I think we are all very interested in seeing the criteria set by the soon-to-be-created govt. fund with respect to not only what they will purchase but also how they will manage it and ultimately dispose of it. I anticipate that the starting criteria on all fronts will change as the buying/managing/disposing process moves along. I don’t know what parameters they will begin with but they very well may end up with a sweeping and immediate mark-to-market action.
We are looking at a huge number of potential defaults in the pipeline. To the extent that the govt. fund is going to purchase souring mortgages in vast quantities, I can envision an immediate principal writedown to something actually below market value, with repayment terms modified into a very attractive 30 yr fixed rate. If the current owner (who is in default) can make the new payment, they keep the home. Essentially, I think we could very well see a situation where the govt. fund writes down principal/interest rate regardless of ability to pay more.
Of course this creates a moral hazard and will lead to more ruthless defaults from those with ability but I think the govt. has already served notice that it is willing to pick its poison. Is the overall economic impact worse if they allow ruthless defaults to run their course in the private sector or is it worse if they just buy the loans and write down the balances regardless of ability? That is the question. I certainly think it’s a possibility that they will determine that the former is the case and therefore they will go the purchase/write down route and keep those people in the home.
