A reader with considerable experience in real estate who has asked to remain anonymous pointed to an article in Housing Wire describing some possible unintended consequences of the Administration’s push for more short sales:
This past week, I received an email from one of my dearest friends that has really stuck with me. It illuminates perhaps one of the single largest shifts in borrower psychology likely to come from a push to short sales:
My neighbors are being foreclosed on….
The house and land (1.3 acres) was valued at $1.8m a few years ago. Now, they are behind on payments and the bank wants to force a short sale for only $700k. She told me that she tried to modify the mortgage twice already, and has been turned down. She is willing and able to make payments on the $700k amount, but the bank is refusing and would rather sell to someone else.
he message paints an interesting picture of a potentially hidden angle to the recent short sale push by the Administration, banks, and Realtors: a renewed call for broad principal forgiveness.
It’s not too hard to see this sort of thinking quickly becoming the norm among many distressed homeowners, as a push for short sales grows ever stronger and many ask themselves why someone else is getting the better deal. More than 11 million borrowers currently owe more on their mortgage than it is worth, according to CoreLogic—and this group of borrowers would love nothing more than to replace their current underwater mortgage with whatever the accepted “short sale price” is deemed to be.
I don’t know that such a response on the part of borrowers could be deemed irrational, either. Many will ask themselves why they have a mortgage at a higher amount, especially if the bank is willing to sell the house to another buyer for less money. Why does someone else get the lower purchase price? Isn’t easier for the bank to just give me that loan instead? I already live here.
The NC correspondent carries it one step further, and points to second lien holders as the likely impediment:
The real solution to the mortgage market problem is principal write downs of underwater mortgage loans. It’s behind discussions of cramdown legislation. It is what TARP money should have been used for because it would have had the dual impact of helping both borrowers and banks.
Second liens – and the JPM, Citi, Wells illusionary accounting – are a big obstacle to cramdowns, which is really total BS. These were high risk loans when made and should be treated as such now. Of course, the truth is, no one has any idea how to model how many 2nd lien borrowers will default over time. There is no reliable historical data and the current accounting conventions completely obscure the real value of second lien risk.
The Housing Wire piece makes an outstanding point about the ridiculousness of short sales and the absence of cramdown legislation. I wouldn’t be surprised if this is an area of future litigation. The only way the banks, their regulators and congressional lapdogs can deal with the issue is by ignoring it.
I doubt that the administration had this outcome in mind when they advocated more aggressive short sales (but it is a remote possibility). If they were unaware of the implications of a push to short sales for individual homeowners, you have to marvel at their blindness or cluelessness.
Finally, how does the Fannie push against “strategic defaulters” fit in? Perhaps, if they can justify that they have segregated “bad” defaulters from “good” ones, they can rationalize principal write downs rather than forcing the sale to other parties?
The political types are terrified of pissing off the “good” borrowers who have been paying their mortgages all along. As a result, the Administration may be trying to gradually get to the cramdown treatment, while avoiding looking like they exhausted all other possibilities first. Interestingly, they didn’t seem so concerned about a slow, measured approach when it came to bailing out the banks.
In the scheme of things, the overall economy would be much better off if the bulk of underwater mortgages were crammed down to levels borrowers can afford, so that more borrowers were kept in their homes, less housing turnover was needed, fewer foreclosure related expenses were incurred (and wasted on lawyers), and the shadow inventory was drastically reduced. For fairness, the crammed down portion of the mortgage can be subordinated so that any subsequent appreciation in value can be captured, in whole or in part, by the lender. The existing second liens would be toast, currently, but would have a further subordinated right if housing really appreciated a lot in the future.
I can’t see any public policy reason why our entire economy should hinge on rewarding second lien lenders, who knew they were undertaking speculative loans in the first place, at the expense of home owners, housing, etc.
Yves here. Sadly, I think we know the real reason for the continued pursuit of this “spare the second lienholders any pain” program. And it has nothing to do with sound public policy. It has everything to do with the fact that the biggest second lien holders, Citi, Bank of America, JP Morgan, and Wells, have simply massive holdings among them and are too big to fail. Admitting the magnitude of the second lien losses would also be hugely embarrassing to Treasury, since it would reveal what a farce its stress tests were, and that the big bank remain woefully undercapitalized.
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Of course there is a major slippery slope to trying to engineer an alternative to price discovery in the face of large scale defaults. When principal writedowns are given in lieu of a shortsale/default, there is every incentive to game the system (on both sides). Could the owner have gotten a loan to buy the short sale (unlikely)? Doesn’t the owner then have the incentive to *decrease* the value of the mortgage by starting to look uncreditworthy?
And then when defaulters are starting to get rewarded, there will be a howl from the populace to write down all mortgages, regardless of distress. Soon the government will simply underwrite 50% of the real estate market regardless of mortgage delinquency, or possibly even regardless of the presence of a mortgage.
Clearing the market by default makes sausage of the finances of a large pool of investors. But so do all of the other choices. Which winners do you choose?
I don’t want the government choosing, or the banks winning. But liberals may have a different slant.