Sunday, October 19, 2008

Mortgages, Foreclosures and Moral Hazard

I was talking to the spousal unit yesterday as we did our part to stimulate the economy (we bought a coffee maker and a crock pot) on how to address the problems of mortgage holders and the damage the housing bubble has done to all house buyers, not just those with toxic mortgages.

While attention has been on the people who face foreclosure or are underwater (noting that owning a house where the loan is greater than the current market value does not mean you face foreclosure), attention should be given to any home purchaser since 2002 who bought in an artificially inflated market. If a HOLC/HOME operation is to avoid moral hazard, which is basically bailing out people who made bad economic choices and making non-participants liable for their bad choices, then it has to be available to any home purchaser from 2003 through anyone whose purchase closed on or before September 30, 2008. Anyone should be able to have recourse to a government renegotiation for their loan, just as the banks can get the government to bail them out - why should Wall Street have all the fun? But there are a few rules.
  • The house must be the principal residence of the home owner. No vacation house, no income properties, no pure speculation buys.
  • Only one bail out per buyer. If you were speculating, too bad.
  • This can only address original loans, not refinances with cash out or HELOCs. Sorry, not interested in supporting your equity extraction.
  • It only addresses first liens. If you have multiple loans on the house, sorry, can't help you with those.
  • It does not matter what kind of loan you have. 30 year fixed, interest only ARM, whatever.

Those rules will eliminate a large bunch of buyers right there. If you aren't living there, and/or you have been using the house like an ATM, and/or you can't be helped with just fixing a first loan, mail in your keys now. Then, there is the loan itself.

  • The value of the home will be calculated as its estimated worth at December 31, 2002. Why? Because that captures all recovery from the last housing slump, so factors in real appreciation (probably too much) but stops short of the market frenzy. It still leaves houses too expensive. My own house would lose about 25% of its purchase value in a case like that.
  • The banks can't refuse to sell the loan back to the government and they will absorb the difference between the purchase price and the 2002 price. You guys should have known better than to make the crappy loans, sorry. It's called taking a financial risk.
  • The owner has to be able to make payments on a 30-year fixed loan with 6.25% interest from their current financial condition. Those are extremely good terms. Can't do that? Sorry, can't help you, mail in the keys.
  • The reduction in home loan value becomes a matter of public record.

OK, so if anyone who has bought a house since January 1, 2003 can go get this spiffy government loan, what's to keep everyone and their cousin from getting out of their debt obligation?

  • If you got a 30-year fixed rate in early 2003, your rate was probably lower and the price difference between your purchase and the December 2002 cost not that much, so there is no advantage to the deal. The further you get from that date and the less conventional your financing, the more valuable the deal becomes. Thus, there is a good incentive structure. Update - also, the closer you get to September 30, 2008, the less good the deal becomes because of depreciation in homes. Thus, while open to all, it really targets people who bought at the height of the market.
  • No equity extraction allowed. We're not here to give you spending money. If you've got other debt, too bad.
  • If the house stops being the primary residence of the borrower, the loan is due in full, i.e., no converting to income property, no handing it over to the kids.
  • If you accept the government deal, you have to hold your house for the full term of the loan. If you sell it for more than the loan amount before the end of the loan, any amount greater than the loan amount up to your original loan amount, less any down payment you put in, goes back to the government.

There is no way for the original borrower to profit off the purchase unless they hold the property for the full 30 year mortage. If the borrower dies, the estate/inheritor can take over the loan on the same terms as the original borrower, or can sell under those terms. The borrower cannot transfer title to another owner to try to get around the 30-year rule. If the borrower does hold, then they may see some appreciation in the value of the home and may have wealth to pass on to heirs. This allows the house to remain a vehicle for multi-generation wealth creation, which helps low income borrowers the most, which is the point of trying to increase home ownership in that group.

Since the government is taking the risk, the government gets the profits of anything short of full performance. You can sell at any time. You just don't get to make money from it. If you have bought the house as a residence, then this is not a problem. If you must move for job or family reasons, you will be able to sell at a reasonable price so are not trapped due to negative equity. The repricing also serves to bring housing values down all over, increasing the stock of affordable homes and hastening the return of more reasonable house prices.

This is a very high level suggestion, of course, but it tries to address how to fairly and equitably revalue the housing market in a way that does not reward the speculators and sheer idiots but provides real relief for people who actually want to keep their house.



lohaces said...

I wonder what Senator Clinton would think of your ideas...

Anglachel said...

Hi lohaces,

No idea what she would think of the actual idea, but I'd like to imagine she'd appreciate the effort.


Unknown said...

Some aspects of these ideas leave a lot to be desired. Everyone holding seconds and thirds just gets to eat the loss? Any idea who those people are?

Be a lot easier to simply say to the banks. You cannot foreclose for year on any property occupied by the note holder.

Then both parties could negotiate a work out without the loaded gun of foreclosure against the head of the noteholder. When you try to control too much....

You end up making a bigger mess.

Anglachel said...

Second and third liens eat the loss *now* in foreclosure and under most workouts unless they call in their debts first and then buy out the other leinholders. This is what happened to one of the first houses we tried to buy. The owner was foreclosed by the second lien holder who was the previous owner who had done this to make the sale. He didn't like our offer so went through with the foreclosure, then bought out the bank. The house is just down the street, it's in bad shape, and the owner can't keep it rented out.

One of the problems with the liens is that they were used to get around down payment requirements, by reducing the loan to 80% of pruchase or to reduce the total loan amount to meet conforming loan limits. If the primary loan can be reduced enough, then there is room and opportunity for the secondary lienholders to negotiate their own workout. If the primary loan is unworkable, everyone gets wiped out.

Putting off foreclosures does nothing to stabilize neighborhoods or resolve the issue. At the moment, the financial sector has zero incentive to workout anything, expecting that the Treasury will buy the toxic waste at their prices. Why would waiting 12 months give them any greater incentive to work out the loan? They want their money and they want to be rid of the problem. Taking less money and tying up their capital in a risky loan is not worth their time.


CMike said...

Good work, you've mentioned some of this before.

I think you do have to leave room for the home owner (the mortgagor) to benefit from a rise in home value from the renegotiated level. He/she must be incentivized to maintain, if not improve the property. I would recommend that the mortgagor be allowed to keep a third of any gain up until the two thirds compensates the mortgagee for the higher value. (Would you include any inflation adjustment?)

Now, who is the mortgagee who should be compensated? I'm not sure it should be the government. Perhaps it should be the mortgagee who was compelled to sell the mortgage to the government. I mean the government is not paying off the mortgage to the mortgagee at the original amount, the government is taking the mortgage for the reduced house assessment.

Of course rights for any proceeds owed in the out years to bearers of the old paper would end up with speculators who payed pennies on the dollar. But if the original mortgagee has surrendered rights at a discount to the government then that mortgagee should be entitled to those pennies.

Elise said...

I would really like to see something like this - it's very similar to the Bottom-Up Bailout plan I proposed previously and Wheelan has a similar plan, too. I still like mine best (duh) and in particular I prefer the following from my plan:

- All mortgages are eligible for government intervention, not restricted by date as in your plan or restricted to only homes in foreclosure or in danger of foreclosure as in Wheelan’s plan. In fact, since I think of this partly to help homeowners and partly to help stabilize the financial system, I’d like to make participation required. I don’t want to leave any ticking time bombs laying around in the form of people who are scraping by now but are going to find themselves in deep Adidas when rates reset in the future.

- The government will intervene with enough money to make sure the mortgage holder does not owe more than 80% of the current market value of the home *and* does not have to pay more than some reasonable percent of income every month (probably no more than 25% but may need to be lower for lower income homeowners). That is, I’d help even people who can’t afford the payments on an 80% mortgage by making the mortgage whatever they can afford. I’d prefer to see this happen within the structure you outline - 30 year, fixed 6.25% - but Wheelan suggests perhaps some 40-year mortgages. Interesting but I think psychologically that’s just too tough, looking at a mortgage you know you won’t get out from under before you’re retired - or dead.

- The government reimburses the lending institution for whatever it takes to get the homeowner to the above condition BUT only 75% of that; the lending institution eats the rest as a reminder to not be so stupid in the future. More generous to the lending institution than your plan but since I’m going beyond just adjusting the purchase price, I think this is advisable. Incidentally, in Wheelan’s plan the government itself seems to become the mortgage holder. I don’t see any need for this and, sheesh, the bureaucracy. Under my plan (and yours I think), the mortgage and paperwork stay with the lending institutions and there’s no reason they can’t do the review and readjustments.

- When the house is sold, the government takes either half the profit or the amount it anted up to straighten the mortgage out, whichever is less. If the government does not recover its bailout money on this sale, it takes half of any subsequent house sales by the same homeowner until the bailout amount is recovered. This allows homeowners to continue to build up some wealth by retaining half of any profits. My government, unlike Wheelan’s, would not charge interest.

On the other hand, I very much like your restrictions on equity extraction once someone has availed herself of this program and your restrictions on getting around the payback by transferring the house to the kids or turning it into revenue property. Essentially, once the house stops being a primary residence for the original homeowners, the government starts getting its money back.

Three other things. First, the July housing help bill seems to have contained some provisions for the FHA to do a half-assed version of this: Housing and Economic Recovery Act of 2008 (the External Link to the Senate Banking Committee Summary is very helpful). As far as I can tell, it helps only people who are unable to make their payments. In other words, this bill addresses only homeowners currently in crisis and does nothing to prevent more homeowners from slipping into trouble. Sigh.

Second, if we’re going to ante up to help homeowners and by extension lending institutions, I’d like to see some rules laid down for future mortgages so we don’t find ourselves doing this again in 20 years. For me, that would include a 20% down payment requirement and a very, very reasonable income to mortgage payment ratio. I’d really like to see the elimination of adjustable rate mortgages and I absolutely want to see the elimination of teaser rates. I can see the argument for helping people who don’t meet these requirements to buy homes but I’d prefer that happen via a government agency that acts as the mortgage holder rather than via banks, not because I think those types of loans crashed the system but because I think it’s very hard to let banks make what I would consider socially desirable risky loans while preventing them from making risky loans with no redeeming social value (e.g., waiving the 20% down payment rule for someone who wants to buy a $500,000 home but only has the down payment for a $250,000 home).

Third, if Wheelan and you and I have all managed to come up with pretty much the same straightforward plan - easy to understand, simple to implement - why the heck are the people in Washington having so much trouble figuring out something like this? This is not - if you’ll pardon the expression - rocket science.