The Obama mortgage plan looks set to help one in nine homeowners. The Wall Street Journal says "Administration officials made a point of noting that the
loan-modification program will not aid people who bought homes merely
as investments; the program is designed for those who live in their
homes." Of course, most of them were taking a flyer on a leveraged investment in housing too.
There are a lot of arguments that this won't help--that only principal reductions work. I'm not sure whether this is so. Many of the mortgage modifications have failed haven't succeeded in reducing payments--they reduce the interest rate, but pile penalties and arrearages onto the principal, so that payments don't drop much. As far as I can tell, the Obama plan will result in actual payment reductions, which should reduce the pressure to default.
How successful you think it will be depends on your view of human nature--do you think people are basically good, and will pay if they can; or do you think that once arrears on their mortgages have already trashed their credit, they'll rationally walk away from any house that doesn't have substantial equity in it? I suppose I take a middling view. Some people will default, live rent free until the bailiffs come, and meanwhile trash the house, because they think they're entitled not to make payments on a house that has fallen in value. On the other hand, people are very attached to their homes. They will often do irrational things to keep them. And at least a few of them actually believe that they ought to repay money they've borrowed, even if it might be to their advantage to default.
The bigger difficulty, I think, is that with interest rates currently pretty low, there's just not all that much room to modify them down to affordability. Very few people default because there's a gap of, say, $50 a month. The gaps are in the hundreds of dollars. If people were paying interest rates of 10%, there'd be a lot of room to adjust interest rates to make their payments affordable. Most people in trouble have fairly new mortgages; a couple of years in, the payment on a 10% 30-year fixed-rate mortgage is nearly all interest, no principal. But as the interest rate falls, the percentage of the payment that's principal goes up, making it harder and harder to eke out enough savings on the interest rate to keep the borrower in the house.
If you can't make enough on the interest rate to keep people in their houses who are really in danger of foreclosure, then all this ends up as is a transfer to people who would rather spend the money for their mortgage payment on something else.
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Extend the loan term to a hundred years at two percent interest. That'll drop the payments. Once they have 20% equity (either through paying off the loan early or a rise in home prices) they can convert to a regular loan if they want.
The downside is that they cannot move without defaulting. But if they were going to default anyway...
And this is why, according to the OCC, 50% of homeowners have defaulted a second time after defaulting and having the terms of their mortgage re-written by the lender.
I would like to see a rational discussion on the possibility that there is no technical solution to the problem. What do we do if (when) the dollar system collapses as a result of the housing/credit crises? Surely we have to see this as a real possibility by now.
At a certain point, a drug addict cannot break the habit without fatal results. If the addict is an entire economy and the drug is a fiat money/fractional reserve/ central bank cocktail, the effect is either deflation or hyperinflation with the accompanying disastrous consequences.
MartyH,
Part of the reason we are in this mess is that people were given loans with preposterous terms that had nothing to do with reality. A 200 year loan is even more insane than a no doc adjustable arm 125% equity mortgage.
Also, on a 200 year mortgage, 20% equity comes at like 70-80 years. So...yeah, not a good plan.
Arguments to hypocrisy are never dispositive; eventually you've always gotta get down to the central question anyway. And I understand what people are saying about moral hazard, about precedent, about the basics of capitalism, all of it.
But as I actually said back when we first started bailing out banks, I really do think that there is a sort of elementary truth to the notion that people who supported bank bailouts have lost the authority to make moral claims about bailing out homeowners. So a lot of the people out there, the Santellis et al, really, really don't come across very well. Yes, I understand the notion of too big to fail. But I think a pretty basic sense of fairness indicates that we shouldn't hold to account individuals for failings and poor decisions that we have exempted businesses and corporations from. I'm open to pragmatic arguments and understand the frustrations from people who opposed both kinds of bailouts. But for those out there who went along quietly when the recipient of trillions was AIG or Citi, but now stamp their feet and freak out about much less money being offered to individual mortgage holders, I think you can forgive me for being a bit deaf to their complaints.
Most (not all) people will pay if they can; your kickers are things like divorce, illness, job loss, employment mobility, which may either provide an impetus to move and/or often involve serious loss of income.
My thoughts are that this will help families where $100-200 or so a month makes all the difference. I'm not sure how many of these are left.
I predict rewarding stupidity will lead to more stupidity.
I could have nearly doubled my square footage and my mortgage a few years ago. Needless to say, I'm glad I didn't, but it seems odd Uncle Sam is going to subsidize those that did overborrow at my expense.
Freddie,
I think very few people "supported" bank bail outs. The argument at the time was "If the banks collapse, they will take the rest of us down with them". The most common response was "I'm not all that sure about that, but I'm not willing to risk it". That is pretty far from support. To this day, I'm not sure if bailing out banks was right or not. However, two wrongs don't make a right. If bailing out banks was wrong, then bailing out home owners is wrong as well, fairness be damned. If you give two kids the same present, and one brakes theirs, you don't brake the other kid's present "to be fair", even if that's is how the kid is going to see it.
If rewriting the terms of the loan is really in the best interest of the bank and the borrower, they will rewrite those terms without involving anyone at all, unless you count their attorneys.
It is not in the banks interest to have the borrowers default on their loans. If you have to force the parties to rewrite the terms, than it is probably not in both their interest. If you force the bank to take a loss, they will pass it on to the next customer.
Freddie: "But I think a pretty basic sense of fairness indicates that we shouldn't hold to account individuals for failings and poor decisions that we have exempted businesses and corporations from."
I don't understand. Businesses were subsidized at the expense of the taxpayers. Therefore, fairness demands that home-borrowers be subsidized at the expense of renters and homeowners?
Could you explain the logic?
By the way, I want a subsidy for porn. We bailed out the banks, fairness demands that NYT readers subsidize porn watchers like me!
"The bigger difficulty, I think, is that with interest rates currently pretty low, there's just not all that much room to modify them down to affordability."
Don't forget about adjustable rate loans and balloon payment loans that people currently cannot re-finance.
Peter-
You're turning them into renters at below market rates with their kids maybe having an asset when they pass away. Consider it suburban rent control. If the home appreciates at 3% a year it will double in value in a little over two decades, at which point they can refinance.
I also realize that this kicks the problem down the road. A lot of times that isn't the right choice, but sometimes it is.
I'm just saying it's an idea-not necessarily a good one.
ken megalnik, as I understand this, the problem is defining who actually holds the mortgage; they were sliced and diced into risk packages and the risk was spread thin through the financial markets. There's typically no single lender for a homeowner to deal with in re-negotiating terms.
And despite the best of plans, it is the three D's of life -- divorce, death, and disease -- that will play havoc with the success of any plan to help people stay in their homes.
But remember there is a goal beyond helping individual homeowners with their too-expensive purchases: helping all the neighbors who are also seeing their wealth diminish as the bottom falls out of the housing market. Stabilizing housing prices by staving off further foreclosures is a large part of the plan.
Zic:
Leaving aside libertarian argument of wether or not it is the gov't job to insure the value of your house, let's get to more practical concerns.
There is little that the administration can do about the three D's, it is a variable out of their control. No reasonable plan can be made to cover for them.
So let's look at the neighbors whose wealth is diminishing due to foreclosures. One of two things is happening. Either their house was really worth what they believed it, and the bottom is currently dropping out of it, but it's value should return once the economy stabilizes. Since these people can afford to keep the house in the mean time, they just need to weather the bad times like everyone else.
Or the value of their house was over inflated due to the bubble, in which case it will not come back, unless another bubble starts, and surely it would be a bad move for the administration to encourage another bubble.
IOW, attempts at stabilizing prices are somewhat moot. Either the prices were inflated, in which case they cannot be stabilized, or the prices were true, in which case that is what they will return to. The only people in trouble are those whom cannot afford to keep the house long enough for the prices to return, and those are the very people who made unwise financial decisions.
But for those out there who went along quietly when the recipient of trillions was AIG or Citi, but now stamp their feet and freak out about much less money being offered to individual mortgage holders, I think you can forgive me for being a bit deaf to their complaints.
So you're deaf to their complaints. So what? One disappointing thing about the new administration is how quickly 'but Bush did things just as bad' has become practically the sole justification for policy. You're just advocating a variation on that.
Rather than shuffling around barge-loads of cash, isn't there a useful governmental role in changing a few of the rules, regulations, or other impediments that may make it hard for lenders to renegotiate loans with insolvent or underwater borrowers? I'd appreciate hearing from someone knowledgeable just what makes it difficult and/or expensive for the private parties to negotiate a resolution, e.g. the requirement that the homeowner have 20% equity to get a refi.
I lean towards the "most folks will do the right thing and try to pay" theory.
My neighbor's daughter's family did the stupid thing of buying too much house. On top of that, the mortgage broker lied through his teeth up until closing day concerning the monthly payment (it ended up being $500/mo more than he "estimated"). They bought it anyways.
After 4 months, they realized that they could not afford the house. They lost much of the daughter's income (she was in real estate of all things), and were overextended. They had 2 options: Walk away from the house, or sell it and take a loss.
They did the right thing. After working with the bank to try to get the payment down (it could have been decreased, but not by enough), they decided to sell. In the end, they got lucky - they only had to come up with $10,000 cash at closing (losing that $$$ plus their down payment plus.....).
Now, not all people will be able to do that. After all, in the grand scheme of things $10k is small compared to what many folks would be under water. But many will try, and many will do the right thing.
I'd appreciate hearing from someone knowledgeable just what makes it difficult and/or expensive for the private parties to negotiate a resolution, e.g. the requirement that the homeowner have 20% equity to get a refi.
The major obstacle is that the bank just services the loan. They take the payments and then send them off to the various security holders. They open themselves up to lawsuits if they modify the loan, since the securities holders will then receive less money. No lawsuits arise if the banks foreclose on the home. Congress would need to pass a law preventing law suits due to a modified loan.
For refi's, the major obstacle is that even if you get rid of the 80% LTV requirement, many of these borrowers can not afford their current principal amortized on a 30-year loan at market rates. If you can only afford a house by paying the minimum payment on an Option-ARM, or an interest only-ARM you can't afford a 30-year fixed PI loan.
You also have the three D's of foreclosure mentioned above, that will continue to cause foreclosures in a declining market. In a rising market foreclosures are more avoidable because the house can be sold for more than the loan. Even in a flat market the three D's are a problem because of the transaction costs involved in selling a home.
But for those out there who went along quietly when the recipient of trillions was AIG or Citi,
This is one of the silliest things people are saying right now. Who, exactly, received that money? Was it shareholders? No, they were wiped out. Was it executives? Hardly; they were lucky to keep their jobs.
The primary recipients of the AIG money were the millions of AIG insurance policyholders, i.e. average people. They hadn't really made any poor decisions, and they weren't some ultra-rich elite.
Actually, I agree with MartyH. In modifying the mortgage into 200 (or whatever) years mortgage three things will happen:
1. No foreclosure
2. No taxpayers' money is involved (what is the most important part)
3 A bank will have to adjust its income which will lead to different kinds of problems. But they will be the bank's problems.
And this idea would not work because of point # 3.
"But as the interest rate falls, the percentage of the payment that's principal goes up, making it harder and harder to eke out enough savings on the interest rate to keep the borrower in the house."
This statement is incorrect.
I like how, when you consider human nature, you contrast "good" with "rational", as if the rational-maximizing choice was evil.
All the economist who are doing the modeling of defaults are assuming rational, and it is fitting the data pretty well.
Take a $200K loan at 7%. Your monthly payments are $1330; for the first year about 13% of that is principle.
Now look at it at 4%. Your monthly payments are $955; for the first year about 30% of that is principle.
I lean towards the "most folks will do the right thing and try to pay" theory.
Perhaps, although I still have trouble assigning moral weight to either choice. If a mortgage is non-recourse, both parties know that going in, so the contract is essentially "make your payments or surrender the house". Walking away is just exercising the "or" option, and I don't see how that's any worse than, say, breaking an apartment lease in the middle of the term (and paying any resulting penalties).
So what? I'm not sure what you are arguing has anything to do with the second important claim. Her statement is "...making it harder and harder to eke out enough savings on the interest rate."
Type:
PMT(0.05,10,100)
PMT(0.04,10,100)
PMT(0.03,10,100)
Into excel and play around with the results. Both the interest payment and the percent of interest paid are decreasing almost linearly with the interest rate; it doesn't get "harder and harder" to reduce either with the interest, at least to any major degree.
Her argument quasi-assumes (I'm guessing) that principle (or perhaps total payment) is constant with the interest moving, but the principle/total payment is a function of the interest rate - it'll always readjust lower with the lower interest rate.
Serious question -- are we approaching the point where many people will, for understandable reasons, decide that they may not need to make any more crippling debt payments, and that so many people will simultaneously arrive at this conclusion that the banking/credit system will collapse suddenly and utterly?
The 200-year idea won't work for the same reason most mortgages are about 30 years. Once you reach that point, the interest is such a large part of the payment that extending the loan outward doesn't reduce monthly payments all that much. To make a 200-year mortgage worthwhile, you would have to reduce the interest to almost nothing.
I'm surprised another reason to oppose the mortgage bailout isn't mentioned more in this thread (I know you're all aware of it, Megan is in this boat along with me). My wife and I live in an area where real estate values got particularly out of control. Rather than buy an inadequate house or over-extend ourselves, we chose to wait for the market to correct and rent in the meantime.
"Fairness" and market principles demand that we be the ones to stop the market slide--prices will stop falling when Megan and I and all the other renters who hope to buy decide the time is right to jump in and buy.
Instead, Obama wants use our tax money to prop up the values of these houses so that we have to pay more to buy. What's "fair" about that?
"The major obstacle is that the bank just services the loan. They take the payments and then send them off to the various security holders"
One solution to this that John Hussman mentioned was for the government to buy all the pieces of a mortgage-derived securities issue. Then it could authorize the servicer to modify the loans without any conflicts. Another approach, one that I suggested several months ago ("Why not this?") would be for the government to offer to buy loans at a discount and then modify them. There are some institutional investors (hedge funds) that own individual mortgages directly and would be in a position to sell them. I would think that the trustee, servicer, or whoever has fiduciary responsibility to the investors in mortgage-derived securities would have the authority to sell non-performing loans as well, if they determined that was in the best interests of their investors; but if not, that's a legal issue that would need to be addressed, as you say.
Megan:
How successful you think it will be depends on your view of human nature--do you think people are basically good, and will pay if they can...
You keep drifting back into this morality discussion, Megan. This is not about morality, it is about business. You wouldn't expect a corporation to do more than uphold its contractual responsbilities, or face the contractual consequences, under the law. Lenders had no basis for expecting anything different from home buyers, and neither should you.
A few facts:
The mortgage adjustment is for mortgages owned by Fannie or Freddie, so there wouldn't be a sliced'n'diced CDO issue.
The guidelines specifically mention that it is for those having decent payment history but being at risk income-wise.
"The Home Affordable Refinance program will be available to 4 to 5 million homeowners who have a solid payment history on an existing mortgage owned by Fannie Mae or Freddie Mac."
It is for owner-occupied houses with non-jumbo loans.
There will be no 100-year mortgages.
Reduction in principal seems to be an option (under exactly what circumstances not spelled out.)
"The modification sequence requires first reducing the interest rate (subject to a rate floor of 2%), then if necessary extending the term or amortization of the loan up to a maximum of 40 years, and then if necessary forbearing principal. Principal forgiveness or a Hope for Homeowners refinancing are acceptable alternatives."
The "guidelines" I'm reading do not specify that the loan returns to normal interest rates after five years, but I read that elsewhere.
Given that five-year window, it's pretty clearly trying to move some of the damage into the future, which is probably better than having all the economic damage all at once.
It's an interesting question as to why banks are (or have been) against loan modifications.
After all, foreclosures are a big loss for the bank.
Tanta from CR thought that an official loan modification in a few cases would force banks to recognize losses generally, so it's an accounting problem.
Banks renegotiating most mortgages is not possible because of the way the "income" from the loans has been split up, the transaction costs would be ridiculous. The mortgages that were not split up (securitized) are mostly among the banks and regions that are not in particular trouble from the housing "crash".
That said, if they could, renegotiating for longer terms or lower rates or both would often be in the mortgage holders' interests, if it could prevent (or at least reduce) defaults.
**That** is an empirical matter, and I doubt anyone actually has the data needed to settle it.
David Hackensack, the markets have been begging for such an action; from what I can tell, the banks are resisting opening up their books for this kind of parsing.
But untangling the knot of toxic assets and viable loans does seem to be the nut of the problem.
One has to wonder why, given what's at stake, the financial industry doesn't want the skein of loans and derivatives untangled. Is there some dark secret or further wrong-doing to be revealed?
Wesson, banks used to renegotiate the loan in borderline cases where the borrower just needs a little help (for the reason you mentioned--they don't want your house, they want your money), but that's not possible in many cases today because the bank doesn't own your loan. In fact, it is often impossible to identify who owns your loan.
This last issue has raised an interesting foreclosure problem that I have no doubt will become the next big headache for banks--in order to foreclose, the bank needs to produce the Note establishing their standing to pursue foreclosure. Because of securitization, not all banks can locate and/or produce the Note. Stopping the foreclosure process in its tracks.
FWIW, I am not the slightest bit mollified by the restrictions on the bailout that you list in your post.
Zic,
The only thing I can think of is that some financial institutions are afraid of additional write-downs, but given the current marks on some of these assets, it seems like the underlying mortgages might be worth than complex securities derived from them in many cases. What's the average amount recouped on a foreclosure, 40% of the loan amount? So even a securitized pool of (first) mortgages where every single mortgage is non-performing ought to have a residual value somewhere in that ballpark. Maybe they'd only be worth half that, but how does that compare to the market prices implied by the ABX indices?
Maybe I'm missing something obvious, but it seems like if the government offered to buy first liens for the lesser of 50% of their face amounts or 50% of their underling properties' current assessed values -- and then wrote down the mortgages by a slightly less amount -- it would be a win-win-win for the tax payers, investors in the mortgages, and the mortgage borrowers.
OWN-TO-RENT:
Seems like the Obama plan basically turns some homeowners into renters (for at least a while), since they probably won't come out with positive equity (not in this market.)
Turning an owner into a renter has the advantage of avoiding foreclosure. This is good for the bank and for the neighbors, and avoids the destruction of real value associated with the deterioration of a vacant house, and may help forestall an overshoot in RE price declines.
Maybe this is a more mollifying way of looking at it :)
I've had the idea previously of the "own-to-rent" foreclosure, in which a three-legged arrangement of bank, erstwhile owner, and property manager is made, so that the owner loses the house, but continues to live in it, but now paying rent to the property manager, who acquired the house (complete with tenant) at slightly above foreclosure prices.
Maybe the property manager and the bank would be the same party - property manager hired by the bank.
It's a shame to see a valuable resource (a house) losing money by standing vacant, while the owner loses their shelter - the disruption of foreclosure causes losses for all concerned.
Probably too complicated for banks to handle, though.
Given that there are proposals to bail out ... well, practically every industry you can think of, because it is about to collapse and the results would be DEVASTATING, I have a question I've been pondering that I guess I'll throw out for Ms. McArdle (or whomever) -
What, historically, have been recession-proof (or notably recession resistant) businesses? Really, or is it just myth? Might they be the same this time? If not, what is different?
I ask because my dad is in the beauty-salon supply business. One of the reasons he said he got into it (believe me, it wasn't because he knew anything about beauty salons) was because it was one of the industries (along with undertakers) that weathered the Depression without a hiccup.
I've always wondered if that was actually true, or just some hairdresser urban legend. I wonder if it will be true this time (he says he's seen no real slack-off of sales or signs of distress from his customers thus far, other than collateral damage from boyfriends and husbands getting laid off). I wonder if it was, or will be, true of other businesses.
Kathryn,
I'm dubious. I haven't done it myself, but it's apparently pretty easy to cut kids' and men's hair at home with a bit of practice. My grandma used to cut grandpa's hair and my brother's hair and anybody else who would sit still long enough. Moreover, with little girls or women, you can just let it grow and just neaten it up every so often. My 6-year-old daughter is now on a biannual haircutting schedule, which means it costs about $20 for the whole year. Presumably, even big people can stretch out the time between appointments or start coloring their hair at home. It would have to be pretty hard times before I would give up my expensive hairdresser, but it definitely wouldn't kill me to go from a $30 haircut to a $16 haircut.
"Rather than buy an inadequate house or over-extend ourselves, we chose to wait for the market to correct and rent in the meantime."
This attitude really isn't all that different from the people that thought house prices would always go up, although it's wrong for different reasons.
Amy,
I cut my kids, husband, and own hair at home, so I share your dubiousness. If I were to color it, I'd probably go pro, but that's because, working summers for my Dad, I've seen how horribly, horribly wrong that can go. Presumably during the Depression, women could easily have done a wash and set at home, but, the story goes, they didn't. Either they refused to cut back where their grooming was concerned, or they thought the smallish indulgence was worth it. Even if it were true then, I wonder if the cost of some fairly common sorts of upkeep these days (multi-toned blondes, I'm looking at you) would change the equation.
Anyhow, there are enough wonky types around here that I was hoping someone would actually have some data or something, or be curious enough to look for some.
You greatly underestimate the number of mortgages carrying very high interest rates after expiry of the initial period of ARM mortgages. The idea that there is "not all that much room to modify (mortgages) down to affordability" is simply untrue - rates on many mortgages are high enough that interest rate modification alone can make a major difference in monthly payments, especially considering the 3% difference between the current 5% general rate and the 2% possible through the program.
Moreover, that general interest rates are at 5% does not benefit many people with preexisting ARM mortgages who are stuck with high post "teaser rate" interest charges of 7% to 12%, and who cannot refinance because of changes in the value of their home leaving them without sufficient equity, because of loss of income, because of changes in qualifications standards for refinancing, etc.
In the NYT today, http://www.nytimes.com/2009/03/06/business/06wall.html?_r=1&partner=rss&emc=rss:
And further down the story:
I wonder if high-risk losses are hiding in the derivative books, preventing the untangling of the toxic assets.
"The 200-year idea won't work for the same reason most mortgages are about 30 years. Once you reach that point, the interest is such a large part of the payment that extending the loan outward doesn't reduce monthly payments all that much."
OK, I did the calculations, and here is what I found. If your interest rate is 4%, you would get a reduction in monthly payments of 30%. For 5%, it would be about 22%, for 6%, it would be 16%, and for 7%, it would be 12%.
By the way, this was the difference between a 30-year and a 100-year mortgage (which is what the original idea was). For 200 years, the percentages would be a little higher.
So unless I've made an error in my calculations, this comment is wrong.
Well, DUH! But there seem to be far too many who don't get that, and the reason is simply the suppression of critical information.
I believe that these "assets" (which are derivatives composed of securitized debt instruments (Collateralized Debt Obligations CDO) have a value that is so indeterminate that, once taxpayer money being fed into AIG and the banks dries up, the market value will go to nil, 0.
Any taxpayer funded guarantee to "cap the losses" will come into play, and the "market value" set by the private investors in a PPP arrangement, up to that cap, will be transferred directly from the taxpayers to the investor. See Krugman in the NYTimes on (I think) the 6th for a description of that process.
The value of the derivatives, based on the securities, based on the debt instruments, is indeterminate and cannot be "unwound" short of a level of evidentiary research typical of a fraud investigation. This is because (1) there was so much fraud involved in the creation of the original debt instruments, and (2) the institutions which packaged and sold them as securities and debts both knew of the fraud, and did not obtain and do not have even copies of the original instrument paperwork.
I will post the links to two papers on this in another comment, to avoid entanglement of this comment in "link moderation".
They are to an article by William K. Black, Assoc. Professor, Univ. of Missouri, Kansas City; Sr. regulator during S&L debacle, at the Huffington Post (The Two Documents Everyone Should Read to Better Understand the Crisis) and to an article (Interest rate 'freeze' - the real story is fraud) posted in December, 2007, at the SFGate site.