Opinion

Felix Salmon

Why mortgage principal reduction isn’t happening

By Felix Salmon
March 25, 2010

BofA’s “earned principal forgiveness” program looks very similar to the Responsible Homeowner Reward plan of Loan Value Group that I wrote about yesterday. In both cases, homeowners staying current on their mortgage payments get a reward after a certain number of years — a principal write-down on their mortgage in the first case, and an old-fashioned cash payment in the second.

I think I prefer the cash payment to the principal write-down, assuming that the write-down would cost the bank just as much money as a cash payment would. While the effect on the homeowner’s balance sheet is the same, most people would prefer a pile of cash to a principal reduction — especially if the principal reduction is taxable, which it might well be, in five years’ time.

There are two problems with such programs catching on, however. The first, as detailed by Shahien Nasiripour, is that Treasury’s loan-mod program seems designed to use principal reductions only as a last resort. And the second is the fact that although such plans can benefit both borrowers and lenders, that doesn’t mean that everybody ends up happy. Tom Brown reprints with approval this letter:

Dear Mr. Moynihan,

I awoke this morning to read that Bank of America intends to begin forgiving mortgage principal for delinquent borrowers. I am writing to inform you that I will never bank with your firm ever again.

Principal forgiveness is an affront to every responsible, non-delinquent borrower in your book of assets… you are rewarding those who bit off more than they could chew, while those who did not take on excess leverage, or who kept their income-to-debt ratios manageable, see no benefit, even as their home equity values have declined. Even worse, you are denying savers who sit in the cash market the opportunity to purchase inventory from the delinquent.

Capitalism should migrate assets from the weak to the strong, not the contrary… allowing those who are delinquent to now benefit from their financial excesses is a despicable solution that ignores the integrity and responsibility of those who actually finance the lion’s share of your earnings: those who don’t default.

I’m not entirely clear how banks are supposed to give their savers the opportunity to buy distressed real estate, or why anybody thinks that’s a particularly good idea. But what’s abundantly clear, not only here but in the comments to my Loan Value Group blog entry, is that the anger behind the infamous Santelli tea party rant has not gone away, and that if people hated the idea of interest-rate reductions on mortgages back then, they’ll really hate the idea of principal write-downs now.

Bankers are always on the look-out for a good excuse not to engage in principal write-downs, and this is another arrow to add to their quiver of such excuses: doing so will enrage and inflame their customer base.

Remember too that it’s pretty much impossible to quantify the upside, to a bank, of a principal reduction, since doing so requires calculating exactly how much the probability of redefault has been reduced. Bankers, as we know, like to do things that make their bank money in quantifiable ways, so that they can then show their boss how much money they’ve made, and ask for a nice seven-figure bonus at the end of the year.

For all these reasons, I suspect that BofA’s move into the world of principal reduction will remain very small-scale, and that insofar as the practice takes off, it will do so only among hedge funds and others who have bought mortgages on the secondary market. At least unless and until Treasury modifies its modification principles.

Update: WaPo is now reporting that “For the first time, the government will offer financial incentives to lenders that cut the principal these homeowners owe on primary mortgages.” I’ll believe it when I see it, although this is undoubtedly encouraging.

Comments
16 comments so far | RSS Comments RSS

1/3 of all foreclosures are now strategic and banks are coming hard after these folks that can afford the mortgage but walked away from the home and its obligations. Judge approved liens and penalties are finding these strategic walk away-ers

Posted by Story_Burn | Report as abusive
 

“Principal forgiveness is an affront to every responsible, non-delinquent borrower in your book of assets… you are rewarding those who bit off more than they could chew, while those who did not take on excess leverage, or who kept their income-to-debt ratios manageable, see no benefit, even as their home equity values have declined”

On one level I can totally understand that response. But at the same time it seems totally misplaced. Be angry at BofA, sure, but be angry at them for lending it to the borrowers in the first place, not for the principal forgiveness! Bank of America rewarded people who bit off more than they could chew by feeding them the stuff in the first place, giving them excess leverage and not restricting their lending to manageable debt to income ratios.

“Capitalism should migrate assets from the weak to the strong, not the contrary”

True enough, but that’s also a pretty good reason why unmitigated capitalism is a moral disaster area. A world in which assets always migrated from the weak to the strong would not be a pleasant one.

Posted by GingerYellow | Report as abusive
 

Mr Nasirpour would be less angry if he looked at it this way:

The home-owner defaulted and walked away from the home. The bank foreclosed, took ownership, and instead of cleaning the home and paying a real estate agent to sell it, called the current homeowner and sold it to him/her at the current market price.

I hate that this can benefit people who got in over their heads. But, the fact remains that many are simply good people who lost their jobs ad are unable to make payments.

Mark Wolfinger
http://blog.mdwoptions.com

Posted by MarkWolfinger | Report as abusive
 

I side with Nasirpour’s general attitude but would rephrase the question in moral philosophical terms:
Why should those who have been prudent and have saved suffer more (assuming this is indeed the case) than those who have not?
It is not a question of ‘unmitigated capitalism’ but a question of what will allow capitalism to function better and more fairly. If savers are consistently penalised (by income taxs and inflation) borrowers will also suffer if savers are pushed into withdrawing from the monetary system, or participating in the unprudent speculative games.

Posted by ed33 | Report as abusive
 

“I’m not entirely clear how banks are supposed to give their savers the opportunity to buy distressed real estate, or why anybody thinks that’s a particularly good idea.”
Foreclose and put the house on the market or allow more short sales. We need prices to reset. It’s not specifically BofA’s savers that will benefit, it’s all of us that have been keeping cash on the sidelines until the market is allowed to fully adjust.

The solutions are simple- any benefits offered must accrue to everyone, since it is hard to tell the irresponsible from the unfortunate (not to mention the responsible from the fortunate).

Posted by mattmc | Report as abusive
 

There are plenty of ways to increase net welfare for the bank-borrower relationship that don’t involve principal forgiveness. Allowing short sales, forgiving late payments that are later remedied, the bank taking ownership and renting to the borrower, extending the length of the loan, modifying a complex loan to eliminate terms that were based on borrower error or lender fraud, etc. Principal forgiveness is handing free money to people who made mistakes. Remember that anyone who bought a reasonable home in a reasonable neighborhood on decent mortgage terms with 20% down and has been making their payments is nowhere near underwater, and is in fact paying exactly what they expected to pay for the house they wanted to live in.

I still see NYC homes going off at joke prices, which I define as prices that have no logical relationship to the income of the typical occupants for that level of home or the sustainable rents that the property could generate over time. The only reason for this continued high level is government’s and banks’ need to pretend that a lot of arrangements don’t need to be liquidated and can be salvaged by pouring in a bit more of the subsidies that got us here.

Posted by najdorf | Report as abusive
 

This is Bank of America we’re talking about here. The same bank that gave people illicit cash incentives to assume mortgages, not all of which have gone sideways (although not for want of the same bank spinning many of them into cotton candy).

Whatever it is they’re really up to, they’re definitely not looking for ways to give away all the back end margin to people in or out of distress. They’re way ahead of the touching definition of capitalism proffered by anonymous writer Brown “quoted” or, more likely, made up.

That bank could give a tinker’s damn whether principled people like them or not. It’s not, and recently never has been, popular approval they’re after.

They’re going to do whatever looks best on BofA’s books in the short run, and by the time you’ve figured out how much it was really worth to them to keep this shell game revolving (actual mortgages representing Higgs boson mass value relative to BofA’s overall derivative complex), dividing and ruling the market of frontline attitude as they go, the actual margin will be in just about anybody’s hands except those who thought they were really buying a house or two they could – more or less – reasonably afford, if they’d been doing business with a real bank.

Posted by HBC | Report as abusive
 

This mornings announcement is another inadequate response. The banks are going to either be forced to write more of their debt through short sales or increase the shadow inventor.

We still have two more waves of resets ahead of us…can’t wait to see the Feds and Treasuries policy response.

Posted by csodak | Report as abusive
 

In many cases the repossessing banks find they can’t sell the property, because there are no buyers, even at a fraction of the official assessed price.
There is a substantial surplus of repossessed homes on the market, and an even bigger ‘shadow’ surplus of homes that would have been already foreclosed in ordinary times.
Under such circumstances the banks don’t seem to have too many choices.

Posted by yr2009 | Report as abusive
 

I think giving people cash, while better for the borrower in theory doesn’t really help the bank. Think about it: if the main problem is that borrower is underwater, giving him some cash which does not apply to principal reduction leads to a borrower that’s *still* underwater on their loan. (Assuming that housing bubble doesn’t reinflate by then and that the borrower was significantly underwater.)

Worse still, a principal reduction on a loan that would otherwise default doesn’t actually cost the bank anything (unless of course they end up writing down the value of other mortgages as well), giving someone cash does.

The principal reductions sound like a win-win. Giving out cash sounds like throwing good money after bad.

Posted by vgalis | Report as abusive
 

But I thought only the bankers were at fault. Americans living beyond their means are deadbeats, scoundrels, squatters, looters, and a few things I dare not write.

Being the compassionate liberal that I am, I recognize that there is nothing I can do about the human failings illustrated by our housing bubble. I can condemn the deadbeat borrowers and predatory finaciciers, but I cannot change them. Their crimes are so vast they threaten to suck me into the vortex of their evil. I will drown with them if I refuse to help so like a good soldier in Iraq and Afghanistan sacrificing his life for an undeserving nation, I am forced to help an unworthy population. It’s sad.

Posted by silliness | Report as abusive
 

“Remember that anyone who bought a reasonable home in a reasonable neighborhood on decent mortgage terms with 20% down and has been making their payments is nowhere near underwater, and is in fact paying exactly what they expected to pay for the house they wanted to live in.”

I have a conventional 30 year 80%LTV and I am over 60% underwater. I live in a very nice neighborhood. My FICO is close to 800. I have never been more than a couple days late on my mortgage. I am with BofA via the Countrywide route and must be one of the very few that did not lie to get a loan. Loan payment is probably 20% of gross income.

I feel the moral hazard is with the banks, who along with their brokers, heated up a real estate market by using loose underwriting standards. Then they securitized the mortgages and screwed their investors. THEN they screwed the USA by requiring bailouts, at which time they rewarded, or tried to, the very same crooks that created this mess. Remember, the banks and mortgage companies are experts in real estate markets, not those of us that purchase once a decade or less. Don’t preach moral hazard to me BofA, et al.

I will pay my mortgage until my income adjusts down or I come to my senses. If I walk away, which I can do and then pay cash for the same house across the street, I only feel sorry for the investor that the banks have screwed over along with those of us that are not professionals in evaluating real estate markets nor can exercise undue influence over our appraisers as the banks could and still can.

Posted by curmudgeonman | Report as abusive
 

While we are on the topic of forgiveness due to a poor investment, what about all the retirees (or soon to retire) who suffer equal or greater perils in their 401(k) accounts. As most homeowners currently suffer losses on their “investment” so do other asset holders, such as 401(k) participants who have purchased stocks and bonds only to watch them melt away over the last couple of years when they needed it most. Where do the bailouts stop? Can everyone claim ignorance where there is risk? I think there is no doubt the government would support housing as an investment and as almost any investment discloses “past performance is no indication of future results.” Over-consumers should suffer the consequences of their choices, otherwise we enable governments to enter win-win situations with the successful speculators and those left holding the bag. The only losers are the ones that are the silent majority – the American Taxpayer. Everyone at some point in life learns a valuable lesson that effects their lives from that point on – let this be theirs.

Posted by arma2009 | Report as abusive
 

The one thing I noticed is not discussed is who put us in this mess in the first place. Starts with Banking, ends with Industry. I happen to have a loan with a balloon due in a few years. Now all the banks have rolled up the red carpet of lending and now do not lend with nearly the same criteria as before and they have destroyed the value of my home. Hence, no options remain. So, strategic default appears the only solution, one which has created havoc in my life as up to now I have always paid my bills and taken care of my obligations, so I do this reluctently as it is the only option left. Should banks reduce principal to save a loan, it is up to them. Since their irreponsibility destroyed any chance of equity in my house, seeing them take the loss seems somehow appropriate and unavoidable. For if I leave, they will certainly take the loss, either way a loss will be had. I do not feel one bit sorry for the pain of the banks right now as their greed created it with irresponsible lending practices which affected the values of everyones home. Am I responsible for the situation? Yes, I share in the responsibility as buying a home with so little down was attractive even though not very sensible as it turns out. So the suffering now is of my own creation as well. But in this, lets not forget it takes 2 to tango, the Banking Industry messed up and so did I, there will be no winners in this all as I may have to move my family out of a place we call home because of all of this and the bank will surely take a loss. So, we may comment and pass blame all we like, any way you slice it, all will take responsibility for their actions as their are no innocent parties here.

Posted by StatDef0 | Report as abusive
 

I found a Private Money Source which I used and it reduced my principal to 80% LTV, yes I now have 20% Equity. No it was not free and yes I had to qualify.
I did it, I was not behind, I did not have to hurt my credit and I did not do a Loan Modification. Due to the restrictions of this site, write to me marksman954@aol.com to discuss with me, the solution to this UpSideDown crisis. Please, do not think you must be UpSideDown, there is a solution, I did it, you can too.

Posted by Icanhelpyou | Report as abusive
 

If a bank is willing to sell a house via short sale, why not just reduce the owner’s principal? I have a neighbor who hasn’t paid his mortgage for two years, but is still living there. He lost his job, but is now working again (for much less). The bank is trying to sell the house for $100K less than his mortgage and no one is interested. Whay not just reduce his principal by, say, $70k and refinance him with a slightly higher interest rate? Everyone wins, sort-of.

Posted by G8rfan | Report as abusive
 

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