Are principal reductions coming. Loanonwers certainly hope so, but the arguments against are more compelling than the arguments in favor.
Irvine Home Address … 8 CHARDONNAY 16 Irvine, CA 92614
Resale Home Price …… $349,900
{book1}
But when I seek out your voice
My ears are overcome with noise
You show and tell with greatest ease
Raving impossibilities
And when the story takes a twist
It folds like a contortionist
Slight of hand and quick exchange
The old tricks have been rearranged
Engaged in crime I grasp my throat
Enraged my mind starts to smoke
Enforce a mental overload
Angry again, angry again, angry
Angry Again — Megadeth
When I first read the article Principal Cuts on Lender Menus as Foreclosures Rise, I thought my head might explode. The idea of forgiving principal, or worse yet paying off mortgages with taxpayer money, enrages me.
The linked article is long, and it makes many of the arguments in favor of forgiving principal. I want to examine these arguments and try to decipher the truth.
The start of this article smells like a Treasury Department leak,
“Efforts by U.S. banks to help
distressed homeowners have focused mainly on temporary fixes
such as interest-rate reductions that may only put off the day
of reckoning, despite policy makers wanting them to do more.
Banks may be forced to resort to a remedy they’ve been
trying to avoid — principal reductions — as another wave of
foreclosures looms and payments on risky loans rise, Bloomberg
BusinessWeek magazine reports in the Jan. 18 issue.
Who said policy makers want them to do more than they do now? Banks may be forced? How? Another wave of foreclosures will not force them to do anything. It might force policymakers to appoint a Foreclosure Czar or some other useless symbolic act, but if forces banks to do nothing.
Negative equity leads to default
The article goes on, ““The evidence is irrefutable,” Laurie Goodman, senior
managing director of Amherst Securities Group in New York,
testified before the U.S. House Financial Services Committee on
Dec. 8. “Negative equity is the most important predictor of
default.””
I covered that one in Cure Rates. Policy makers have reason to look at this relationship because increasing equity is the only way to prevent more foreclosures. Everyone in power already knows this which explains why the US Government is now acting conservator of the GSEs, sustaining the new home market through FHA, and working together with the Federal Reserve to buy the GSE debt at inflated prices. They are working to create equity through payment affordability, but they can only go so far. The hopelessly underwater will only make it through principal reductions. In short, we have to give them money.
“The 25 percent plunge in residential real estate prices
from their 2006 peak has left homeowners underwater by $745
billion, according to research firm First American CoreLogic –a
number that tops the government’s $700 billion bailout for
banks. That’s why Federal Deposit Insurance Corp. Chairman
Sheila Bair is considering incentives for lenders to cut the
principal on as much as $45 billion of mortgages acquired from
seized banks. “We’re looking now at whether we should provide
some further loss-sharing for principal writedowns,” says Bair.”
First, look at the enormity of the problem — $745
billion. How much of that was mortgage equity withdrawal? How much HELOC abuse are you willing to subsidize?
Second, if Ms. Bair is going to spend $45 billion to reduce mortgage balances, what exactly is gained? If there is a foreclosure or a principal reduction, the final result is a homeowner in a property they can afford. By reducing principal to avoid a foreclosure, we are rewarding the foolish homedebtor who previously outbid the prudent renter by using toxic financing. Now that the prudent renter is ready to deploy their downpayment with a stable loan to acquire the house — a house they should have rightfully had to begin with — the Government wants to step in and take the prudent renter’s tax money and pay off the mortgage of the foolish homedebtor squatting in the prudent renter’s home. Screw that.
Moral hazard of principal reduction
This is a moral hazard issue. Remember, responsible homeowners are NOT losing their homes the foolish and irresponsible are.
“Some lenders may be coming around to the idea of principal
reduction. “If you can right-size the mortgage and return to an
equity situation, the incentive is to stay,” says Micah Green,
an attorney at Patton Boggs in Washington and a lobbyist for a
coalition of mortgage bond investors. Banks can either forgive
principal outright or defer it. In deferrals the borrower must
pay back the full amount on the original mortgage when he sells
the property; if the ultimate sales price doesn’t cover the
principal, the homeowner has to pay the difference, making it a
less effective tool.”
First, no lender anywhere is coming around to the idea of principal reduction. Principal reduction inevitably leads to moral hazard and the collapse of banking, and lenders know this. When banks start giving money away, they are no longer banks; they are charities.
Second, notice how we have a need to “right-size” the mortgage? This is a wonderful choice of language. You almost forget to ask, why weren’t the mortgages right-sized to begin with? And shouldn’t those who “wrong-sized” these mortgages fix the problem?
Deferred balances (zero coupon bonds)
Then we get into the juicy stuff about deferred loan balances… finally… I predicted back in April 2007 in How Homedebtors Could Avoid Foreclosure:
“As much as it pains me to write this, there is a short to medium
term solution to the foreclosure problem: convert part of the mortgage
to a zero coupon bond.
For those of you not steeped in finance, a zero coupon bond is a bond
which does not make periodic interest payments. Think of it a zero
amortization loan. You don’t pay either the interest or the principal,
and both accumulate for the life of the loan. The loan would be due
upon the sale of the house.
Here is how it would work for our typical homedebtor: Assume our
financial genius utilized 100% financing and took out a $500,000
interest-only mortgage with a 2% teaser rate that is due to adjust to
6%. Let’s further assume his real income (not what he reported on his
liar loan) could support a $1,500 payment on a $250,000 conventional
30-year mortgage at 6%. The bank could convert $250,000 to a
conventional mortgage, and convert the other $250,000 to a zero coupon
bond at 6% due on sale. The homedebtor can now make their payment, and
they get to keep their house. But here is the catch: when they sell
their house, they will owe the bank a lot of money. If they sell the
house in 20 years, they will owe $800,000 on the zero coupon bond note.
In other words, all the equity gain on the value of the home will go to the bank.”
Do you understand how this mechanism works? The effect of loan deferment is identical to Option ARMs; you add to the mortgage balance, and you pay compound interest on this new balance. If you want to fully understand why this is such a bad idea, go back and read How Homedebtors Could Avoid Foreclosure.
Losing is winning
“Banks that negotiate principal reductions have seen positive
results. Principal forgiveness can be more than twice as
effective in slowing re-defaults than reducing an interest rate,
according to a December study by the Federal Reserve Bank of New
York. Cutting a homeowner’s principal would be especially
powerful in Florida, Nevada and Arizona, markets likely years
away from recovery, said Joseph Tracy, executive vice president
of the New York Fed and coauthor of the study.”
When the author wrote that first sentence, I wonder if he giggled? Banks lose money, but it is positive. I am amazed that a VP at a FED bank would write something so laughably stupid.
“Lenders are going to eat the losses at some point in
time,” Tracy said. “There’s a real chance to recognize the
loss by forgiving principal today instead of waiting.”
Is this a sales pitch to get lenders to act; lose now or lose later? How does a bank benefit from taking this loss today, particularly when most believe they can hold on and take a smaller loss later? Do you see why we are building a shadow inventory?
Wells Fargo is forgiving loan principal!
Every Wells Fargo customer should feign poverty and get a principal reduction. Is your spouse out of work? Perhaps your spouse should quit work while you negotiate a principal reduction?
Last year, Wells Fargo & Co. cut $2 billion of principal on
delinquent loans. After the modifications, the six-month re-
default rate on those loans was roughly 15 percent to 20
percent. That’s less than half the industry average. “We are
very comfortable with what we’ve been doing,” says Franklin
Codel, chief financial officer of the bank’s home-lending unit.
“We offer a principal reduction if that makes sense for that
individual borrower’s situation.”
Wells Fargo has publicly announced they are forgiving principal on home loans. What are you waiting for?
Back to the article, “When principal reductions were granted for pay-option
adjustable-rate mortgages — loans with high default rates
because they enabled borrowers to pay less than the cost of
interest as the principal increased — the re-default rate after
60 days fell to 6 percent, according to Mortgage Metrics.”
Loan Modifications don’t work
OMG! Six percent of modified loans cannot even make two payments, and this is touted as a success? And how much principal reduction are we talking about? Remember last weeks post Option ARMs Leave Borrowers No Good Options where I showed a sample property where the payment was about to increase from $1,939 to $3,708? Is the owner of that property entitled to keep it making a $1,939 payment? If that is all they can afford, a principal reduction program should set out to reduce the payment to that level.
The more ridiculous the teaser rate and the more risk a borrower took on, the more they will be rewarded by a principal reduction. People who used Option ARMs crowded out the prudent, and now the prudent get to subsidise them. Is everyone excited about that?
The conflicting interests of mortgage lenders and home-
equity lenders is a roadblock to doing principal reductions.
Banks, credit unions and thrifts held $951.6 billion in home-
equity loans as of Sept. 30, according to Federal Reserve data.
Mortgage lenders don’t want to cut principal unless the
home-equity lenders agree to take a hit. Typically, though, the
home-equity lenders are reluctant; much of the value of their
loans would be wiped out. That could drive more banks into
insolvency, says Joshua Rosner, an analyst at investment
research firm Graham Fisher in New York.
Maybe there is a silver lining in this after all. If principal reductions serve to wipe out HELOC lenders, then I say, bring them on.
Renter’s Tax Credit
Anyone who rented during the 00s and failed to participate in the Ownership Society is now being asked to bail out the disaster created by everyone else. Renters are blameless, and if they saved during the 00s, they are being asked to pay the most and are obtaining the least for their efforts. Owners got a free ride on the HELOC gravy train, pampering themselves with fancy meals and the ultimate in entitled extravagance — clothing poodles.
I have a solution. I want the Federal Government to pass a Renter’s Tax Credit that grants everyone who did not claim a home mortgage interest deduction a tax credit — a direct government gift. The tax credit amount should be equal to the average loan balance forgiven. For instance, if homeowners get an average principal reduction of $12,000 (some will need hundreds of thousands), then renters should get a $12,000 tax credit. After all, if the most foolish overextended and imprudent homeowners, are going to get a payment, give me my equal payment — bribe me — then I will be OK with it.
Isn’t that what this is about? The government takes our money and gives it to the constituency with the most clout. Do pissed-off renters have enough pull to get a $12,000 direct payment sent to them? Homeowners think they do.
Principal Reductions are a bad idea
Diana Olick has a post last week, Are Principal Writedowns the Answer to Housing Crisis? She aptly stated, “I would honestly rather see my home’s value go down than see the guy next door (figurative: my neighbors are lovely and fiscally responsible) who made a poor/negligent financial decision get a mulligan at my expense.”
I could go on, but the case against principal reductions is pretty strong. Of course, underwater borrowers — and there are many of them — think principal reduction is a great idea. They may have enough political clout to get policy makers to consider the idea, but there is no way this comes to pass. Over the next several months, Congress is going to turn its attention to regulation of our financial markets. Dumb ideas like this one will be touted by grandstanding legislators while the lending industry quietly lobbies to kill it. If you are hoping for a reduction in your loan principal, don’t hold your breath.
Irvine Home Address … 8 CHARDONNAY 16 Irvine, CA 92614
Resale Home Price … $349,900
Income Requirement ……. $74,693
Downpayment Needed … $12,247
3.5% Down FHA Financing
Home Purchase Price … $205,000
Home Purchase Date …. 4/18/1990
Net Gain (Loss) ………. $123,906
Percent Change ………. 70.7%
Annual Appreciation … 2.7%
Mortgage Interest Rate ………. 5.27%
Monthly Mortgage Payment … $1,869
Monthly Cash Outlays ………… $2,610
Monthly Cost of Ownership … $1,980
Property Details for 8 CHARDONNAY 16 Irvine, CA 92614
Beds 1
Baths 1 full 1 part baths
Size 1,348 sq ft
($260 / sq ft)
Lot Size 1,348 sq ft
Year Built 1980
Days on Market 3
Listing Updated 1/7/2010
MLS Number P716438
Property Type Condominium, Residential
Community Woodbridge
Tract Ct
According to the listing agent, this listing may be a pre-foreclosure or short sale.
Gracious and large 1 bedroom + 1 den unit demonstrates pride of ownership throughout the property! The unit surrouds a private atrium with brick fountain and waterfall! The living room is dramatized by the vaulted ceiling, recessed lightings and a fireplace. The den is currently used as a guest bedroom with folding doors and a private deck overlooking the atrium. Attached 2 car garage with automatic roll up garage door and laundry hookups. This property locates in an award winning Woodbridge community features two ‘landmark’ lakes and swimming lagoons, two beach clubs (with boat docks), 24 tennis courts, 16 pools plus many other recreational amenities for use by the residents!
surrouds? Other than that misspelling and the occasional exclamation point, this description is not bad.
Notice this property has only appreciated at 2.7% since 1990. Property values go up to match wages which have gone up 4.4% annually since the 1970s. This property was purchased at the peak of the previous bubble, and it has not fallen to its eventual bottom of this bubble. Many markets in California will show zero appreciation between the 1990 peak and the 2012 trough.
The 1990 owner was not the current one. The current owner was a grade D HELOC abuse who managed to triple his debt.
Helpussaveourhome.org
Is $1,300,000 too much to ask for?
C’mon, we’ve got SIX kids!
Pleeeeeeeeaaassssse!
http://thetyee.cachefly.net/News/2009/10/08/34-FraserStreetEvictions.jpg
I love the sign in the background, “Bail out Renters”
https://www.irvinehousingblog.com/images/uploads/201012/HC7953-001.jpg
This has happened before….
The government doesn’t care about screwed housing gamblers – their only concern is maintaining social order and preserving their (and their business partners) high standard of living.
Unfortunately, the majority of the public has this belief that the government exists to perform services for them and mitigate all of their problems in life.
So here we go with all this nonsense where screwed house debtors demand SERVICE from their government. I took on more debt than I should have! I listened to bad advice from a lot of foolish people! I demand that my government now fix it! Are you kidding me?
These policies are a joke because our people are a joke. If the typical American reacted with the same horror to a politician calling for house purchase subsidies from the government as they do to a senator noting the president’s lack of a particular dialect then this kind of junk could not run amok. It is a cultural problem that will not be going away any time soon.
Once again, David is spot on.
The only thing I believe that can get American’s off the entitlement tit, is tuff(er) economic times.
BTW, I still can’t believe we all set her in our comfortably lives, and watched as THEY (govt & corporations) shipped our jobs out of the country. And to think, so many of us believed them when they said we could maintain and expand our wealth by simply moving paper around. What the fu** were we thinking. Idiots!
I have a suggestion for the banks-convert them to 99 year fixed rate loans. Payments will be small (good for the home”owner”), but lots of interest will be collected overall (good for the bank), and the loan will be paid in full when the house is sold or refinanced down the line, after prices have eventually recovered (also good for the bank). Nobody will ever pay off these loans off without a sale or refinance-it will be like renting the house from the bank, without the bank having to do all the things that come with renting (pay taxes and repairs and HOA fess and the like). Now, a few of these loan mods will fail, but much less than anything except principal reduction, and the home”owner” won’t be able to move until prices recover, but if they wanted to move they would just let the house fall into foreclosure in the first place.
I really don’t see the downside to this approach. Seems like a win-win for both parties. Why aren’t the banks doing this, or is there something I’m missing?
Once you get beyond about 30 years, going out any further doesn’t really affect your payment size. The reason is that those payments so far into the future are really tiny in present value terms. (you have to discount future cash flows back to today’s dollars based on the inflation rate).
Here’s a website where you can play with loan terms and try putting in a 99 year loan, you’ll see that it doesn’t change the monthly payment much at all:
http://www.cs.miami.edu/~burt/learning/Math119/js-AutoLoan.html
If you give them a rate of 2% it works. The logic of no benefit of 30 or 99 years assumes normal rates.
I don’t like any of the give away options, but I like a 2% 99 year loan better then present value cash write downs. A little less moral hazard.
I’m with Don’tbehating on this; if your house isn’t worth the amount of principal * interest at the time of sale/death, how does that help the bank?
Should we help the banks? Didn’t they make a lot of dumb loans? Shouldn’t they suffer and lose their shirts? I think we all agree that this would be OK if only it didn’t involve taxpayer money. If only….
Hater,
The solution IS foreclosure or short sale, NOT principle reduction!
TWO THINGS:
IrvineRenter says this, “By reducing principal to avoid a foreclosure, we are rewarding the foolish homedebtor who previously outbid the prudent renter by using toxic financing.”
Why should the homeowner get a hundred thousand-plus GIFT for finding a way to latch on to a home they could never really afford?
And, why should this same person get this gift when his responsible neighbor does not?
Home values WILL increase in the future (not tomorrow, but think years down the line), at which point the irresponsible liar will reap, say $300,000 from his sale (principle was reduced $200,000), while his long term neighbor who made all his payments nets only $100,000 (no principle reduction).
Principle DEFERRAL is Ok… This way the guy gets an affordable payment today, but STILL OWES the entire balance years later upon sale.
NO MORE BAILOUTS… people can just go rent somewhere, and the market will stabilize at fundamental values.
“NO MORE BAILOUTS… people can just go rent somewhere, and the market will stabilize at fundamental values.”
http://icanhascheezburger.files.wordpress.com/2007/10/128343688002656250hallelujahpra.jpg
Both banks and investors use the moral issue to cajole homedebtors into continuing to make payments on a loan when it is not in the borrower’s best interest to do so. They don’t view the transaction itself as a moral issue, but they don’t mind exploiting morality if it suits their purposes.
I note for future reference that statements like this do not further the conversation:
“But I can assure you your oppinion doesn’t matter too much and is also likely biased as well.”
We are an opinion board. When the opinions expressed are based on fact, they tend to carry more weight, but each person gets to decide that for themselves. The debate is intended to be open, and the strengths and weaknesses of the positions taken will be shown by the light of collective reason. Statements designed to squelch debate will be ignored.
While it injures my sense of justice, I believe you are right. Probably the most effective way of promoting the due consideration of prinicpal reductions would be for the federal government to convinciningly withdraw all support from the housing market, making the participants aware that the performance of their loans is going to be whatever they make of them. Right now I sense that lenders are holding onto extend and pretend solutions as they sense enormous amounts of fresh third-party money is around the corner (viz Dec. 24 Fannie/Freddie announcements). You would have to be an idiot to settle on a big principal reduction today if some other sucker is on the verge of taking it substantially off your hands. But this is not likely to happen as what party facing elections would trust the voters to follow the logic that doing nothing was the most prodcutive course?
The reason Obama will compensate the banks for principal reductions is to keep light from showing on the member banks insolvency. Obama will frame principal reductions as saving American homes, and he will give the banks $800 billion in order to reduce the principal on FHA/Fannie/Freddie loans to the point where the equity will equal the actual value.
If this did happen, what does it do to prices in the jumbo market? Everything over the conforming limit is not going to receive a GSE principal reduction. The coastal market would still be crushed. Do you think there is political will to save the elites on California’s coast?
It will do nothing to save the “over conforming limit” market in the short term, but it will put a floor in the lower and mid range markets which will eventually percolate up to the move up and higher range market. Just a guess.
The intention is not to help the housing market. the intention is to put a floor on price decay so the banks can remain in biz. Homeowners may lose some equity in a foreclosure, but maybe not much. It is banks that are losing in foreclosures. American homes must be saved so that bankers can continue to get rich, wars can continue to be funded through treasury debt, political contributions can be made, etc.
I do not think the coastal market is on the radar map of the politicians.
1) Where will he get the money from?
2) What prevents me from stopping my mtgt payments if i know that the banks will be forced to modify my loan and reduce my principal?
(kool aid induced)homeowners in irvine are paying 4000 – 5000 per month on mortgage + 1000-1500 on taxes. 2 months of missed payments and they start digging a hole they can nver climb out off.
I was supporting Obama because i thought that he was trying to slowly deflate the bubble. Now i realize that they are all the same…
Renters Tax Credit is the best idea i have heard…after all it was our money that padded their pockets
Realize, there was and is no housing crisis. While a foreclosure may be a crisis for an individual homeowner, foreclosures are not a societal crisis, but rather a free market method of price discovery and transfering homes to those who can afford them. Affordable homes are not a housing crisis.
There was and is a bank solvency crisis and this is what Obama, Geithner, Summers, Rubin, Bernanke, et al. are trying to address and avoid. The bank solvency crisis was created by government intervention is the free markets and will not be solve with more government intervention.
THank you, Awgee – a nice rational reminder.
Deregulation and the repeal of Glass-Steagall are the political causes of this distress – causes which simply enabled the root cause, greed.
So instead of having a mob-rule pile-on over the internet, shouldn’t we be calling our congresspersons and demanding reinstatement of G-S and bank regulation?
We don’t need regulation, we need smart lenders and smart borrowers. The free market regulates efficiently and it doesn’t require my money to do it. A bank can make poor loans forever and stay in business?
Greed is not the problem, lack of fear is the problem.
The root cause is forced altruism. As nice as it seems, it is the bane of our society.
No,
We do not need GS.
We need to get rid of fractional reserve banking, fiat currency, and the Fedeal Reserve.
I meant “IN the free markets”, and “solved”.
“The extreme bulls thought these fundamentals would go on forever: creative financing and appreciation. The mistake the extreme bears made was thinking that the government would allow mortgage rates and affordability to be dictated by the market rather than Japanese style stimulus on steroids.”
In these two statements you have implied that being only moderately bearish was the correct path because the level of Government intervention was foreseeable. What the US Government in concert with the Federal Reserve has done is way beyond Japanese style stimulus on steroids. Being moderately bearish was wrong, and nobody foresaw the conservatorship of the GSEs coupled with Federal Reserve direct purchase of GSE paper to sustain the housing market. These actions where unprecedented, and heretofore illegal. NOBODY anticipated this.
To suggest that a moderately bearish view was correct given the circumstance is wrong. The moderately bearish market we have seen to date is not a sign of a correct moderate worldview, but another indication of how the wrong were made to be right by unprecedented Government meddling.
“but another indication of how the wrong were made to be right by unprecedented Government meddling”
The unprecedented govt meddling has only deferred the medicine America needs to swallow. Here’s another analyst who believes we’re at the brink of something big.
Try it again
“but another indication of how the wrong were made to be right by unprecedented Government meddling”
The unprecedented govt meddling has only deferred the medicine America needs to swallow. Here’s another analyst who believes we’re at the brink of something big.
I feel like a one-note song, but I said it when I first found your blog and I’ll say it again: There is no way the government is going to just let foreclosures cure the market, no matter what action it has to take. The ONLY way people like the posters on this blog will stop things like principal reduction is to scream at their congressional representatives long and loud and get anyone who will listen to us to scream also. We must scream louder than the bankers and the homedebtors, and keep screaming until our elected officials believe that the politically expedient thing for them to do is to listen to US instead of THEM. I truly believe that it is that simple.
Also, scream with your vote.
Vote Libertarian.
Government is never the answer. The only prudent course is to keep government as small as possible. We are wildly spinning in the wrong direction at the moment.
Also known as voting to not to vote.
Look, even when a well-known libertarian (Ron Paul) runs for a major party nomination, he got his ass ripped off his bottom and handed to him. Libertarian policies, especially in a pure form, are simply unpopular, and one needs to be popular to win elections.
I see libertarianism gaining momentum as our black hole of a government makes progressively larger mistakes and produces unfavorable results. The people are waking up, they just need some prodding.
I used to be a die hard socialist/anti-capitalist and it took one debate with a good friend to help me see the error of my ways.
Changing minds is the most efficient use of one’s time and energy.
It can matter if enough of us stop voting for Republicans and Democrats.
awgee: “It can matter if enough of us stop voting for Republicans and Democrats.”
Then we really are screwed. If I only had a dollar for every time I’ve heard that wishful “solution” over the years…
Let’s forget about what we’d like or how things should be. What matters is what IS, not what should.
-Darth
Most elections are a binary choice. That’s just the way it is. Welcome to the real world; enjoy your stay.
The only elections with more than two semi-viable candidates are a very small minority of primary elections, and occasionally a general election where somebody rich, or famous, or rich and famous, runs as an independent or third party candidate.
As long as the American voters keep accepting mediocrity (and sometimes idiocy) in our elected officials, we will continue to have a two party system. This is America, by the people, for the people. We elect these people into office so they are a direct reflection of our moral and intellectual values. If you don’t like it, then use your vote for someone you LIKE! Don’t follow the herd just because you think there is no alternative.
@OrangeRenter:
“The solution IS foreclosure or short sale, NOT principle reduction!”
But in many cases, doesn’t that result in the same drain on taxpayers?
I listened to bank asset managers talk at a BIA meeting. They were presented with the hypothetical situation where a borrower is in default, and this borrower is also the highest bidder in a short sale situation at 70 cents on a dollar. The assembled asset managers said they would rather sell to someone else at 65 cents on a dollar that retrade the loan back to the original borrower at 70 cents. Each of them said that to renegotiate the loan with the original borrower would cause every borrower to come back at them, and they would rather lose an extra 5% on a few borrowers than give all their borrowers 30% off. Put yourself in their shoes. Wouldn’t you do the same?
This isn’t about what is better in dollars and cents in the short term, and lenders know this. Principal reductions are not coming even if it costs everyone more in the end.
Go back ask those same bank asset managers if they would take money from the government for principal reductions.
At a min what I would want to see explored is some kind of warrant given to the lender/government that if they cut principal, then some % of future appreciation after the date of forgiveness is paid until the amount forgiven is recovered.
I’ve been involved in corporate bankruptcies and and what you usually see is that the lender will agree to some level of haircut on the loan, but then get some level of equity in the businesses as a concession for taking the haircut. So if the business recovers the lender may recoup some of his loss (i’ve actually seen situations where we recovered a multiple of our haircut). I don’t see why this can’t work with homes in concept (what the exact % would be I’m not sure – ie I think if the lender got 100%, there is no incentive for the homeowner to, say, maintain the value of the home so probably needs to be something less to be effective).
BTW another complexity on forgiveness is that it appears from regular reading of IHB that at least a significant minority, if not a majority, of homes were purchased with some degree of 2nd lien financing. These loans, especially in Southern Cal, would almost all be underwater. Now I can see a 1st lien lender saying that forgiving, say, 20% of the loan is better than foreclosure. But the 2nd lien lender is facing a total loss today – ie what motivates them to take 100% write off today if there is some low, but non zero, chance I may get something in 5 years? More precisely since the 2nd lien loan was likely sold into a Bear Stearns or Citibank securitization, how can the servicer agree to a writeoff outside foreclosure?
There is an entire business model formed around buying these second mortgages for pennies on the dollar and waiting to go after these borrowers once they have equity.
What many fail to realize is that the second may be reduced to almost zero value in a foreclosure, but it is not “wiped out.” The holder of this second mortgage has not exercised its “single action,” and they still have a bullet to fire at the defaulting borrower.
In the short term, the holders of these seconds will get wiped out in foreclosure, or they will become defacto zero coupon bonds held against the property waiting for a sale to get some money back.
So if the 2nd lien loan remains secured and full recourse what does forgiving some portion of the 1st lien loan do? Say I bought for $500k with a $400k option arm and $100k 2nd lien loan. Today the house is worth $300k and lets suppose I can service a $300k loan at a 4.5% 30 yr fixed rate. If I wipe out $100k of the original 1st lien loan to $300k I’m at 100% LTV, I can service it so it is a successful mod. But actually I’m still $100k underwater due to the 2nd lien so I’m still motivated to walk away. The 1st lien lender isn’t going to forgive more than so that I’m at 100% LTV even when I add in the 2nd lien. There is no reason for the 2nd lien lender to forgive the loan since as IR notes they may have some recourse some day in the future which is worth something. Plus I don’t think the 1st lien lender will even make the offer since the 2nd lien lender can create problems.
In further reading IR’s description it also occurs to me that how you do mods and forgiveness potentially has 50 variations since the rules differ state by state. For example in a non-recourse state like California there is less downside to walking away than in a state, like NJ where I am, where 1st lien purchase money mortgages are full recourse. So you probably need a larger mod in CA since walking away is painless. As complex as this might be, when you think that you need probably 50 variations (with the 2 Senators from that state trying to get better deals for their residents) this becomes very complicated to say the least.
I think the vultures will do well…if Citibank gets aggressive the CEO gets put on 60 minutes, but bob’s loan shark company has less compunction on going after debtors more aggressively.
Pay your debts and Bob’s Loan Shark has no reason to bother you.
Hmm… are these things being traded?
I wouldn’t mind buying some La Cosa Nostra Inc 2nd mortgage CMOs myself… sounds like I could make some real money.
Even if it does (it shouldn’t, but only does right now because of money pumped into banks to cover losses), it is still better than “giving” an iresponsible liar a (potentially) hundred thousand dollar direct gift of our tax money. Especially when renters and resonsible home owners will not be receiving these gifts of equity.
Ok, all this is good, but at the same time, I don’t think the home price is really going down much in Irvine.
I find it amazing that in some other area like san Diego, market have crashed to a wider extend, and rental parity is almost there. At least you can get decent 160-180x ratio for 2000sqft family detached home in nice area.
In Irvine, you still have these homes in Westpark, Woodbridge and TR saling for >700k$. No sense.
It seems that in these areas, >300$ psqft is still the norm.
WHAT IS GOING ON !!??
You are comparing apples to oranges. Like Orange County, San Diego has many different areas, each area’s housing market being affected differently. Thus, you need to compare San Diego County to Orange County; as opposed to San Diego to Irvine. There are many areas in Orange County that are at rental parity as well.
I’d suggest comparing Irvine to an equivalent type of area in San Diego, like Carmel Valley. These areas have many similarities: primarily newer tract home communities aimed at younger, professional families; a good school districts; and close to high-tech jobs. I live in SD, and those looking to buy in Carmel Valley have many of the same comments as you do about Irvine (e.g., prices have not fallen as much as other areas).
Well, you are absolutely right.
I believe Carmel Valley typical family house would have gone down a little more than Irvine, this is still in segment which got maintained high.
Which brings be back to the questions: how come “nice area” like these (Carmel Valley, Irvine/Westpark/Woodbridge/TR, or others in OC or SD County) are still able to maintain such a premimuim, and how long this is going to last !?
In Irvine, I though the pressure from the somehow collapse of columbus/woodbury and the ‘north’ or west Irvine would have put pressure on the above mentioned Irvine areas.
It has certainly not, and some much older houses, in almost poor conditions are sold (or for sale) 20% higher in WP/WB/TR compared to Northpark or others. Even counting the M. Ross, it does not make any sense.
Given Irvine’s demographics, I’d say it’s rich FCBs, REITs and flippers that are keeping the prices higher than normal. Of course, the lack of inventory also contributes to this feeling of immediacy.
I predict the most likely policy – based on recent history of corporate bailouts – will be a hybrid forbearance scheme. Government will forgive X amount of dollars, but if the home owner sells or refinances within Y number of years, then the homedebtor will need to pay back the government a certain percentage of the amount forgiven. The percentage will decrease the longer the homedebtor stays in the home.
The government will market this as a can’t lose “an investment for taxpayers,” because housing prices always go up in the long term.
Of course, a year or so later when the housing market is still stalled, the government will repeal the requirement that the homedebtor repay anything.
Looks like Scott wrote about a better description of the plan I was getting at.
Great blog post as usual. I am really tired of the bailouts. The foreclosure maps in my area light up like a Christmas tree while would be land barons squeezed close to a trillion dollars from the economy to fund adventures into lunacy is infuriating. Now they want widespread principal reductions?!
How much money that could have been spent creating something worth value was spent inflating yet another bubble? Hell, for that kind of money we could have built an orbital space elevator and developed an elaborate array of solar collectors to power the continent. (well maybe not…) Still, we spent almost a trillion dollars on a housing bubble so people could play a gambling game called “no money down.”
I think we should spend our money elsewhere. No more bailouts!
My .02c
Any portfolio loan held by banks will have principal forgiven with a clawback if you sell within x years. Example:
6.625% loan for $535,000 = $3,425. This is an unrefinanceable loan as it’s not FN/FR and also “upside down”.
$417,000 will be the new loan amount, refinanced into a 5.0% rate. New payment $2,238.
The $118,000 forgiven will be a silent 2nd with deferred interest based on a 10 year Tbill rate.
If you sell or refi in 10 years, as much of that deferred second plus interest is repayable if equity exists.
If the homedebtor cannot survive with a $2,238 payment, then they don’t deserve home ownership and must be foreclosed upon.
Could this solution simply turn homedebtors into homerentors, locked into living where they are forever?, Yes, but aren’t they at the same position now?
This IMHO is why FN/FR have unlimited capital to work with.
Soylent Green Is People
I suspect that in the short to medium term, we’ll see that IR and DBH are both right. Enormous sums of money will be spent by government in an attempt to avoid falling out of political favor with the home debtors. The banks will make a gesture at complying with the govt.’s desires, while making sure that one way or another it pays out big time for them.
In the middle will be a lot of confused citizens: some wondering how this mess occurred, and some still cheerleading the home owning router to riches.
None of the guilty parties will do the right thing and admit that a market lead solution (foreclose on those not paying; don’t throw good money after bad banks!) is the way to go.
Foreclosure is actually a form of “principal reduction” for banks, isn’t it? The only difference between the principal reduction in question and foreclosure is that banks reward the speculators and the home debtors who made reckless/foolish decisions rather than renters and other future buyers. It’s a perverse wealth transfer from renters/savers to home debtors. Why would banks want to do this and risk encouraging many more who can afford to pay but choose to strategically default in order to get the principal reduction? They will do it only if gov’t sweetens the deal, a lot.
And principal reduction would not stop the market decline even if it got pushed through. The fundamental problem with our housing market is still affordability. All loan mods (including principal reduction) are simply delay tactics. A more interesting aspect in near term is how long Fed can keep mortgage rate at the current level thru buying RMBS. In a couple of years even mortgage rates will not matter anymore after a fundamental psychological shift takes place. Contrary to what many believe the “Japanese style stimulus on steroids” (as stated by don’t be hating) did not work. 2% mortgate rate did not stop Japanese RE from falling for straight 15 years.
It’s a cute place but they are cuckoo nuts if they believe it is worth 1/3 of a million dollars – even in Irvine.
So I like the pie slice HELOC rating chart, but it’s hard to see which one is active. You say that this is a ‘D-level abuser’ but it doesn’t stand out in the chart.
You’re right. It doesn’t read as well as I hoped. I will go back and darken those up to make them stand out more. Thank you for the constructive feedback.
IR,
How about an arrow instead? Some of your readers may be color blind, and an arrow can distinctly point out what grade this HELOC is. (Think the arrow on the Wheel of Fortune)
Principal reduction and loan modifications will not work with the way the economy is going. The unemployment and underemployment will take its toll eventually. Distributing free money is not the solution. I do not understand when will the fed and the Govt. realize this simple fact.
Lets take a hypothetical case say in Las Vegas a couple bought their house for say 250K and say their loan is modified to 150K (to market). Say if the couple looses their job or get their hours reduced or bot. Now they cannot afford the 150K mortgage. So will they reduce the principle again?
“IrvineRenter: NOBODY anticipated this.”
There is nothing new under the sun. What you see is capitalism slowly mutating into socialism.
Read the bailout used by Hoover. Just like today’s bailout under Bush and BHO. BHO was just a little bit smarter by justifying the bailouts as helping saving the homes of hard working Americans. Mostly bailouts of the banks and WS.
Simialarities:
Toxic loans,
Creative bookkeeping,
Forgiveness of loans to exec and the special classes.
Over extension of credit.
Lower real wages (basic good cost increases exceded increases in wages).
Increase efficiencies, profits and capacity but wages did not keep up.
Bubble bursted and blame the guy in office when both parties were having their parties.
There is nothing new under the sun.
To IrvineRenter: “nobody foresaw the conservatorship of the GSEs coupled with Federal Reserve direct purchase of GSE paper to sustain the housing market. These actions where unprecedented, and heretofore illegal. NOBODY anticipated this.”
Well, perhaps we just didn’t want to even think of this possibility, as long as home prices kept going up, and employment was running along well, and incomes bubbled up like they did, and as long as Obama came along promising change.
Indeed the Fed’s actions, plus the reduction of the Fed Rate to 0% to 0.25%, the acquisition of toxic assets under TARP, the interpretation of FASB 167 and 168 to allow mark-to-fantasy, the Fed’s acquisition of AIG with 100% payment of derivative positions using Treasury funds, and the nationalization of General Motors, as well as other things is truly unprecedented … barely legal in my thinking. But had not the Fed done this, and had not the other central banks done similar things, there would have been a total economic worldwide collapse; in other words it would have been like a nuclear explosion — a nuclear winter wiping out all economic activity as it is known today.
I read the article you suggested: U.S. Postponed the Great Depression, Not Prevented It, Says Trend Forecaster, and agree with Celente who believes the bailouts have just postponed a depression — not prevented one.
Had the Fed not made support for the GSEs, the US dollar would have plummeted quite quickly; with the Fed support of the GSEs, the Chinese have continued to buy their paper.
The Fed, and the FDIC hopes to stabilize things while at the same time supporting the banking elite and the investment bankers; they have little care for the people. We are not, repeat not witnessing a rise of socialism, but rather a fast and thorough integration of government, banking and industry, into a tight combine where all three work as one; and we may soon see medical care integrated as well. We are seeing the quick ascent of corporatism — state corporate rule where the elite rule and the US Constitution and traditional legal principles vanish before our eyes.
Recently, there has been a sharp rise in the steepness of the yield curve, which is measured by the difference between the yields on the two year Treasury note compared to the ten year Treasure note, $UST10Y:$UST2Y; this causes a monetization, that is an inflation, in the price of gold.
I expect gold, $gold, to rise significantly in price as the US Central Bank strives to keep short term interest rates low; and market forces draw longer out rates higher; and as unemployment and US deficits remains high.
I strongly encourage investment in the gold ETF, GLD, held in a trust account (not a brokerage account), gold coins, as well as the purchase of gold at BullionVault.com.
I like the variety of topics in your blog, the photos of the properties in Irvine and the wide variety of comments. As more insight and data comes on shadow inventory please keep us advised.
This year I am doing focused research on the auction market in preparation to launch a buyer’s service. I have been compiling statistics on the market to try to paint a more detailed and nuanced view. Over the next couple of months, I will compile and begin to release this data.
For international corp. and the extremely weathly who control non-US companies, US law outlawing the trading of gold will be of little value in stopping them from trading outside the USA. The great depression used a similar appoach. Before the anti-gold trading laws, the bailout money was tricked down to bailout the special investment bankers, who quickly converted to gold and move the assess out of the US. Later the US would not honor the gold standard to US citizens. The external cash could be then washed through foreign govt. to get gold at the old price; US citizens who needed gold for industial/manf. purposes, needed to pay with inflate dollars, i.e., gold price when up. Moving to 2009, the bailout money and 0.2% interest Fed loans were used to buy assess (stock and hard assess) instead of leaning to US companies to “lessen unemployment.” Thus a rise in stock prices and devaluation of savings. Commonly called the carry trade, which is just another name for welfare for the rich. I say welfare should be for the least of society to show compasion for the less fortunate. End welfare for the rich.
Irvinerenter, I am so pissed at current administration over this BS loan modification that now I am finding out not being able to buy home still after waiting all these years because there are cash rich folks scooping up whatever comes out in the market, then there are those folks who are earning very well yet not making their mortgage payments in order to get loan modifications, to qualify, these folks have rigged their expenses by buying SUV’s etc. that increased their expenses compared to their income. Banks are not relesing inventory or kicking out these folks to the curb.
My frustration level is so high that I might outright buy the most expensive home that I can qualify for being a first time home buyer with little down and then stop paying my monthly payment as soon as I can. This BS pricing will drop anyway and I will live one year for free and then get my fair share of loan modification as well.
This is just a crazy thought but I would definitely do it if I get the wind that I may be losing my job, heck who doesnt want to live for free when this Govt. is encouraging it!