To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. If everyone eligible participated, the one-time cost would be under $350 billion. Here’s how such a policy might work:
If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. For the millions of underwater mortgages that are held by Fannie Mae and Freddie Mac, the government would just be paying itself. And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home. This would all be voluntary.
Here is more.
Picking up (even half) the tab for bank mortgage losses would not pass a popular referendum these days. Besides, surely a stunt like this would require unbundling all the MBSs. And, to boot, we get a new govt bureaucracy to administer it all.
No, thanks. Count me out of this ivory tower proposal.
I would accept principle adjustment for homes at or around local average home value (not for people who bought 3500 sq ft mcmansions) WITHOUT full recourse if the government would claw back bank CEO and mortgage broker ill gotten wealth. Or just identify them and audit them via IRS, the slime probably cheated on taxes during those years, too–Get ‘em that way. But make them suffer like the average joe who just ill timed a diseased housing market or at least not prosper.
what about the average joe bankers who just ill timed a diseased mortgage backed securities market?
princiPAL
Let prices fall. The cheaper housing is the better.
+1
Check-plus.
I didn’t need another reason to not read the moronic NYT.
Yeah! Local governments could lower property taxes, too, and insurance companies . . .
House prices must fall for certain market to clear from the bubble.
The delinquents are concentrated in AZ, CA, FL, IL, MI, NV.
What about us idiots that paid our loans?
The government aided and abetted the massive housing bubble and now Marty Feldman’s (the actor is smarter) cousin wants to compound it.
Besides, he’d give the paying a windfall and defaulters are living rent free for years it takes to foreclose and they won’t do it.
The single biggest factor keeping housing prices from clearing at market rates are mortgages written for much higher than the house is now worth. That forces everyone (And I do mean everyone– buyers, sellers, lenders, tax authorities, insurers) to pretend that the house is worth what is owed on it.
What if the mortgage was recourse already, like many are? Even in a no-recourse state like California that only applies to original purchase mortgages, not refis.
Most of the time it is not worth doing a judicial foreclosure just to be able to get a deficiency judgment against a broke homeowner. Even on a refi most banks will do a non-judicial foreclosure, and forfeit the deficiency.
We have to stop trying to prop up bubbles. Let house prices go to a level that’s affordable.
Propping up bubbles provides very large opportunities for graft within our political class.
Won’t anybody think of the political class?!?!?!?
What is Feldstein’s basis for saying that most loans are nonrecourse? Only a handful of states have really strong anti-deficiency statues. Just he just mean that most people are judgment-proof, because they have no significant assets other than their homes? I’m not sure that’s true.
Good point. Even if most people are judgment proof, his proposal could not make the loans recourse for those people– absent making them non-dischargeable in bankruptcy.
Even making a debt non-dischargeable cannot create recourse out of thin air when the borrower has no significant assets and is income-constrained.
Propping up prices? Why not just repeal the law of gravity?
Why do people see this as an attempt to prop up housing prices?
I would have thought the intent was the opposite — making it easier for underwater home owners to sell their houses are current market prices.
Because current market prices aren’t the bottom of the bubble.
Opening with the phrase “To halt the fall in house prices,” would be kind of disingenuous if the intent wasn’t to prop up prices.
I read this article today and I was dumbfounded by it. Why should taxpayers continue to subsidize the housing market? “Under $350 billion.” Thats a great line, he makes it sound like a drop in the bucket!
I’m 31 years old and until 2008 I was told by every home-owner that I was an idiot for not buying a house. They all said I was throwing money away. And now this guy is suggesting that my tax money is going to literally be thrown away by bailing them out.
Am I crazy? I think they should shut down Fannie Mae and Freddie Mac. Recent studies show that the benefits of homeownership are dubious at best…
Now would be a good time to buy. If you are going to be forced [through wasteful spending] to throw away your money, you might as well get the property in return.
“Buy when there is blood on the streets …”
You could do something in the form of an exchange, however, with less cost and possibly no subsidy: government refinance at low rate with a waiver of cap gains exclusion upon the sale of the house. Govt recovers later when seller resells and pays taxes on the gain.
That sounds fair.
This would seem to help the homeowners who least need the help and do nothing for those who need the most.
Let’s say you’re a homeowner with a good, stable job with a house which is now underwater, but it’s likely the housing market in your area is likely to come back. Then you’d take this deal. You’d significantly cut your mortgage and you don’t have much risk of defaulting and just a few years of real estate appreciation would leave you no longer underwater. However, that is exactly the person who is least likely to default on their mortgage in the first place.
On the other hand if you’re out of a job or think you’re likely to lose your job and the housing market in you’re area isn’t going to come back soon, you definitely wouldn’t take this deal. If you lose your job for an extended period foreclosure is likely going to happen no matter by how much the house is underwater, but now you can’t walk away.
If you think you’re in category 1 when you’re in category 2, this will screw you completely. This will give the banks who made poor lending decisions a bunch of money, give to people who really don’t need help some free money , and at best do nothing for people who need help and at worst allow the banks to seize a large fraction of their assets.
Category 1 is at risk for strategic default. Think about it. If your house is now worth 20% less than when you purchased it, people call it a business cycle. You should be okay in a few years. If it is worth 50% less, that is a business “cyclone” caused by greedy bastards in banking, mortgages and real estate. You’ll never recover.
It is like a fire or tornado, but no insurance. That is why Robert Shiller of the case/Shiller index wants us to basically “short” our housing markets when we buy houses so we don’t get ruined by a business cyclone. MIP just insures the bank.
Of course, limits should be in place. I don’t want to subsidise someone in a nicer home than me. There is a kid in my daughter’s HS band who is getting free private lessons because her parents won’t pay and their house is newer and bigger than ours.
Let the strategic defaults happen. Its called an efficient breach of contract.
Would the economic impact be equal to just taking $350b and distributing it to all tax paying citizens?
Or putting it in a pile and setting it on fire?
About $3500 per household. Last time we got 2k in 2001 or 2002 I just put it in the bank but my neighbor put a patio around her pool. For those that need it it isn’t enough, and for those that don’t they either save it or buy something they would have bought next year anyway.
Specifically, would you personally take $1200 for every person in your family and contribute it to pay for this plan? I wouldn’t pay $10 towards this plan.
Somehow I think if policy idiocies like this were proposed that way instead of as “under $350 Billion”, people would be a little more resistant.
For the record, the “housing crisis” will be over as soon as people start selling at market prices. The government can only get in the way of that.
Gargantuan nonsense.
“If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half.”
The losses have already happened, have already been realised. Tried pricing mortgage bonds recently?
Bondholders, who have already realised huge losses, should renegotiate the mortgage principal. Still cheaper than repossessions and defaults, no?
Why would the borrower sign up for this? Why would he agree to recourse when strategic default remains an option? And how would Feldstein accomplish the necessary changes to various state laws to allow for this?
And why would the banks agree to this? For any loan that is still performing, especially at this stage of the process, wouldn’t the bank place significant value on the possibility that the homeowner will continue to pay the full price? Would the hope that the borrow has other assets that would make up the difference be enough?
Finally, how does 110% help? The homeowner still can’t sell the house at a price that repays his mortgage, thus the housing market doesn’t get unstuck.
I don’t mean to be critical, and I’d like something to be done, but this doesn’t sound like it would work to me.
I agree. 110% is a disaster. 100% is a disaster which is why we’re in a disaster. It costs 10% to sell a house. That is why a 10% down payment is essential. So if someone takes a full recourse loan for 110% of market value and loses a job or gets cancer they are screwed big time at a time when they need all the breaks they can get.
I like the capital gains on any future gains.
My spidey sense is tingling that this is a contrarian indicator, house prices have stopped falling, transaction volume is picking up, and will continue to do so if we don’t get another financial crisis and economic air pocket.
that is a mighty ‘if’
“just be paying itself” is a little misleading. If you owe me $10, and I agree reduce the debt to $5, am i “just paying myself”?
Even worse, the GSEs have promised to pay full principal and interest on all the securities they sell, guaranteed. So any decrease in mortgage principal still has to be paid out in full to the securities market. The government would be very directly paying money not remotely to itself, but straight out into the mortgage backed securities market.
We got to stop with these convoluted schemes and just let prices fall. Yes, we will have more foreclosures and that is the price to pay for all the irresponsible behavior we had during the time where people thought the laws of economics did not apply anymore. No one was forced into a mortgage. I remember when I bought my house, the real estate guy really tried to convince me to go for a bigger house. I just said no. How about all the people who paid off their mortgage? Are we going to continue with these imoral policies just because we think it *might* help the economy overall?
We should be using our time to think about new productive ways to get out of this mess. Let’s stop with all the nonsense.
I have never understood why a variation of this, the Shared Appreciation Loan modification is never seriously considered. Homeowners would get reductions in principal, reductions in interest and agree to pay for that with part of the equity proceeds upon sale.
No matter how underwater a mortgage is, eventually it will be above water as it is paid off. For a homeowner who wishes to stay in the house for a long period of time but cannot afford the payments this would seem to be an effective solution. The homeownder does not get a free ride, the house stays out of foreclosure and off the market and everyone benefits.
Maybe that’s the problem, it’s too good of a solution.
One problem with that (and with that as well as Feldstein’s proposal) is the issue of you do valuations. Absent a market price for the house valuations are likely to be a source of significant disagreement between buyer and lender because with each proposal so much is riding on the valuation.
With the shared appreciation mortgage, the borrower has an incentive to enagage in sham sale (or at least insufficient incentives to maximize the value of the house when sold) so as to minimize the gain shared with the lender– while receiving some other compensation that the lender never sees.
Admittedly these problems are not as bad as those under Feldtein’s proposal where borrower’s have a huge incentive to undervalue their homes in order to maximize debt forgiveness.
“No matter how underwater a mortgage is, eventually it will be above water as it is paid off.” This is not true if you factor in interest. When you consider interest, it is certainly possible to have a payment plan where the mortgage is *never* above water, and, in fact, only gets deeper as time goes on.
Add in taxes, depreciation, insurance and maintenance and it’s pretty clear the “dream” of home ownership is just a marketing ploy.
Houses are durable consumer goods. Only the land is an asset. But there’s land in Detroit they can’t even give away.
If we did this it would have a deflationary effect (I know, that’s the point) that would drag other houses values down and possibly into compliance. I invest in real estate (REOs, short sales, etc) and advice and have friends that do like wise. We underwrite our deals very conservatively and I still feel like it can be like catching a falling knife.
Something needs to be done to force liquidity into the market. I think now that BofA has come to some semblance of an agreement with the states attorneys general, some of the back up will start to come through the foreclosure pipeline. It’s real specific to small markets, too. Some markets have gone through their worst and are not subject to anything but the biggest macro shocks. Other markets (I’m betting in places like NV and CA) could be in for another ride down.
Any kind of non-conforming property (think a single condo in a 3-flat with no home owners association) sells very, very cheaply and for cash only (because no one will give a loan on it. That worries me, because even taking into account the risk priced into that price, I tend to believe cash-only price and cash-or-loan-enduser prices will converge over time.
crazy times
My place is 80k underwater. I don’t want reduction in principle on the taxpayer’s dime, but I do want to refinance at the current rates. I have a 30 year fixed at 6.625. I’d love to shave off a few points. I figure that we the taxpayers have already paid enough to the banks for them to endure the write down of their future profits. This would allow me to pay down my mortgage sooner.
I’d love to shave a few points off my student loans. A lot of people would love to shave some points off their credit cards.
Point taken. However, the banks got trillions of taxpayer money to fix the mortgage not the student loan/credit card issue. And they haven’t.
Any set of rules for fixing house prices will be flawed, let’s just appoint a board of economic experts to take a lot of the market factors into account and have them decide what is best.
Those who bought homes or refinanced to the limit during the housing bubble were the primary contributors to the economic downturn. They are the ones who kept the bubble going and growing. Lenders were secondary contributors through their stupidity in making loans. Their shareholders took huge “haircuts” – in the 90+% range for some of the big banks.
Now someone wants to bail out those who bought into the housing bubble as a can’t miss investment? Insane.
If one feels the need to throw money at housing (I don’t), why not provide subsidies to those who stayed out of the housing market after it got too frothy and now want to buy one of the forclosed houses at more reasonable prices?
They should give that $350 to all of us who bought homes we could afford, and managed to pay our mortgages. I’d really like a garage, bigger yard, and to not be in a townhouse anymore. Why exactly do I have to pay for my neighbor who refinanced 3 times during the bubble?
“And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home.” So we’re going to put DOJ, the federal courts, and the federal marshal service into the foreclosure and eviction business? Even if that were a good idea — and it isn’t — there’s no way it could work politically.
Here’s my alternative suggestion. My adjustable rate mortgage just dropped to 2 1/8% (Yeah, 2 1/8%!). We’ve been with the same company, well, was Countrywide, now B of A for 17 years. I say have all those loans with Fannie Mae and Freddie Mac lower their % to 0% for the next 2 years. All payments go towards principal, then change the % to 2 points over the Fed rate for another 2 years. See how many families can afford to stay in their homes under those circumstances. Save on foreclosure. See if the market won’t stabilize and let local governments collect property taxes. The middle class is choking on debt right now. Add in 9%+ unemployment and the economy isn’t going anywhere. Aggregate demand will continue to be stinko until the middle class gets some relief.
What relief do you propose to give to those who did not purchase houses they could not afford?
They can have a kick in the balls and a deduction in pay for not thinking like a proper American.
Huh? Those people do need any relief. Your post reeks of the politics of envy. If a hurricane hits Florida or an earthquake hits California would you complain that the disaster victims were getting relief why you (in, say, Minnesota) were getting nothing?
A hurricane and an earthquake are unforeseen events. Buying a house with a payment of 35% of your income with no or little down payment is risky behavior. Many people chose this path, while many others (myself included) chose to buy a smaller house than we could afford and saved up and made a large down payment.
So this plan smacks of taking money from the people who took little risk and giving it too those who took a large risk.
>the government could go after the borrower’s other assets if he defaulted on the home.
Yeah, right. Unless there’s an election coming up, which there always is. In that case, the government does not want to appear mean, especially if you are a member of the Protected Class. So, hey, just take some more time! The taxpayers can always cover for you while you sort things out!
Government paying itself, huh?
Why do I suspect that the payments to the GSEs will be counted as revenue and the writedowns not counted as an expenditure?
Aside from that, it’s idiotic to reward the stupidest 1% of borrowers in the crisis at the expense of the other 99% of taxpayers.
But I guess Obama needs Nevada, Florida, and Michigan to win the election, and there’s an Arizona senate seat up for grabs.
If the intent is to avoid a wave of strategic defaults, wouldn’t it be a better idea to simply address the problem of strategic default?
I’m Canadian, so I don’t know the mortgage laws in the states. What happens if you walk away from a house that’s underwater? The bank just gets the house, and that’s it? Does the mortgage holder have to go through bankruptcy to get out of the liability?
If not, how about just recognizing strategic default as a special case of default, and change the rules to punish people who do it? Do something equivalent to bankruptcy – if they have assets, they must be disposed of to make up the difference between the market value of the house and the outstanding principle. The truly broke who have lost their jobs and can’t afford the payments get a waiver. A person with a decent job or who otherwise has a demonstrated ability to pay the mortgage, but who walks away anyway, gets nailed with the underwater part of the mortgage plus 10% of the value of the principle, to cover the bank’s transaction costs.
There have to be other remedies that can be used to curb that behavior.
Just brainstorming here, but would there be a way to isolate house-flippers who profited from the housing boom, but now want to walk away from the last house they can’t flip? Perhaps make anyone who has purchased more than two homes in the past 7 years ineligible? Or first deduct any profits made from home sales in the past 10 years from the amount the owner can walk away from?
Even if I’m not a flipper, what if I’m someone who bought a home for $200K in 2000, sold it for $600K in 2006, then banked the money and bought another home with zero down in 2006 for $600K, and now it’s worth 400K? I’m underwater by $200K on this home, but I’ve still profited from the bubble to the tune of $200,000. Should I be allowed to write down the principle I owe? It seems to me that any plan needs to take all these various cases into account.
Mortgage law is a matter of contract, constrained by statutory laws of the various states. In California, a purchase money mortgage is no-recourse, such that a person who defaults on the loan loses the house in foreclosure, but cannot be subject to a deficiency judgment for the difference between the amount of the loan and the price at the foreclosure sale.
As for non-purchase money mortgages, a deficiency judgment may only be had if the lender does a judicial foreclosure (which is a lawsuit in which the court ultimately orders the home sold to pay off the loan). This is much more expensive and time consuming than a non-judicial foreclosure, which is done by the Trustee without any court proceedings. Since most borrowers don’t have any significant assets other than their houses, lenders almost always go with non-judicial foreclosures, which effectively makes the loans non-recourse.
Even if their was the political will to change these laws (and there likely is not), it would be extremely difficult or impossible to change them in a retroactive manner so that they apply to mortgages that have already been entered into.
I heard that for the price of the bailout the government could have just bought the non-performing loans. Is this true?
The most expensive bailout that had a significant cost to the taxpayer was the Chrysler bailout which cost in the tens of billions. The financial sector bailouts, for all their controversy, have cost less. The dollar figures for those bailouts were for loans and distressed equity purchases, but the vast majority of the loans have been repaid and the vast majority of the distressed equity is worth at least what the Feds paid for it.
The most expensive bailout was Fannie/Freddie. It has cost us over $150bn to date can could cost over twice that much if this CBO report is to be believed.
http://www.cbo.gov/ftpdocs/122xx/doc12213/06-02-GSEs_Testimony.pdf
Why would I voluntarily take out a recourse loan where the debt is 110% of the value of the asset I’m buying? No comprendo.
If Congress passed a law allowing cramdowns on residential real estate in bankruptcy, a bill that would amend just a dozen or so words in the United States Code, the banks would voluntarily enter into negotiations with homeowners for principle reductions where it was justified without a single additional federal government employee being hired and without the need for any federal government spending.
The “110%-way” has been applied in Iceland. Honestly, don’t think it matters much… house prices have to rise for this to be effective. In the US, it still seems optimal for people to walk away from their mortgage, something that is not possible in Iceland, as the mortgage is attached to the individual but not the property.
“as the mortgage is attached to the individual but not the property.”
If that is the case then they aren’t mortgages at all. They are simply large unsecured loans.
The biggest problem with Feldstein’s plan is its failure to distinguish between the first and second lien-holders on these mortgages.
The banks mostly sold off the first liens to investors who would love nothing more than to write down the principal because losing 50% in a cramdown is better than losing 80% through foreclosure/short sale. However, these writedowns cannot go forward without completely wiping out the second liens on the mortgage (home equity loans and second mortgages), which are still on bank balance sheets. The magnitude of the exposure is something like $750 billion, which is why the banks have been standing in the way of the investors who want principal reductions. They are able to get away with this because the big mortgage servicers are owned by the very banks that want to keep people current on their HELOCs but could care less about whether they pay their primary mortgages. Alphaville recently did a good rundown of the issues:
http://ftalphaville.ft.com/blog/2011/10/10/696591/the-mystery-of-us-banks-second-mortgage-exposure/
Basically, the problem is one of principal-agent issues. If the actual investors had been able to get their way and were not stymied by the intermediaries, this would have already been resolved by the market.
Not all second liens are on underwater or defaulted homes.
As a practical matter full recourse is meaningless if the borrower doesn’t have any other attachable assets, and suffers an income shock. And I don’t see anything about rewriting bankruptcy laws to make mortgage debt non-dischargeable– which would very bad policy (see: student loan debt) if we did.
Scott Sumner responds.
Feldstein is an idiot.
First of all, his figure of 350 Billion is a lie. It will cost taxpayers 28% more than that. Why? Because forgiven debt is income and these deadbeats won’t be paying income tax on it. So we, the taxpayers, will have to pick up that slack.
Second: propping up house prices is wrong. Aren’t these liberals for affordable housing? I am.
Here’s a better plan. For people who put a downpayment down, did not lie on their mortgage application (ensure that stated income matched 1040 reported income), and didn’t take out HELOC, and paid their mortgages, offer a refund of their downpayment if they return the house to the bank. This would help people who may have honestly paid too much for a house, but didn’t intend to use it as a get-rich-quick scheme. And it’s fair. It would be no different than someone who bought a house and then sold it a few years later for the same amount. They’re actually ahead because there’s a transaction cost for agent fees.
Of course, there are few people who would meet these criteria.
But people with non-recourse loans who put no money down lose nothing if they give the house back to the bank. They were just renting a house. I want to vomit when I they get sympathy and handouts from the Government.
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