San Diego Housing Bubble News and Analysis

When I see comments like this I just shake my head. Doesn't Taleb understand that the bank already owns 100% of the house since the mortgage is more than the house's market value? How can the bank take part-ownership when they already own 100% of the house?

I agree that it's disheartening that our government leaders don't know what's going on, but it's just as disheartening to see "experts" who also don't get it.

XBoxBoy

I'm thinking he's referring to the lender taking a stake in any appreciation -- up to the point that the mortgage is paid off (with interest, I'd hope).

This, as opposed to principal reductions, would be my guess.

They have 100% of the risk now but no ownership until they take the property.

He is saying take part ownership now in exchange for loan modifications.

Basically selling part of the property to the Bank.

It would change the accounting treatment of how the loans are valued.

John

Interesting thread, hopefully I didn't read it too fast. Let me coin a new term "Lien in Lieu". This would be where the bank agrees to accept a Lien for the underwater amount or more. If I was the bank I would rather have a lien,someone paying something,and not have to pay for eviction/foreclosure/real estate fees. On the books it would appear essentially as an interest free loan I guess,payable upon sale of property. Thoughts? I know interest free loan is not in a bankers vocabulary,but these are dire times for many folks.

If that's true, then it's a horrible idea for the banks.

Ask yourself, what does part-ownership mean and what would be its value? It means nothing and has for all practical purposes no value.

Say the bank approached a "homeowner" who was struggling and said, "Ok, we'll reduce your million dollar loan by 40% in exchange for owning 40% of the house." Great, but what a can of worms the bank has just gotten itself into.

What if the person lives in it for the next 30 years, pays off the loan but never sells the place. Then when they die, passes their 60% ownership to one of their kids. All the while, the bank owns 40% but receives no interest or rent on their share? What's the value to the bank? The bank also can't sell this interest, after all who wants to buy a 40% stake in a house that you can't live in and can't collect rent from?

What if the person lives there for 5 years, and then puts in a pool and adds a cabana. Then two years later wants to sell. Does the bank get 20% ownership in the value of the improvements? The "homeowner" is not going to want to do improvements if that's the case.

The most likely scenario though is that the house doesn't appreciate any time soon, and a year or two from now the "homeowner" wants to sell. But the "owner" now only owns 60% of the house. Suppose the money from the sale is first used to pay off the loan, then there will be nothing left to compensate the bank for its share. (To see how this works, use some numbers. Imagine the original purchase was a million with nothing down. The house is now worth 600k, and the bank reduces the principle to 600k, and takes a 40% ownership. Without any appreciation, the house sells a year or two from now for 600k. That pays the loan but leaves the bank with a big fat zero for its "ownership" share)

It's important to realize there is no new value generated by the bank taking an ownership stake in the house. All that really happens is the bank takes a loss through principle reduction, with a potential to maybe recoup some back in the future. But that potential is too dependent on the "homeowner" to be really worth much of anything.

Bottom line here is there is no free lunch that's going to make things better. And "experts" like Taleb need to stop proposing things as if they will.

XBoxBoy

XBoxBoy,

I say let them all go bankrupt.

John

Like a reverse mortgage?

While I'm not exactly sure of the details of Taleb's plan I think it's straightforward principal reduction in exchange for a part ownership that has little if any value and potentially lots of administrative headaches. If that's better than outright principal reduction it is only a very small amount better.

Back up a second. The problem is that the banks hold loans that due to falling prices are no longer sufficiently collateralized. If the borrower continues to pay the mortgage, the bank does not have a problem. However, if the borrower stops paying the mortgage, the bank has three choices:

1) Take their losses either with a foreclosure or short sale.

2) Outright principal reduction. This is a particularly bad option because doing this for one person only encourages others to go into default hoping to get their principal reduced.

3) Try some scheme that kicks the payments down the road, hoping that some time in the future somehow the borrower coughs up more money. My perspective is that virtually all the schemes put forward, including this one from Mr. Taleb, are nothing more than a fancy cover for this option. They are not a fix, just a postponement of the problem.

Notice that before I listed the bank's options, I made clear that if the borrower continued to make payments there was no problem. So, if the bank was thinking things through they would realize that a very high priority is to make sure that people keep paying in full at the agreed upon terms. Option 2 and 3 undermine that. (As we've discussed in a number of threads here on piggington)

So, regardless of the area I think it's pretty clear foreclosure and/or short sales are the best answer.

In regards to your comments about areas where the economy is collapsing. (Modesto, Bakersfield, Detroit) In these areas, it's the broad economic issues that need to be addressed first before housing can be addressed. (ie, what are people in these areas going to produce/sell that will generate the cash coming into the community so that it can grow) Since these issues are not being addressed seriously, I doubt that any kicking the problem down the road will work, only postpone the problem.

XBoxBoy

The trick is to make it not to attractive to do a workout/remod. Would you trash your credit in exchange for a lien that brings your house out from under water? Most people would not,I think. So the only people that really would benefit would be the ones that a)have income source b)want to stay in their homes c)are willing to take the credit hit. It is a logical solution where the newly appraised value would determine the lien amount. People normally want their house to appraise high,in this case the lien would be smaller though,so if one was greedy and tried to get it to appraise low(for a higher lien) then it would depress the neighborhood values making it harder to sell in the near future(flip) thus keeping people honest with this system of checks and balances.

There's a reason the foreclosure process exists! It's because it's a clean way to get accounts settled and move on. It needs to happen. All this talk about modifications and renogiations etc, is just stalling the inevitable. The methodical process of highly leveraged assets unwinding is hard enough as it is. Throwing this into the mix only screws it up more and prolongs the pain. If you think it through, foreclosure needs to be allowed to run its course.

Can the banks/institutions really absorb all the foreclosures that are coming down the road? I think not! Without some way to extend the pain we are headed for Depression for sure! I myself am ok, it's my fellow man I'm worried about, which will eventually affect us all. If it makes sense for all parties involved and helps avoid a Depression then I say it's worth a look.

When prices are dropped to the point when demand matches supply, then the market can handle all the foreclosures. The problem most people have is that they want a big chunk of the massive gains in RE prices since 1996 to stick around until they cash in. That's not a fundamental economic problem, it's simply one group anxious to use political power to manipulate prices their way.

Amen, peter!

Peter is exactly right, but the powers that be (voted in by all of us) are doing everything they can to prevent the market from correcting.

Which is why we should all be making an effort to get in front of our Congressman and vigorously make our case. The people who want to avoid consequences for their bad decisions are in total control right now, with all the top finance Congressmen (Frank, Dodd, Schumer) in their pocket. Maybe we cannot make a difference, but we shouldn't be too cynical. Life does bring opportunities, and being too cynical means you miss lots of opportunities. We should at least make these Congressmen feel uncomfortable whenever they let borrowers, investors, and bankers off the hook for another trillion dollars.

@XboxBoy

You missed one of the choices of the bank in dealing with the delinquent home 'owner'.. the forth is to take the property in foreclosure and then lease/rent it back to the previous 'owner' they foreclosed on. The bank then takes the lease payments and applies them to the banks cost of capital for the money the bank borrowed to finance the mortgage in the first place. This gives the banks time for/to:

1) find a better tenant.
2) sell the property when real estate prices have stabilized.

Admittedly, #2 has risks, but it may be better to the bank instead of flooding the market with foreclosed properties. All they time that the banks are waiting for the prices to stabilize/inventory to decrease, they are getting 'rental' payments on the property.

I will say one thing in support of TPTB....if this all happened at once, the system could collapse.

If 25% of the mortgages in SD county are upside down at ths time, and if unemployment persists, I could see this being a slow grind down, punctuated by times of extreme drops during the RE "off season" for several more years.

I think collapse could be avoided using simple govt guarantees of bank deposits, debts, and bank counterparty guarantees. What these guys are trying to avoid is the restructuring pain. It cannot be avoided, only passed on to others. There's no need for us (i.e. the others) to accept that, if we were smart enough to see what was happening.

Hey, I have no problem with that if the bank wants to do that. But isn't that still a foreclosure? (Which would be number one of the three options) What the bank wants to do with the place after they foreclose is up to them.

I do see two problems with this though.
1) Banks are not equipped nor do they want to become property managers.
2) Most people aren't going to want to rent the house they were just foreclosed on for various psychological reasons.

I would think that most people who make it to foreclosure auction just want forget the whole mess. Okay, some want to stay rent free until they get evicted or get cash for keys, but I doubt many will want to pay rent to stay in a place that daily reminds them of their failed financial endeavour. Just my guess though.

XBoxBoy