The Nuclear Housing Bailout Option

Submitted by Rich Toscano on February 26, 2010 - 8:32pm
A couple of interesting bailout-related items crossed my desk today.  I have given up on trying to keep track of all the bailouts, but these both relate directly to our beloved topic of shadow inventory so I thought I'd note them.

First, the White House is trying to ban any foreclosure unless the loan in question has been screened for HAMP, the government's flavor-of-the-month home loan modification program.  As I understand it, HAMP has been fairly useless, for reasons I will describe below.  But no matter -- an extra mandatory step to screen every mortgage for eligibility will further delay the foreclosure process, perhaps resulting in even more delinquent mortgages remaining in pre-foreclosure limbo.

The reason that HAMP and the government's other varied foreclosure prevention schemes haven't made much of a splash is that they don't address the main cause of foreclosures: that many homeowners owe more than their homes are worth.

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Submitted by ybitz on February 26, 2010 - 11:32pm.

sounds like bad news for potential buyers :(

Submitted by SD Realtor on February 27, 2010 - 11:13am.

Rich this is the nuclear option and in my opinion it will happen. To me this is as sad as it gets and epitomizes just how far reaching the controls are over our entire system. This represents a systemic failure of basic capitalism at the root and will legitimize poor decision making. It will turn out to be the ultimate punishment to the diligent renters who have waited to buy a home and for many people it will push housing beyond their ability to purchase.

In the end it will be like a snake digesting a multitrillion dollar lunch that will take a few years. Normalization will not occur until the interest rate cycle pushes prices to where they need to be which will take a few years.

What is unfortunate is that we all whiffed on this one. I don't think I started crowing about my fears of govt intervention until 2007 or so... I am to lazy to look back at posts but I think it was around that time.

Anyways, it is all extremely depressing but those that are in control have such an iron grip on the reins that essentially we are all powerless. As more measures are pressed through congress, and as the Fed and Treasury continue to press forward, we will always remember this as a very low point in the history of our country.

Submitted by peterh on February 27, 2010 - 12:49pm.

64K Question is: Will it work? I think not, nor do I think this will even get off the ground, unless we've all gone mad. Just think for a moment of the unimaginable moral hazard this would create. If this takes place, it would be open season for everyone with a pulse to buy a million+ dollar home with one of those "pay option ARM", liar or other toxic loans, default, then have the principal reduced to "what is affordable". With a guarantee like this from Uncle Sam, these loans would be back in a flash, big time. Like magic, we all own mansions and get a great discount in the end. It's all backed by the government, so banks and mortgage companies can't loose, the proces will start over again and this time no downside! This is one of pandora's boxes that cannot be opened.

Submitted by SD Realtor on February 27, 2010 - 1:08pm.

I agree. I don't think it will work. I cannot even begin to think of the ramifications. Yet it is not like it already has not started happening.

Submitted by Arraya on February 27, 2010 - 1:29pm.

With a projected 70% increase in foreclosures this year, I'd say, that is your "tsunami". Looks like this is the economic FEMA and they are breaking out the sandbags to try and stop the levee from breaking.

No job growth means that new demand is going to have to come from somewhere just to maintain price levels or....more downward pressure, foreclosures, etc... Job losses spiking up again would also add a tremendous amount of pressure to an already fragile system. Principle reductions don't help the unemployed.

At this point strategic defaulters are still a small percentage. That's the kind of herding behavior that goes viral if psychology changes. The question regarding principle reductions is: how many are defaulting because of truly not being about to afford, as in a loan reset or loss of income? I thought resets are lower today? Or is the strategic defaulter in the position to negotiate a lower principle, even if they can afford it now, just because the need people to keep paying? When do they start threatening strategic defaulters?

This is a desperation move, big time and the unrecognized downward pressure is mounting.

Submitted by CA renter on February 27, 2010 - 11:22pm.

peterh wrote:
64K Question is: Will it work? I think not, nor do I think this will even get off the ground, unless we've all gone mad. Just think for a moment of the unimaginable moral hazard this would create. If this takes place, it would be open season for everyone with a pulse to buy a million+ dollar home with one of those "pay option ARM", liar or other toxic loans, default, then have the principal reduced to "what is affordable". With a guarantee like this from Uncle Sam, these loans would be back in a flash, big time. Like magic, we all own mansions and get a great discount in the end. It's all backed by the government, so banks and mortgage companies can't loose, the proces will start over again and this time no downside! This is one of pandora's boxes that cannot be opened.

If the principal reductions were recorded and used as comps, AND if the banks were taking the losses, instead of the taxpayers, I wouldn't have a problem with principal reductions (I even advocated for them years ago, with losses being borne by the lenders alone).

One thing I can assure the PTB. If they move ahead with principal reductions, the number of "strategic defaults" will swell beyond anything they've ever imagined. Every single past, present, and future buyer will no longer honor their mortgage; and why should they? The govt is treading on VERY thin ice with this idea. I would hope they understand what the ramifications will be.

Submitted by Rich Toscano on February 27, 2010 - 11:48pm.

They can just say that only loans already in default will get principal reductions. To prevent the option arm blowup, they can just refi option arm holders into some GSE refinance scheme. Etc. They change the rules however it suits them.

Rich

Submitted by andymajumder on February 28, 2010 - 12:16am.

I think - it is possible to create political pressure against such a measure. Most of these "pricipal reductions" would happen in four states, California, Florida, Nevada and Arizona, the so called bubble states. I am not sure why taxpayers and congressmen from rest of the country, would agree to such a move. With enough publicity through blogs, it is maybe possible that tax payers in snowed in midwest would revolt against such a move paying thousands of dollars to folks in California so that they can enjoy their beautiful homes near the beach.

Of course the moral hazard ramification of such a move in enormous, there will be flood of strategic defaults if this is allowed.

Submitted by Greg in LA on February 28, 2010 - 12:34am.

I am sensing a degree of despondency in this article and in the replies.

I agree that the "higher ups" are planning and would love principle reductions for underwater home "owners". Will they be able to actually do it, I don't know.
This is why I don't think it will happen.

As Rich previously said this is all a political question. And right now politicts are in a real upheavel. Take the Government health care proposal, it failed and caused a backlash.
Take all the major elections in the last three months, another backlash. What is the newest political force in the country these days, the "Tea Party". This also is a backlash to the bailouts, big government, Obama and the Federal Reserve.

Without a doubt we are living in a time of growing resentment to the bailouts and the failures of big government. the failures of big government is what the public perceives as the root of failure and its growing astronomical debt.

If there is an atempt to force taxpayers to buy down the debt of underwater homeowners, there will be an even bigger backlash.

The thing to also consider is that ellections will be coming in November. Do politicians really think they will be imune, if they sign on to principle reductions? I do not think so. They are on thin ice already.

If outrage is big enough, it will be stoped. Look to the recent Obama health care proposal and the illegal alien amnesty proposal of 2007 if you need confirmation and presidence to why I don't think it will happen.

Bottom line: to risky to try.

Submitted by CA renter on February 28, 2010 - 2:25am.

Rich Toscano wrote:
They can just say that only loans already in default will get principal reductions. To prevent the option arm blowup, they can just refi option arm holders into some GSE refinance scheme. Etc. They change the rules however it suits them.

Rich

Absolutely, they will probably make that one of the conditions, but what if the rest of the borrowers get smart and decide that they can also force the govt to give them principal reductions if enough of them join together in another "too big to fail" mass-default scheme?. Again, why not? Isn't the govt essentially engaging in discrimination if they reduce principal balances for some and not for others? What about renters? Should we also stop paying our rent so that we can get some of the govt gravy, too?

What never ceases to amaze me is how "ignorant" people supposedly didn't understand anything (like their mortgage contracts) as the bubble grew; but as the market goes down, once borrowers get wind of some loopholes, those same borrowers are keenly aware of every new scam as soon as it's discovered (like making lenders prove they have the mortgage documents, or filing for BK, or various other stall tactics that enabled them to live for free...for years!).

You should see the FB's sites to see what they're up to. It's impressive to see how "savvy" these same "poor victims" can be when it benefits them.

Submitted by ucodegen on February 28, 2010 - 2:42am.

Take all the major elections in the last three months, another backlash. What is the newest political force in the country these days, the "Tea Party". This also is a backlash to the bailouts, big government, Obama and the Federal Reserve.

The part that fascinates me about all of this, is how the political parties largely claim that the backlash is because they didn't portray what they were proposing, in the most favorable light. They seem to forget that they are supposed to represent the voters that put them into power in the first place.

Submitted by 4plexowner on February 28, 2010 - 5:20am.

seems like there are at least two ways principal reduction might occur:

1. outright reduction - 'poof' and the principal disappears for both lender and borrower

2. paper reduction - 'poof' and some portion of the principal becomes a lien or equity-share agreement that is recorded against the property but does not require payments

here are the challenges I see to either of these:

1.
- moral hazard - everybody with a mortgage will expect principal reductions
- pariah status for anyone receiving an outright reduction - imagine the hallway conversation at work where Joe Dipshit tells you that he just got a $60K or $200K reduction on the mortgage for the house he couldn't afford but was allowed to buy anyway - imagine the same conversation at the neighborhood BBQ - assuming you are responsible with your finances, how are you going to feel towards Joe? (Joe might be smart enough to keep his mouth shut but all of this will be public record)
- derivative paper written on top of these mortgages - what happens to the MBS, CDO, etc that includes the reduced mortgage?

2.
- property is still underwater although the borrower now has a mortgage payment they can handle (maybe)
- property value is affected - given two identical properties, the property with a lien or equity-share agreement recorded against it is worth less than the same property with an unclouded title
- what happens when the borrower needs to sell the property? lien stays with property? lien has to be payed off? lien becomes a judgment against the borrower (what about non-recourse states)?

~

hmmm - #2 is an easier sell politically since no 'handouts' are being given to irresponsible people, but it doesn't really accomplish anything - the principal either exists or it doesn't - moving the principal off the mortgage and onto a lien (or whatever they decide to call it) still leaves an underwater property - and if the principal still exists, the borrower still has motivation to do a strategic default

another possibility with #2 is that a few years down the road our fearless leaders can enact an 'olly olly oxen free' law and erase all of the liens that were written as part of the principal reduction - ie, this is option #1 with a time delay - the typical American's attention span is less than the time between two episodes of American Idle so three years from now they won't even remember that principals were reduced

Submitted by ownhomeinSD on February 28, 2010 - 9:09am.

Lowering interest rate (e.g. 2%)is a better way than principle reduction. Here is an example that shows how the government's current Making Homes Affordable program is working for homeowners who are deeply underwater.

"Carlson, whose home has lost nearly half its value since he bought it three years ago, learned earlier this month that he received a permanent modification that lowers his interest rate to 2% for five years, making his monthly payment only $944. The rate slowly rises until it hits 5.125% in year nine, where it is frozen for the next 31 years."

Submitted by peterb on February 28, 2010 - 10:10am.

How far will they be able to kick the can down the road? This is what's been happening and the trend is continuing. Keep in mind that any real resolution would require the lender to recognize the losses. This would prove catastrophic for most of them. Govt and private. Extend and pretend will keep happening until it implodes.

Submitted by 4plexowner on February 28, 2010 - 11:19am.

"There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency system involved."

- Ludwig von Mises

Submitted by jpinpb on February 28, 2010 - 1:20pm.

Greg in LA wrote:
IIf there is an atempt to force taxpayers to buy down the debt of underwater homeowners, there will be an even bigger backlash.

Except I think there is a greater percentage of homeowners than renters, so most will be in favor.

Submitted by JC on February 28, 2010 - 2:06pm.

interesting point, but what about all of the folks that are homeowners with no mortgage or the ones that continue to make their payments?

Submitted by Hitler on February 28, 2010 - 7:46pm.

CA renter wrote:

What never ceases to amaze me is how "ignorant" people supposedly didn't understand anything (like their mortgage contracts) as the bubble grew; but as the market goes down, once borrowers get wind of some loopholes, those same borrowers are keenly aware of every new scam as soon as it's discovered (like making lenders prove they have the mortgage documents, or filing for BK, or various other stall tactics that enabled them to live for free...for years!).

You should see the FB's sites to see what they're up to. It's impressive to see how "savvy" these same "poor victims" can be when it benefits them.

None of what you mention above is a 'scam'.

Making lenders prove that they actually own the mortgage sounds perfectly legitimate to me. If lenders didn't have to do that, any Tom, Dick, or Harry could try and foreclose even though they don't have legitimate rights to do so.

Same with filing for bankruptcy. It's been a legal way to wipe out debts for hundreds of years. Donald Trump (a well-respected real estate mogul in some circles) has filed for bankruptcy multiple times.

Mortgages used to be written such that the mortgagee (home 'buyer') could pay off the note over time or give the house back to the bank. Back in the day before lenders and the government learned that they could conspire to rip off the taxpayer, lenders would normally require a significant down payment (20%) to ensure that if the buyer gave the house back, the lender wouldn't lose any money.

The shenanigans borrowers are engaged in aren't any worse than the shenanigans that lenders have been engaged in. In fact, if you want to blame some one for 'scamming', blame the lenders as they are certainly savvy enough to write mortgages that protect their interests. The lenders didn't because they received their fee almost immediately after the sale and then chucked the mortgage to Fannie, Freddie, or some fund set up by Wall Street and peddled to idiots with money.

I agree with you that the system is broken, but it was broken by the greedy criminal banksters. The borrowers are just doing things that are allowed under the law in order to maximize their ROI.

Submitted by scaredyclassic on February 28, 2010 - 7:51pm.

why write down the principal? Wouldn't it end up costing the same to just give everyone a check for a couple hundred thousand to buy a house?

Submitted by scaredyclassic on February 28, 2010 - 10:45pm.

why NOT buy now? will they w rite down the principal if it goes down? how can I lose?

Submitted by Greg in LA on February 28, 2010 - 11:20pm.

Question: What is the goal of the HAMP program.

Answer: To examine verified income and assets of individuals to attempt to get housing payments inbalance with actual income.

The market use to take care of that all by its self, forever and with no help.

Now the government has HAMP and HUMP and bailouts and moratoriums and tax rebates and stimulus and Fannie and Freddie and FHA and so much else, all to do what use to be done by doing NOTHING!!!!!!!!!!!

Submitted by UCGal on March 1, 2010 - 10:07am.

I think a decent number of foreclosing properties will still make it to foreclosure even with the HAMP test... HAMP requires verifiable income - a lot of the folks who bought in the bubble years were using liar loans - and did not necessarily have the income then... Think of all the folks in real estate, construction, etc who have less income now - and they probably exaggerated their income back then... Plus a lot of folks bought REALLY expensive houses with mortgages higher than the HAMP limits.

I have a question though - if a house already has a NOT filed - does it have to go back and get looked at for HAMP - or is it already in the foreclosure pipe - no longer in "preforeclosure".?

Submitted by cr on March 1, 2010 - 1:12pm.

The thing is, principal reductions will help individuals.

Our government is only out to help the banks.

Submitted by zerospeed on March 1, 2010 - 4:43pm.

Race to the bottom. I have to wonder whether such a scheme as "paying down the principle" will in fact trigger an avalanche of lowering housing prices below what would otherwise be supported by the market. If I were hugely underwater and the govenment was willing to pay off the difference, I might take the opportunity to bail. The more who bail, the lower housing prices will fall. In the end, such a scheme is as likely to destabilize the housing market as it is to stabilize it, IMO.

Zero

Submitted by sdduuuude on March 1, 2010 - 5:51pm.

My impression of HAMP is that very few people actually qualify. So, this may just slow down the process, but not really change the market because everyone will be evaluated, but not necessarily "helped."

Also, so many HAMP participant have re-defaulted, it just seems to be another can-kick.

Finally - someone please correct me if I'm wrong - the principal isn't forgiven in the case where the owner sells the house for more than the new principal amount, but less than the original loan amount. That difference goes back to the bank (i.e. gov). Who really wants that ? It's just continued slavery to the home. Actually, it's more like renting. If the value of the home goes up, you make nothing. If the value of the home goes down, you get another bailout and a lower payment.

Can you get a HAMP mod, then sell immediately ? This would be a way to get out of the house without a short-sale delay.

Delays, just delays.

Submitted by jcarter04 on March 1, 2010 - 6:29pm.

The law of unintended consequences is par for the course when it comes to government intervention. The attempt to keep people in a house they can't afford is a foolish notion. The too-big-to-fails must have been high-fiving each other in '06 when they appeared to have completed what took 70 years to accomplish, making lifelong debt slaves of the populace. Now that de-leveraging threatens their existence and the reelection hopes of their paid-for politicians, bail-out programs will become more desperate but will, in the end, be another government failure. The die has been cast. There is no escaping this de-leveraging event. Government intervention may be able to prolong the time it takes housing to find a bottom but will not prevent U.S. housing from declining as far as it would have otherwise.
I was one of the foolish who purchased a new home in Naples, FL for 360k in 2007. I recently purchased a 1600 sq ft condo closer to town for 36k cash. I'm in the process of a short-sale selling the house for 160k. There's nothing the government can do to keep people from trying to reduce their debt load during this cycle. It's going to get worse. 2012-2014 should be entertaining as it represents the "hard-down" phase of the 120-year Kress cycle as well as the relative bottom of the Kondratieff cycle. If interest rates creep up just 1 or 2%, residential housing will take another leg down, astonishing the talking heads on bubble vision. Banks may tighten credit yet again once the commercial real estate debacle is in full bloom. On a positive note, housing should be affordable again.

Submitted by jpinpb on March 2, 2010 - 9:28am.

sdduuuude wrote:
Can you get a HAMP mod, then sell immediately ? This would be a way to get out of the house without a short-sale delay.

Delays, just delays.


That's a good question. I'd like to know. Maybe we can track down one of the so many people who have loan mods and find out.

And if they get principle reduction, how does/will that work? Can they turn around and sell for more and keep the profit?

Submitted by 4plexowner on March 2, 2010 - 1:07pm.

jcarter04

when did you learn about Kress and Kondratieff cycles relative to your purchase in 2007?

Submitted by pemeliza on March 2, 2010 - 3:20pm.

"I was one of the foolish who purchased a new home in Naples, FL for 360k in 2007. I recently purchased a 1600 sq ft condo closer to town for 36k cash. I'm in the process of a short-sale selling the house for 160k."

You may have been foolish but it doesn't sound like you really payed much of a price for your mistake.

Submitted by sdrealtor on March 2, 2010 - 3:26pm.

Unless his house had the Chinese Drywall which was pervasive in that area. Then he could be headed for respiratory trouble.

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