One Last Chance To Save Housing

All of the news about housing that was so good in the fourth quarter became bad in the first two months of the new year. Foreclosure rates are still up and some analysts expect them to hit 3 million, a bit higher than last year. Warren Buffett claims that the economy is not strong enough to allow a home price rebound until next year.

There is increasing evidence that banks, particularly small and mid-sized financial firms that supply a lot of home loans, will take few credit risks until they resolve their commercial mortgage loans. A number of banks with exposure to office buildings and malls will be shut down by the FDIC. Banks want larger down payments from home buyers to mitigate loan risk. Most people don’t have the money or do not want to risk it on a house which could still lose part of its value.
The Administration’s ill-advised $75 billion Homeowner Stability Initiative did very little to reverse the default and foreclosure troubles. This program had two weaknesses, both of which could have been foreseen. The first is that many people who received modified loans defaulted anyway. People who cannot pay their mortgages are often on the edge of insolvency. A small decrease in monthly costs was generally not adequate for them to make mortgage payments for a long period because they still had the financial burdens of food, clothing, heating, and transportation. And, some of the people with home loans lost their jobs.

The other issue is more disturbing. Only 116,297 mortgages were permanently modified from the start of the program through January so the homeowners could have ongoing lower monthly payments. It is a compliment to the program to say it is a failure so far.

The home stability relies on mortgage companies to do most of the paperwork. They have little incentive to do so and often make more money pushing people out of their homes than helping them to stay. There is a booming and profitable business in charging late fees for mortgages.

But the single most cogent criticism of the Home Stability Initiative is that it alters what people pay each month on their mortgages, but does not change the amount of the home loan itself. A person with a home worth $200,000 and a $300,000 home loan may take a monthly payment modification, but the temptation to walk away from an underwater mortgage is still great. There are over 11 million underwater mortgages in the US now, mostly in housing markets that are still in trouble like Florida, Nevada, and California.
The regulators who helped craft the home owner bailout have finally concluded that the most likely way to keep people in their homes is to drop their monthly payments and decrease the balance of their mortgages. Then, the mortgage holder has at least some hope that he can sell his home in the future and walk away with a small profit for retirement. The Washington Post reports that “The Federal Deposit Insurance Corp. is developing a program to test whether decreasing the mortgage balances for those who owe significantly more than their homes are worth is an effective method for saving homeowners from foreclosure.” The plan is bound to be a success, on paper. It only covers loans which the FDIC has seized as it closed banks. That is a small universe. It is not at all certain that the program will be expanded, even if it works.

The biggest hurdle to this new plan is that banks have no efficient way to account for a mortgage when its balance is reduced. The result would normally be a write-off, which few banks can afford even if they were inclined to.  The program cannot succeed as long as the government has no way to keep banks whole on these complete mortgage modifications.
The other obstacle to the plan to actually change the principle amount of mortgages is the lethargy and bureaucracy of the banks themselves. It is the same problem that the Administration’s initial home mortgage modification plan had. Banks have little incentive to help the home owner or the government. There is no profit in it for them

The FDIC’s plan is the only plan that has any chance of working. It gives a homeowner a reason to stay in his home beyond the emotional attachment that many people have to their homes. People who have almost no hope of ever owing their homes because of the disparity between their bank loans and home values would have reason to believe that owning a home could be financially worthwhile again.

The FDIC program will probably be criticized for ceating “moral hazard”. Once one group of Americans gets a deal, then so should anyone else with mortgage trouble. The argument is not entirely unfair, so the rules for modification will have to be unusually strict.
All that is left, if the government wants to keep many people from default or foreclosure, is a system like the one the FDIC proposes. The federal government can roll it out as fast as possible, or watch the housing market continue to collapse for another year.

Douglas A. McIntyre