Quite a few housing market experts have argued that principal modifications to viable borrowers are the best way to resolve the housing market malaise. In the stone ages when banks kept the mortgages they originated, mortgage modifications, including principal mods, were standard practice when a borrower got in financial difficulty but was still salvageable. And because these restructurings were done behind closed doors, no one but the banker and his grateful customer were the wiser. But now that servicer bad incentives have meant they don’t do mods unless cajoled or bribed by the government (and not much even then), the topic has entered the public debate.
It had appeared that any principal mod program was going to come over the dead bodies of the banks, who have been feigned compliance with various Federal programs but either dragged their feet and/or gamed the schemes. So it was surprising to read that the acting head of the FHAF, Edward DeMarco, is considering what amounts to a principal mod program implemented through bankruptcy courts.
As Shahien Nasiripour reports in the Financial Times:
The Federal Housing Finance Agency is “actively considering” a plan that would call for Fannie and Freddie to allow homeowners in Chapter 13 bankruptcy proceedings who owe more on their housing debt than their homes are worth to pay zero per cent interest for five years, subject to approval by bankruptcy judges, according to a letter to Congress dated Monday.
If you were to use a market rate mortgage starting today, five years of payments with 0% interest is roughly 17% of principal. The amortization with a regular payment schedule would be 3%, so you have a 14% difference. Now with typical loans seasoned a few years, the difference between the two amounts would be somewhat less. As reader MBS Guy wrote, “This won’t solve the problem in Nevada or Florida, but it isn’t a bad start if it can be accomplished without congressional (or Administration) approval.”
The FHFA is fixated on minimizing losses, so they have presumably taken the view that taking a modest loss is better than a foreclosure. These mods may not be deep enough to make as much a difference as one would hope. But it may also serve to reopen the debate on the cleanest way to cut the Gordian knot of badly designed securitization contracts and disempowered investors: that of bankruptcy cramdowns. If GSE borrowers can get mods in bankruptcy, why are other borrowers, who account for half the mortgages outstanding, left out?
And how will the private mortgage market ever come back if GSE mortgages offer this important protection to homeowners, and private label mortgages don’t?
The other interesting part of this proposal is that the FHFA wrote to Congress. This is the second end run of the Administration for being unduly friendly to banks that has come to light this week (the earlier one was the HUD inspector general ignoring the usual channel for prosecutions, the Department of Justice, and teaming up with New York attorney general Eric Schneiderman instead). One has to assume that DeMarco is lining up allies in Congress, since the Obama Administration is not backing the plan. Again from the FT:
But the White House said the initiative is not under consideration, angering members of Congress who have tried to get the Obama administration to devote more attention to the slumping property market.
It’s better late than never to see some regulators realize that business as usual on the mortgage front will result in only greater losses to homeowners, the economy, and ultimately, banks. Let’s hope DeMarco succeeds in moving his plan forward despite Team Obama. If nothing else, this idea demonstrates that more can be done than is being done.
Team Obama’s neglect of the suffering of people is most despicable…and that is coming from a guy who had no love lost whatsoever for the Bush-Cheney team.
If you look at the past 4 to 5 administrations (possibly back farther) it is readily apparent that the voters do not matter. Actions – look at the actions. The voters are simply rubes who go to the polls every 4 years to vote themselves more benefits, the actions show that what really matters is oil, wars, and finance.
A large number of the voters in this country are disenfranchised. Look at the last election in Venango County, PA and apply it across the land.
In daily political commentary, “the people” are the media and lobbyists who are part of the chattering inner circle. And, of course, the wealthy who finance them.
Speaking of end runs, how about this one?
An Army of Schneidermans: Court Finds Private Right of Action in Securities Fraud Law in New York
The money quote from NY Law Journal:
Hey, I want a mod and a principal reduction….we all do
No one turns a hair when a corporation renegotiates a contract with suppliers, customers, or a union. So why is renegotiating a contract with the bank a violation of decency, right, and the sanctity of motherhood?
A bank takes the proffer of a mortgage as a business deal. No more no less. The relationship isn’t personal, the obligations aren’t moral. Money changes hands according to a contract, and contracts can be modified.
Modification isn’t the act of slick deadbeats taking advantage of saintly bankers. It’s looking at reality and dealing with it. More reality, less morality, and we might all live better.
A most excellent post. I’m going to borrow bits of it next time I encounter either the “deadbeat borrower” or “sanctity-and-moral-obligation-of-a-contract” memes.
Scraping_By you’re absolutely right.
I have friends who lauded GM when they filed bankruptcy and renegotiated their contracts with the unions and restructured their debt; however, when I mentioned to these same friends I was attempting to renegotiate (while current on my note) the terms of my mortgage with my lender I was treated as if this was something most unsavory.
When I advised the bank started foreclosure proceedings while my note was still current, I was reminded by my “friends” of the clause in my mortgage where the lender can call the note at any moment.
Sadly, there are a lot of decent, educated folks who buy into the whole “You’re a deadbeat” and “moral obligation” arguments when it comes to mortgage defaults. They fail to see that banks force many of the defaults.
The banks and their money are what fuels this propaganda. Until the number of people affected by their shennanigans reaches critical mass (which it has – most just don’t realize it) their PR BS will continue to be an effective weapon.
Your friends aren’t really making a judgment of “moral obligation”. This is merely the first objection that comes to mind. It’s a reflexive opinion, like Orwell’s duckspeak.
How many people really, truly have strong, well thought out and consistent moral positions on financial issues? Answer: virtually zero. Human beings are not rational. They are not logical. They make dramatically different moral decisions when faced with slightly-rephrased but otherwise identical situations. To characterize a mortgage as a “moral obligation” is, as you point out, an absurd and hypocritical double standard.
No. Your friends’ real objection (which perhaps they themselves do not realize) was that you lowered your social status by admitting to what could be perceived as financial difficulties. Of course it’s not polite to gloat over one’s friends in front of them or to be too sympathetic (lest you reveal your own problems). The socially sanctioned alternative, conversationally speaking, consists of references to deadbeats and fortune cookie morality.
It’s important to matter-of-factly refute this sort of base illogic at the source. And it sounds like you did.
So, if a borrower has filed for bankruptcy, THEN a principal reduction equivalent via zero interest will be considered.
Reminds me of the eurocrisis. Too little, too late. Wonder how many wouldn’t end up in default again? Why not intervene BEFORE homeowners are in such dire straits? Why doesn’t Congress pass legislation mandating the GSE’s to modify all underwater mortgages? (Pollyanna here. Like Congress could pass legislation to keep the bathrooms in the Capitol stocked with toilet paper these days.) Mark the mortgages to market value. Investors would immediately lose money but that’s the risk one takes with investing, sometimes values drop, and when borrowers default, they will lose money anyways. With the anticipated drop in defaults, the losses would be taken primarily up front vs. stretched out over time, and the housing market could begin to recover. Obama wouldn’t dare veto the bill right before his re-election.
This would have little or no value in states such as Calif with the negative mortgage in many cases exceeds 200K.
It’s pretty much socialism, isn’t it. You pay what you can for the house.
I am no Obama fan, but he did float this idea early on, and it went nowhere.
Socialism? Sadly, no.
When an individual comes to a bank and solicits an offer for a mortgage on a piece of property, the bank accepts the deal on terms stated. One of the terms of the loan is the house (field, warehouse, store) is the collateral for the loan.
When any loan amount is greater than the value of the collateral, banking 101 calls for renegotiation. There will come a point where the loss of value is greater than the cost of default, making a walkaway the right thing to do. Most homeowners don’t think in those terms, so “strategic default” is just a propaganda motto for acting like a banker.
Since a house with mortgage costs the homeowner 2x to 3x the asking price, this will lower the loan amount. Any ‘equity’ disappeared in the initial crash and the subsequent slide, but this is less money out of pocket. The homeowner in this plan is still a renter, but the rent is lowered.
Calling a specific idea “socialism” is pretty much an oversimplification, right?
and, giving insolvent banks loans at .25% so they can then loan these same dollars back to the US taxpayer a higher rate of interest and pocket the difference is ‘free market wealth generation by bold and courageous capitalists’? I am challenged as to how to respond to that comment; with pathos or derision
What an awful band-aid. Absent meaningful principal reductions (0 pct is not a principal reduction) and suspecting the real deal is going to except the discharge of personal liability as the quid pro quo for the 5 yr abeyance I expect few takers and continued advice to debtors in recourse states like Fla. to let em eat dirt.
Gottta say, having dug into this I know enough to know we don’t know enough. DeMarco is an oddball and he might be grasping reality, but…still seems like the reality he’s grasping is pretty rose colored. No way in hell is his actual mandate “minimizing losses”—even if he thinks it is. Here and here were my findings as of fall. I’ll check back in, but it seems to me, while we’re on the subject of bankruptcy, why can’t Ed DeMarco operate like a the rational bankruptcy receiver he purports himself to be? Something is deeply screwy with the GSEs. Like, wayyyy screwier than it ever was before 2008.
I know what you mean, We come to the end of a fine series of articles on capitalization. We have already been through the most common mistakes I find as an editor, and now I will present some not-so-common mistakes I run across.
Keep up the posts!
~ PaulH at I Buy Your Difficult Properties – Quick!!
We buy debt-ridden houses and “handyman specials” without needing a bank, so if you can be flexible on the terms, we can offer you the price you need, today.
…If u no longer want it, we do!
In case you know of somebody who has to sell a problem house, we pay a $500 finder’s fee for any property we buy.