1991 the home was worth $222,000 ( so said the town's assessor for tax purposes). I appraised the house myself for $180,000 in June of 1991.

As a certified general appraiser I worked for the FDIC and appraised foreclosed real estate for three years (1990 to 1993). There were a lot of people and businesses who lost a lot of money in real estate. (Remember the S&L crisis?).

Here is what I learned from my experience:

1. Don't loan more than 80% of the fair market value of the home.
2. Ask the lender for the appraisal. Then read the appraisal. If you do not understand the appraisal then find someone who does.
3. If the appraisal was properly done then READ THE LOAN DOCUMENTS BEFORE YOU SIGN THE MORTGAGE PAPERS. If the mortgage is not clear, and if terms were changed WALK AWAY FROM THE SALE.
4. NEVER,NEVER,NEVER take out a 2nd mortgage or 3rd mortgage or home equity loan. Don't take on more debt than you can afford.
5. Everyone who does 1 through 4 ends up paying for those who do not follow 1 through 4.

Some folks will pay more than others. It's called inflation, higher taxes, more national debt, more expensive financing (if you can get it), and a decreased standard of living for the middle class.

Finally, from about 1990 to 1993 those folks with cash who could read an appraisal or who could place a value on real property themselves ( like lawyers or real estate brokers) bought real estate cheap. Just like they are doing now in certain markets like FL., AZ, NV or Ca.

2008 May 26 08:50 AM

[jjason:]

Sorry for the double post.

2008 May 26 08:53 AM