Paying Homeowners To Be Responsible

A few weeks ago, I wrote about how the Obama administration wants to let bankruptcy judges reduce both the interest rate and the principal (also known as a cramdown) for bankrupt homeowners who bit off more than they could chew. Now, the White House wants to pay homeowners for being good boys and girls by paying their bills. Here are a couple of clips from a WSJ article:

"...Loan-servicing companies will receive up to $3,500 from the government to participate, with the government also matching a portion of the lenders' costs, dollar-for-dollar. Homeowners will get as much as $5,000 apiece in federal money to reduce their outstanding balances, as a way to encourage them to stay current on the modified mortgages..."

"...Borrowers will have to sign affidavits attesting to their financial hardships. In return, they will see their interest rates drop to as low as 2%, their payment periods lengthened, and other modifications aimed at bringing their monthly payments to 31% of their income -- commonly considered a reasonable ratio. This program will be limited to first-lien mortgages with outstanding principal balances that don't exceed $729,750, in the case of single-family homes...."

I'm not a homeowner, but if I was, I would get a bit nauseous every time I read the above. As a renter, I still find it irksome. It's almost as though the smarts folks who are running the show have no understanding of the term "moral hazard."

But, then again, the housing situation is so bad that such measures may be necessary. After all, if all these struggling homeowners lose their homes, whole neighborhoods will decline, and when that happens, vacated homes will get trashed. Who is going to want to buy a home that's infested with rats, mice and roaches, and has had all the its copper plumbing stripped out? That's the reality of the American housing sector right now.

Exactly how many homeowners are underwater? Here's a clip from a Bloomberg article:

"...More than 8.3 million U.S. mortgage holders owed more on their loans in the fourth quarter than their property was worth as the recession cut home values by $2.4 trillion last year, First American CoreLogic said.

An additional 2.2 million borrowers will be underwater if home prices decline another 5 percent, First American, a Santa Ana, California-based seller of mortgage and economic data, said in a report today. Households with negative equity or near it account for a quarter of all mortgage holders..."

And here's the latest on delinquencies, from today's Mortgage Bankers Association press release:

"...The delinquency rate for mortgage loans on one-to-four-unit residential properties rose to a seasonally adjusted rate of 7.88 percent of all loans outstanding as of the end of the fourth quarter of 2008, up 89 basis points from the third quarter of 2008, and up 206 basis points from one year ago, according to the Mortgage Bankers Association’s (MBA) National Delinquency Survey.

The delinquency rate breaks the record set last quarter and the quarter-to-quarter jump is the also the largest. The records are based on MBA data dating back to 1972.

The delinquency rate includes loans that are at least one payment past due but does not include loans somewhere in the process of foreclosure. The percentage of loans in the foreclosure process at the end of the fourth quarter was 3.30 percent, an increase of 33 basis points from the third quarter of 2008 and 126 basis points from one year ago. The combined percent of loans in foreclosure and at least one payment past due was 11.18 percent on a seasonally adjusted basis and 11.93 percent on a non-seasonally adjusted basis. Both of these numbers are the highest ever recorded in the MBA delinquency survey..."

Instead of borrowing and spending hundreds of billions of dollars with all kinds of convoluted government programs aimed at jump starting the economy, why not give every American household a prepaid credit card for $100,000. The idea seemed a bit crazy to me months ago, but it doesn't anymore. Bottom line:

• It would cost less than all the government plans being implemented.
  
  
• It would be fair, because every household would get an equal amount, including those who are already rich.
  
  
• It would get Americans spending again, no doubt. The housing sector would be back on track in no time.
  
  
• Corruption and wasteful spending wouldn't be an issue, since the money would go directly to the American people.
  

But what about inflation? Here's my plan:

• As a preemptive move, the Fed would raise short-term interest rates just before the Treasury Department issued the prepaid cards. All quantitative easing and cheap money programs would end immediately.
  
  
• Spending limit on each card would be set to around $5,000 per month with only one exception: consumers would be able to use more to make a down payment on a home, or to buy a home outright. Program would have a "use it or lose it" policy.
  

No spending on luxury items (luxury cars, boats, etc.) Eating out? OK. Investing in stocks? No problem. Want to buy new, energy saving appliances or install solar panels on the roof? Yes! Pay contractors to build you a new kitchen? Go right ahead! Use the cash to start a business? By all means! Want to send your problem child to a private boarding school? Start packing. Pay your taxes? Absolutely.

Let's take this idea to the American people with a referendum. Give voters the option of the above plan, or to continue with the administration's plans.

I'm a big fan of Barack Obama. I just don't like some of his administration's ideas related to fixing the housing problem.

As a final note, everyone should listen to the recent Bad Bank episode of the NPR radio program This American Life. It's really great (then again, this show is always great. I also highly recommend MarketPlace on NPR.) The Bad Bank episode contains a very compelling, private-sector solution to the housing mess. The program also explains why the banks aren't lending, despite having received billions in federal aid. Grab yourself a cup if coffee and enjoy.

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The Helping Families Save Their Homes in Bankruptcy Act of 2009

A couple of years ago, the mother of my child moved out of the townhouse where I still live (and rent) and moved into a coop nearby. It was (and still is) my opinion that it's never a good idea to buy a home when you have no cash in the bank, but she did it anyway. I had cash, but not enough to make me feel comfortable about buying a nice home in a decent neighborhood, and put 20% or more down. I decided to continue renting, even though I could have qualified (easily) for an ALT-A mortgage. I felt that it was the right move: continue renting for a few more years, then buy a really great home when I had enough cash in the bank.

The mother of my child is struggling now, and she may have to file for bankruptcy protection. H. R. 200, the Helping Families Save Their Homes in Bankruptcy Act of 2009, is a bill that, if enacted into law, would empower bankruptcy judges to modify the terms of a mortgage in bankruptcy court. A bankruptcy judge would be able to lower both the principal and the interest rate on a mortgage loan. A lot of American see this bill as an unfair helping hand for homeowners who bought a home they really couldn't afford. Here is how John Conyers, Jr., the bill's main sponsor, explains it,

"...The legislation before us today would grant bankruptcy courts the ability to modify the terms of a home mortgage in a chapter 13 bankruptcy to bring them closer in line with the value of the home in a depressed real estate market.

For families in dire distress, this is a much-needed reform. And considering the realistic alternatives, it is fair – to all concerned.

I have been working on this legislation – on a bipartisan, bicameral basis – for nearly two years, because I believe it represents one of the most tangible steps we can take to limit the fallout from the real estate depression sweeping the nation.

While bankruptcy reform may not provide all of the answers to this crisis, surely it provides a common-sense and practical approach to helping stop the spiral of home foreclosures – which are not helping anyone.

To those who say we should continue to hold up this legislation while we seek to encourage voluntary mortgage loan modifications, outside of bankruptcy, I would point out that the evidence has shown that such modifications don’t work.

For one thing, most of the servicers who control the mortgage loans are not even legally permitted to agree to voluntary modifications.

And even when they can agree, their financial incentives are stacked in the direction of foreclosure.

As a result, the much-vaunted “Hope for Homeowners” program, which went into effect last October with the goal of helping hundreds of thousands of distressed homeowners, has processed less than 400 applications to date.

To those who claim that this legislation will only end up harming consumers by increasing the cost of credit, I would respectfully suggest that they are not taking account of the track record of the modern-day Bankruptcy Code, and have perhaps not kept up with the latest changes we will be making to the bill today..."

"...Finally, to those who argue that this legislation constitutes some form of “moral hazard” that will encourage reckless borrowing in the future, I would simply ask them to come to Detroit.

Detroit has had more than 100,000 foreclosures over the last three years. And they are continuing at the rate of 126 each day. We have block after block of “for sale” and foreclosure signs – feeding off each other, driving down home values, uprooting families, decimating communities – and causing local tax revenue that pays for police and firefighters to plummet.

We don’t have the luxury of worrying about theoretical future moral lessons; we need to stop the actual bleeding today. And the same is true in Ohio. And in California, and Florida, and Nevada, and Massachusetts, and Arizona – and in countless communities all across the country.

If we can spend 700 billion dollars to bail out the brokers on Wall Street, it seems the very least we can do is allow working families, willing to repay their debts as best they can, under court supervision, the dignity of being able to stay in their home..."

It's all pretty convincing, until you reach the part about increasing the cost of credit. I'm not an economist, but it's clear to me that this bill would increase the cost of credit, making it harder for responsible borrowers to buy a home. Mr. Conyers is not being realistic. When a bank prices a loan, the primary factor is risk. Giving bankruptcy judges the power to modify mortgages would obviously make loans riskier, which would in turn drive up interest rates.

Mr. Conyers then tries to dismiss the moral hazard issue like it's some theoretical nonsense. He doesn't seem to get that, for responsible borrowers, it's an issue of fairness . Mr. Conyers, it seems, doesn't mind rewarding the irresponsible. H.R. 200 would legitimize reckless borrowing at the highest possible level by condoning it in the United States Code.

And now for the counter. George Mason University law professor Todd Zywicki wrote an extremely poignant article about this issue in the Wall Street Journal:

"...The nation faces a foreclosure crisis of historic proportions, and there is an understandable desire on the part of the federal government to "do something" to help. House Judiciary Chairman John Conyers's bill, which is moving swiftly through Congress (and companion legislation introduced by Sen. Richard Durbin) would allow bankruptcy judges to modify home mortgages by reducing both the interest rate and principal amount on the loan. This would be a profound mistake.

Mortgage modification would indeed provide a windfall for some troubled homeowners -- but its costs will be borne by aspiring future homeowners, and by any American who uses credit of any kind, from car loans to credit cards. The ripple effects could further roil America's consumer credit markets.

In the first place, mortgage costs will rise. If bankruptcy judges can rewrite mortgage loans after they are made, it will increase the risk of mortgage lending at the time they are made. Increased risk increases the overall cost of lending, which in turn will require future borrowers to pay higher interest rates and upfront costs, such as higher down payments and points. This is illustrated by a recent example: In 2005, Congress eliminated the power of bankruptcy judges to modify auto loans. A recent staff report by the Federal Reserve Bank of New York estimated a 265 basis-point reduction on average in auto loan terms as a result of the reform.

Allowing mortgage modification in bankruptcy also could unleash a torrent of bankruptcies. To gain a sense of the potential size of the problem, consider that about 800,000 American families filed for bankruptcy in 2007. Rising unemployment and the weakening economy pushed the number near one million in 2008. But by recent count, some five million homeowners are currently delinquent on their mortgages and some 12 million to 15 million homeowners owe more on their mortgages than the home is worth. If even a fraction of those homeowners file for bankruptcy to reduce their interest rates or strip down their principal amounts to the value of their homes, we could see an unprecedented surge in filings, overwhelming the bankruptcy system.

Finally, a bankruptcy proceeding sweeps in all of the filer's other debts, including credit cards, car loans, unpaid medical bills, etc. This means that a surge in new bankruptcy filings, brought about by a judge's power to modify mortgages, could destabilize the market for all other types of consumer credit.

There are other problems. A bankruptcy judge's power to reset interest rates and strip down principal to the value of the property sets up a dynamic that will fail to help many needy homeowners, and also reward bankruptcy abuse.

Consider that the pending legislation requires the judge to set the interest rate at the prime rate plus "a reasonable premium for risk." Question: What is a reasonable risk premium for an already risky subprime borrower who has filed for bankruptcy and is getting the equivalent of a new loan with nothing down?

In a competitive market, such a mortgage would likely fetch a double-digit interest rate -- comparable to the rate they already have. Thus, the bankruptcy plan would offer either no relief at all to a subprime borrower, or the bankruptcy judge would set the interest rate at a submarket rate, apparently violating the premise of the statute and piling further harm on the lender.

More worrisome is the opportunity for abuse.

Imagine the following situation: A few years ago a borrower took out a $300,000 loan with nothing down to buy a new house. The house rises in value to $400,000, at which time he refinances or takes out a home-equity loan to buy a big-screen TV and expensive vacations. He still has no equity in the house.

The house subsequently falls in value to $250,000, at which point the borrower files for bankruptcy, the mortgage principal is written down, and the homeowner keeps all the goodies purchased with the home-equity loan. Several years from now, however, the house appreciates in value back to $300,000 or more -- at which point the homeowner sells the house for a tidy profit.

Nothing in Mr. Conyers's proposed legislation would prevent this scenario from occurring. To modify a mortgage, a borrower would have to enter a Chapter 13 repayment plan for five years. If the homeowner sells his house while he is still in bankruptcy, the mortgage lender can recapture some of any appreciation in its value on a sliding scale -- 80% the first year, 60% the second, 40% the third, and 20% the fourth. After that, however, any appreciation in the value of the house goes into the debtor's pocket.

This dynamic creates obvious opportunities for borrowers to file for bankruptcy to strip down the value of their property in anticipation of rising real-estate markets down the road. At the very least, Congress should extend the time period for allowing lenders to recapture home appreciation beyond five years.

Mortgage modifications during bankruptcy will almost certainly increase the losses of mortgage lenders -- and this may further freeze credit markets. The reason is that when mortgage-backed securities were created, they provided no allocation of how losses were to be assessed in the event that Congress would do something inconceivable, such as permitting modification of home mortgages in bankruptcy. According to a Standard & Poor's study, most mortgage-backed securities provide that bankruptcy losses (at least above a certain initial carve-out) should be assessed pro rata across all tranches of securities holders. Given the likelihood of an explosion of bankruptcy filings and mortgage losses through bankruptcy, these pro rata sharing provisions likely will be triggered. Thus, the holders of the most senior, lowest-risk tranches would be assessed losses on the same basis as the most junior, riskiest tranches.

The implications of this are obvious and potentially severe: The uncertainty will exacerbate the already existing uncertainty in the financial system, further freezing credit markets.

If Congress wants to deal with the rising number of foreclosures, it should not create a new mess by converting the mortgage crisis into a bankruptcy crisis. Doing so will open the door to a host of unintended consequences that will further freeze credit markets, raise interest rates for new home buyers, and spread the mortgage contagion to other types of consumer credit. Congress needs to reject this plan and look for better solutions..."

Sorry, but I just had to quote the whole thing. I didn't want to dilute the power of the article by leaving anything out.

I've been watching the credit crisis very closely since it began, and I think Todd Zywicki is right on all points.

I found myself cheering as I watched CNBC's Rick Santelli tell it like it is:




Yes, calling misguided homebuyers "losers" on national television was indelicate. Mr. Santelli could have been a bit more diplomatic in his tirade, but no one should hold that slip of the tongue against him. When you're fired up, sometimes the wrong word slips out. Happens to the best of us.

So, what does H.R. 200 do for folks like me who made responsible, housing-related decisions when others did whatever they wanted? What does it do for those responsible borrowers who put 20% down and bought the right-sized house, and who now owe more on their mortgage than their home is worth? Nothing. Lots of decent Americans are getting very hot under the collar about the government's fixes for the economic crisis. Lots of hard working, responsible Americans have been gnashing their teeth as careless mortgage borrowers and Wall Street banks get generous bailouts, while they get...well, they get to sit in their underwater homes and watch.

The American Recovery and Reinvestment Act of 2009, which was recently signed into law by President Obama does offer some help for those who may be looking to buy soon. That help comes in the form of a homebuyer tax credit:

"...$8,000 credit for all homes bought between 1/1/2009 and 12/1/2009 and repayment provision repealed for homes purchased in 2009 and held more than three years..."

The Senate wanted a $15,000 tax credit. It's a shame they didn't get their way.

The new law also contain these provisions:

• $2 billion to help communities purchase and repair foreclosed housing
• $200 million for helping rural Americans buy homes

Hmmm...Maybe it's just me, but these numbers seem kinda' wimpy considering the scale of the entire package. At the core of this nation's economic woes is a major housing crisis, so I think the spending in this arena should be as aggressive as possible. Lawmakers should make sure that people like me have all the help we need to go into a distressed neighborhood, buy a foreclosed home on the cheap and fix it up. Without the boldest possible action, I fear that the housing crisis will still be with us 2 years from now.

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If the mother of my child ends up loosing her home, my daughter always the option of moving back with me. I recently fixed her up her room with a desktop computer I put together with mostly salvaged parts from other PC's.

Foreclosed homeowners can move back to renting. What's wrong with that? There's nothing wrong with renting!

I think the big question is: do we, as Americans, want to be a nation of Sullenbergers or a nation of Sulemans? There's a great WSJ article by Peggy Noonan here.

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