How to clean up the muddy mortgage mess

October 27, 2010

Felix Salmon has written extensively about the ongoing mortgage crisis, from the problems with mortgage bonds to the impact of foreclosures on bank stocks. Here is a new video in which Felix offers a potential solution, in the form of principal reduction.

Posted by James Ledbetter.

22 comments

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Issuing new mortgages with principal reduction addresses 1/ legal issues with previous mortgages and 2/ underwater homeowners who have little incentive to pay for a mortgage worth more than their house.

But what about the moral issue behind any sort of systematic principal reduction program? Why would some people get a free gift like that and not others? After all, I’d be happy to have a principal reduction on my mortgage too.

Posted by MatNYC | Report as abusive

This seems to combine a simplistic approach that the banks would actually want (just paper over the thing and say everyone has a fresh, clean mortgage) with a more or less orthogonal issue (the principal reduction approach to the underwater problem) that the banks would dislike.

What do these have to do with each other, apart from each being a component of the larger current mess? I guess doing both at once would make the paperwork a bit easier, but considering neither has broad support this seems like a non-starter (unless all those objections cancel out somehow when combined).

Posted by absinthe | Report as abusive

this problem has no solution only prevention. this is a cancer. the capital gain on property must be taxed at (100–LIBOR)% once there is no gain there wont be any speculation and when there is no speculation there wont be any buyer who does not need a home to leave. This mess is as if Bill Bates & Warren Guffet buying all food grains produced for next 10 years and inflating burger price to $50.

Posted by Robot | Report as abusive

good ideas get implemented only in Utopia.

Posted by whistle_blower | Report as abusive

good ideas get implemented only in Utopia.

Posted by whistle_blower | Report as abusive

In fact I had even better idea 2 years ago during the financial meltdown. Instead of bailing out bank directly, I wanted the government to pay off part of the mortgage principal of homeowners to the banks.

This would have helped homeowner by reducing monthly payments, helped banks by giving them instant boost of extra money, helped avoid foreclosures and walkaways, helped draw a line under falling property prices.

If only good ideas ever get heard in the chambers in DC.

Posted by whistle_blower | Report as abusive

The problem with this “solution” is that it’s not that these mortgages are generally unenforceable. It’s that the big banks can’t demonstrate that they have standing to enforce the mortgage. The specifics are going to vary on a case-by-case basis, but it’s unlikely a lot of these people have free-and-clear title to their homes. Plus the costs of curing paperwork and sorting out who has what right to sue is expensive, but at the end of the day, it’s probably less expensive for the banks than writing down outstanding balances.

On the margin, these costs additional costs to foreclosure might seem to make modifications seem more attractive, but that would only effect some home-owners.

Also, even if your solution did work to avoid mortgages and reduce principles, what about the “push-back” problems? That seems to be the most significant problem in this whole mess, but I see nothing in here that is going to prevent investors from rescinding MBS purchases.

Posted by cgotterba | Report as abusive

This is a truly viable and in the end the most cost effective solution and ought to be extended to all homeowners to eliminate any moral issues and offer the benefit of lower interest rates to all homeowners. This can be accomplished with universal short documents to simplify the process with further legal expenses.

Posted by amj | Report as abusive

Let’s Cut the *#%## on the Housing Debate
=====================================
The current debate about the housing market and the foreclosure debacle glosses over the central point – Wall Street is set to make allot of money so foreclosures will continue. There have been numerous studies by the Congressional Research Service (CRS), the TARP oversight committee, and consumer groups such as the NCLC- National Consumer Law Center that highlights this truth[1].

Wall Street versus Main Street is always a lopsided duel with the winner already predetermined by K street lobbyist. Main Street is out gunned and out manned in this battle so is there a way for both sides to win.

Main Street and its supporters must not fight Wall Street but work within the market dynamics to achieve a win-win. The central goal of Main Street is allowing homeowners who could afford to stay in their home a means to do so without impairing the economic interest of Wall Street. Homeowners in the most need are those with underwater mortgages that must be written down to restore their economic value. Unable to achieve a principal reduction of their existing loan for a number a legal reasons which are not going to change anytime soon; the question is how to achieve this simple objective. The current problem is that once homeowners are foreclosed they transition into credit hell unable to obtain loans for seven years. There homes are then sold at fire sale prices equivalent or below the point that the foreclosed homeowner could afford. Everyone on all sides agree that this is a sub-optimal situation but no one wants to be seen rewarding homeowners who made bad decisions or facing Wall Street wrath if one impedes their economic interest.

The solution to this dilemma is the creation of a Main Street Preservation Fund (MSPF) that would buy houses from Banks at 60% of their FMV and resell them back to homeowners at 70% to 80% of their FMV. Funding such a fund would be possible under the various federal programs. Federal money would attract the billion in Wall Street money that is sitting idle and looking for positive returns. Homeowners under the program would not avoid foreclosure thus penalizing them for their poor decision but not leaving them and us in worst position than before. The program would provide a road to redemption. MSPF would hold the mortgage for up to 24 months before selling them to the GSEs (Fannie Mae and Freddie Mac) under their existing programs such as Mycommunity and Homepossible. During the 24 month period homeowner would be required to attend credit and budget counseling classes.

The Main Street Preservation Funds could be established for each state and in certain cases where there is a foreclosure crisis (FL, NV, CA, IL, and MI) funds could be established by county. MSPF attractiveness to investors could be enhanced with application of state Neighborhood Stabilization Program (NSP) funds and New Market Tax Credits. There are over $2b in unused tax credits awarded by Treasury of which $800m are with TARP funded banks.

While the MSPF will not address every case, it does provide an effective market means to help homeowners who fall outside of Federal programs. No legislative action is needed to implement it. It provides Banks an effective means to dispose of properties without impeding the economic interest of their Wall Street clients and provides Wall Street an effective way to do well by doing good. MSPF fund would earn a gross return of 16% to 20% which in this day and age is pretty good. To reinforce their social mission, MPSFs could be launched as REIT to allow everyday Americans a means to help their neighbors, earn a positive return, and help preserve home values by reducing the needless overhang of foreclosed houses. We also have to believe that the Banks and Wall Street are composed of everyday Americans as well who are looking for a effective market oriented means to help out in this crisis.

Homefree USA a national non-profit based in Washington, DC is at the forefront of Main Street Preservation Fund movement. They are in discussion with the leading Banks to launch Main Street Preservation Funds. With the latest foreclosure issue of messy legal paperwork, everyone is a looking for an effective means to deal with the central issue of keeping American in their homes.

Posted by dctruthseeker | Report as abusive

If I were living in a house where I couldn’t afford the rent, I would move. Yet for some reason, these renters think they are owed a rent reduction because, well, they don’t want to move. Curious.

Posted by silliness | Report as abusive

cgotterba, care to back the “mortgages are generally unenforceable” claim up with some hard data? Because I call BS on that statement.

Write down outstanding balances? You of course know how big the mortgage market is right? No? Didn’t think so.

Posted by Danny_Black | Report as abusive

dctruthseeker, ok so you got the 2bn all you need know is the remaining 3 trillion 898billion to buy out those mortgages at 60 cents on the dollar. Also why would the banks take an automatic 40% reduction across the board? Why would in an era of negative real rates would investors want across the board pre-payments? Why should homeowners get to have 30% of their debt written off?

PS You think Wall Street is currently outbidding Main Street – aka democrats desparately trying to latch onto a populist winner, lawyers and pressure groups?

Posted by Danny_Black | Report as abusive

Danny Black: “Why should homeowners get to have 30% of their debt written off?”

One possible reason- because it might be a better deal for the banks/investors than having the home repoed & auctioned?

Another possible reason- we were in a gargantuan housing bubble, and it’s *fair* for everyone to share the pain of recovering from that bubble.

Posted by mattski | Report as abusive

mattski, only a small percentage of loans are actually non-performing. Maybe 10% are in default? The number that actually make it through foreclosure is even smaller. If you write down 30% of the debt across the board, you are TRIPLING the size of the problem — and that is assuming a recovery rate of 0% in foreclosure. (Actual recovery rate may be closer to 50%?) Congratulations! You’ve just found a simple way to take down the US economy.

Banks are already free to renegotiate specific loans where they feel it is in their best interests to do so. Forcing them to write down loans across the board would be incredibly destructive. As a rule of thumb, banks/investors don’t need YOU to determine what is in THEIR best interest. They’ll figure it out on their own.

And “fair for everyone to share the pain”?!?!? I don’t see any “shared pain” in your solution. I see you dumping all of the pain onto the banks/investors, with the stupid and greedy homeowners getting a windfall profit when (eventually) the market rebounds. I’ve got a solution that shares the pain more evenly. The borrowers lose their 10% down payment as well as the additional money they put into the house. Call it a 20% loss. The banks/investors sell at 60 cents on the dollar and lose a third to half of what they originally loaned out. This novel solution to share the pain is called “foreclosure”. Let it do the job.

The nice thing about foreclosure is that it DOES share the pain quite liberally, making it unlikely for borrowers to abuse the process. If you come up with a “solution” that doesn’t cause the borrowers pain, then you’ll see a massive wave of strategic defaults.

Posted by TFF | Report as abusive

Is it just me, or is Felix’s “solution” an incredibly shallow, simplistic bit of nothing?

“The banks” don’t own the vast majority of US mortgages — they belong to private investors (pension funds?) and/or our wonderful GSEs. So when Felix says “the banks” will take haircuts, he really means that pension funds and (guess what) taxpayers, should forgive 30-40% of the debt.

If you say ‘well, sure, but the pension funds and GSEs will put the paper back to the banks’ that’s fine, but that also introduces a hugely complex layer of doubt/delay into the “solution”.

Anyway, if “the banks” didn’t bother to perfect their collateral security interests, why should they be given a pass (giving them a new mortgage, even written down, would be FAR better than what they deserve, i.e. if they can’t document the loan, they should lose 100%!).

Conservatives yap that “deadbeats who don’t pay should lose their homes”. Fine. But, by mis-handling the documentation, banks have ALSO breached their legal duties. Why is it fair to enforce the law against deadbeats, but not against the banks?

Posted by dbsmith1 | Report as abusive

TFF nailed it… no way can you fairly apply a solution to the entire subset of residental debtors. The cost of the solution woudl dwarf the cost of the problem.

I’m under water on my home but I keep paying because I like living there… I’ve got kids in local schools… I have relationships with my neighbors… I like thinking of myself as an upstanding member of society rather than a deadbeat… ect

I do think I am in a much larger group of people who would “semi-strategic” default if they lost their job.

My wife and I have the few months living expences socked away and many times our salary in retirement accounts… but it would be a tough decision to start draining retirement accounts to support the carring costs of a house with a negitive net value.

I think this issue is the #1 reason the Fed seems hell bent on nuking the dollar via QE. If they can drive inflation to 5% per annum then the whole housing thing goes away in 4 years through principal paydowns and inflation.

The biggest issue I have with the Feds “solution” is that the people who are being hurt the “medicine” tend to be much more responsible than the people being helped. IE the roughly 70 year old retired husband and wife that worked square jobs their whole life put 3 kids through college, and still managed to squirl away a million bucks to retire on. The had hoped to leave a substantial legacy to their church, their local land trust, and their kids.

In 2006 they made ballpark $50,000 of investment income… not a lavish lifestyle by western standards but a huge boost to go along with their social security.

In 2011 we are projecting they will clear perhaps $20,000 in income from their portfolio. They would never complain because they understand just how lucky they are / have been in life… but still their choices are to lower their lifestyle or spend principal that they never intended to touch.

Many commenters may respond that it’s tough to cry over teh plight of the relitively well off and I see that point but just remember the ultra-low rate enviroment is directly a result of the millions of people who chose to pull cash out of their home to live well beyond their means.

Posted by y2kurtus | Report as abusive

TFF, I apologize for commenting half in ignorance. I wasn’t aware that Felix was proposing across the board write-downs. (Did he?)

OTOH, you write: “As a rule of thumb, banks/investors don’t need YOU to determine what is in THEIR best interest.”

Are you saying banks don’t need to be constrained from making BAD loans? Because evidently that was just a teeny-tiny problem…

Posted by mattski | Report as abusive

mattski, there are many factors that contributed to those bad loans being written and sold. “Mass hysteria” is perhaps a polite way to describe the collective malfeasance of realtors, borrowers, brokers, banks, and investors. Does that mean the government should step in and legislate rational behavior?

In any case, we are out of that “mass hysteria” phase and banks are now looking for the cleanest and least costly solution to the problems they helped create for themselves. If principal reductions and workouts are likely to be the least costly solution, the banks are quite capable of implementing them. Why does anybody else need to be involved?

The last thing I want to see is the government dumping tax dollars (that we don’t have) into the system, rewarding both bank and borrower for their collective stupidity. And if the government isn’t helping to fund the principal reductions, then I don’t see any justification for them forcibly writing down mortgages. As Felix says, “The banks would hate it.” The reason the banks would hate it is because it would massively devalue their assets.

P.S. I’m not absolutely certain what Felix was proposing. But it didn’t sound like a voluntary program to me.

Posted by TFF | Report as abusive

TFF, ” Why does anybody else need to be involved?” That sounds like “what do we need laws for?” to me.

Look, here’s a basic issue I’ve got: the impatience people have with those they disagree with. I responded to a specific statement Danny Black made. I didn’t make any assumptions, I just offered two possible explanations for his question. But you jumped all over me a) without knowing exactly what Felix’s proposal was and b) making completely unwarranted assumptions about the implications of my response to Danny. Certainly, nothing I wrote implied the kinds of broad accusations you laid on me.

So, I request you dial it down.

Posted by mattski | Report as abusive

I listened to the podcast — twice. I don’t know the details of what Felix is proposing because he didn’t state details, just a broad outline of what he would like to see. My question is, “Who pays the bill?”

If the banks pay the bill, then I believe we need to allow the banks the freedom to make the choice. If the government pays the bill, bailing out both banks and homeowners, then I would oppose that. How is that jumping on you?

And I see a difference between “laws” and ex-facto confiscation of assets. I strongly support laws and regulations to ensure that the banks maintain sufficient reserves to cover their risks. But declaring that banks ought to forfeit 30% of their assets because we sympathize with the homeowners? That scares me.

Doesn’t ultimately matter anyways. Five years of inflation will put everybody above water again. Much of the current problem will go away (with new problems instead).

Posted by TFF | Report as abusive

mattski, not sure what you are suggesting.

If you are suggesting 30% across the board that is a massive amount of money – comfortably in the many trillions – disproportionately helps people who overleveraged vs people who were more prudent – or didn’t have their circumstances massively change – and only rewards those people. Investors, such as your pension, fund get screwed, banks get screwed.

If you are suggesting it for people stuggling with their mortgages why reward just them? Why not people who didn’t overleverage? This is before the fact that most modifications resulted in the mortgagee redefaulting in pretty soon after.

Either way makes no sense.

Posted by Danny_Black | Report as abusive

DannyBlack, I’m also very nervous about anything that weakens the principle of “rule of law”. (The concept of “moral hazard” is related.)

It is important that the rules be made clear when a deal is signed. It is important that the rules be followed. It is very important that the rules not be significantly changed after the fact.

We’ve had violations of the first two of those principles already, I would hate to see it compounded by tossing the third in the dustbin as well.

When talking about “underwater mortgages” (and I’ve heard that some 25% are technically underwater at this point?) we should remember that the market value of a home is only relevant when you refinance or move. There are many underwater homeowners who continue to make payments because for THEM nothing has changed. They still have jobs, still have income, and still wish to continue living in that house. Any sweeping restructuring of mortgages risks tripling the size of the problem.

Posted by TFF | Report as abusive