Stopping Counter-Productive Mortgage Mods and Foreclosure Abatements

“The choice we appear to be making is trying to modify our way out of this, which has the effect of lengthening the crisis. We have simply slowed the foreclosure pipeline, with people staying in houses they are ultimately not going to be able to afford anyway.”

-Kevin Katari, managing member of Watershed Asset Management, a San Francisco-based hedge fund


I have some good news and some bad news for you:

The bad news is the $75 billion HAMP program to protect homeowners from foreclosure has been widely pronounced a disappointment. The good news is that more than a few mainstream economists — and even some policy makers — are slowly being recognizing that it has only delayed the inevitable. We may end up with something more functional as a result.

Some of this is discussed in a front page NYT article. It echos what I have been writing for 2 years now — that the mortgage modifications and foreclosure abatements programs are counter-productive.

The $75 billion program Making Home Affordable:

“has lowered mortgage payments on a trial basis for hundreds of thousands of people but has largely failed to provide permanent relief. Critics increasingly argue that the program has raised false hopes among people who simply cannot afford their homes.

As a result, desperate homeowners have sent payments to banks in often-futile efforts to keep their homes, which some see as wasting dollars they could have saved in preparation for moving to cheaper rental residences. Some borrowers have seen their credit tarnished while falsely assuming that loan modifications involved no negative reports to credit agencies.

Some experts argue the program has impeded economic recovery by delaying a wrenching yet cleansing process through which borrowers give up unaffordable homes and banks fully reckon with their disastrous bets on real estate, enabling money to flow more freely through the financial system.

Mr. Katari contends that banks have been using temporary loan modifications under the Obama plan as justification to avoid an honest accounting of the mortgage losses still on their books. Only after banks are forced to acknowledge losses and the real estate market absorbs a now pent-up surge of foreclosed properties will housing prices drop to levels at which enough Americans can afford to buy, he argues.” (emphasis added)

That sums up the situation perfectly. I am a “rip-off-the-band-aid-quickly” kinda guy, and what we are doing instead is peeling it off as slowly as possible, lengthening the pain, while only delaying the inevitable.

As we have long argued, national home prices remain too elevated for a healthy real estate market; The cheaper properties — primarily distressed units, foreclosures and short sales — are what is driving the bulk of real estate transactions today.

Why so few get this is simply astounding.

Prices should be allow to normalize through ordinary foreclosure processes. Banks should be compelled to write down bad mortgages. Underwater borrowers should be given the option of a cram-down or a foreclosure.  I favor sharing the write-down between the borrower and lender, with a zero interest, 10 year balloon payment for a chunk of the write down (A modified version of our 30/20/10 proposal).

For more details, I have to go to chapter 21 of Bailout Nation, titled The Virtues of Foreclosure:

“It’s not that people are unwilling to buy real estate in the United States; it’s that buyers are now unwilling to over pay.

And therein lies the heart of the problem with most rescue plans. They are designed to prevent the continued downward spiral of the housing market, which unfortunately is precisely what is needed. The artificial demand of the ultralow rates and lax lending standards sent prices to unsustainable levels, and put millions of people into homes they could not afford. The markets are correcting these excesses as people trade out of those homes. It is a classic unwind of a bubble.

In much of the country, home prices remain too high, and the over priced homes are not moving. That’s reflected in the huge inventory overhang of unsold homes. (See Figure 21.4.) And the inventory data of homes for sale does not include the shadow inventory—all of the homes purchased as investments, by flippers, as second homes, or as rental units. These owners are waiting in the shadows for the opportunity to get rid of their properties. Any improvement in the real estate market is likely to bring forth this additional supply.

Until prices revert back toward historical nor ms, the excess inventory will not be removed, the foreclosures will not stop, and the total sales will remain depressed. The sooner Washington, D.C., figures this out, the better off the economy and U.S. homeowners will be.”

The healthiest thing we could do would be to:

1. Allow foreclosures to proceed normally;

2. stop subsidizing purchases at elevated prices;

3. force banks to take writedowns of bad loans;

4. do a “shared pain” cramdown where both the borrower and lender split the loss  of an underwater mortgage, replacing the old original loan with something more sustainable.

We could also bring rates to more reasonable levels — say 2% from 0% — to further stop the subsidy and normalize prices. I am less confident this is likely anytime soon.


Fixing Housing & Finance: 30/20/10 Proposal (September 22nd, 2008)

$15,000 Home Buyers Credit Costs $292,000/home (October 22nd, 2009)

U.S. Loan Effort Is Seen as Adding to Housing Woes
NYT, January 1, 2010

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