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One in Ten

posted by Elizabeth Warren

The latest numbers are out:  One in ten homeowners has no equity in the family home. The data show that about 15% will be below water if prices continue to slide, owing more than their homes are worth.

So what's the plan here?  One in ten homeowners could just walk away right now. Indeed, most of them, if they were the rational maximizers so prominently featured in classical economic analysis, would stop paying now, put the money in a savings account and wait the 90 days or two years or whatever until the lender could force them out by foreclosure.  In non-recourse states, they could just pocket the money and walk away free and clear.  In other states, they might need bankruptcy or a last-ditch deal with the lender for a short sale. The economics of the deal shift when the homeowner has no equity to protect.

If they walk, the national--and world--economy will seize up.  The investors who hold those mortgages can avoid that if they are willing to share the pain and acknowledge that their loans are only partially secured. Like practical lenders have done for thousands of years, they could decide that getting a steady, partial payment is better than no payment at all.  So far, however, the investors are holding tight, even as Fed Chairman Bernake asks them please please please renegotiate these crazy mortgages. 

The only proposal on the table that would make the investors renegotiate their mortgages and either get people into mortgages they can afford or get them out of the houses is the amendment to the bankruptcy laws.  Last week, the Republicans filibustered the bill in the Senate, and a cloture vote failed.  But no one is giving up yet. Professor Lynn LoPucki had a terrific op-ed in the Atlanta papers this morning, and USA Today had one this week as well. 

The industry has tried a scare tactic, claiming that the bankruptcy bill would cause all mortgages to increase by 2 percentage points.  The press dutifully reports the number, although some have begun to cite Credit Slips' own Adam Levitin's work that shows the numbers are bogus.  When he testified last week, Chairman Bernake was asked about the industry numbers and, after some fumbling, he admitted that he didn't know of any data to support the industry claim.

The mortgage industry has blocked the bankruptcy amendment, but the question that puzzles me is why anyone is listening to the mortgage industry's herd of lobbyists.  These are the people who said the industry didn't need regulation, that high-risk mortgages could be turned into low-risk bonds, and that everything was perfectly safe--right up until it all came crashing down. 

How bad will the mortgage numbers have to be before Chairman Bernake says it is time to stop asking and start acting?

Comments

If they walk, the national--and world--economy will seize up.

I'm unclear why this is so -- could you elaborate for us laymen in the audience? It's not like if the bank gets a house in foreclosure they then have to tear it down. They sell the house to someone like me, who hasn't been able to afford a house during the bubble years and is currently renting. Sure, the bank loses the difference between the amount of the original mortgage and what they can now sell the house for at auction, but they stand to lose that anyway if they renegotiate the loans. I don't understand why keeping the people who happen to own houses right now in those houses is vital to all of us, when as a side effect it's going to prevent those of us who don't currently own a house from ever being able to buy one.

To: sdrenter

Because the "banks" (who financed their own lending and who traded the mortgages around like hot potatoes) owe on them too and used them as security for their own loans. When and if the holders of these loans foreclose en masse, they will be liquidating the security they used to borrow against, and they will not get enough to pay back their own obligations. If they renegotiate them instead, they can hope to avoid a liquidation that will lead to a default and ultimately insolvency on their own part.

Everything financial is now globally interrelated. For example, just recently the Carlyle Group, one of the most sophisticated investment groups in the world, defaulted on loans it used to purchase FNMA and FHLMC bonds. These were good, solid bonds but their purchase was so highly leveraged by Carlyle that even a slight decline put the Group underwater without enough liquid capital to pay the difference due and owing on the loans.

In the NPR story today announcing the fact that Americans' housing debt exceeds their equity for the first time in a long time (or perhaps for the first time ever, I don't recall), once again they had an MIT economist stating that more and more people are walking away from their underwater homes. Especially after that awful Steve Croft piece on 60 Minutes a while back, we've been hearing more and more about a rising incidence of "jingle mail," but I haven't seen any empirical evidence of this. Any idea where (or whether) there is empirical support for the notion that homeowners are increasingly walking away from underwater mortgages? Any idea WHERE this is happening; i.e., in non-recourse states like CA and AZ, or elsewhere? This is starting to seem like one more of the unsupported but ugly claims of the industry designed to undermine support for homeowners in trouble.

Okay, so here's an alternative proposal. Suppose the Jones's owe $400,000 on a house that now would sell for $300,000, but for some reason are in danger of losing the house. Under your plan, somebody (the bank? taxpayers?) effectively gives the Jones's $100,000 which they will use to pay down their debt, in that hope that they will now be able to handle the monthly payments on the remaining balance, or refinance into a mortgage with a more favorable interest rate. Do I have this right?

Here's the proposal. Instead of giving $100,000 to the Jones's, why not give it to me? If I add that to my savings, I'll now be able to afford to buy the Jones's house for the $400,000 they owe. That'll let them pay off their mortgage and move into the rental that I vacated when I move to my new house.

Now, I can't imagine anyone going for my plan. It's nuts, right? But as far as I can tell, the net effect is the same as it would be under Bernanke's proposal: one family lives in a house they own, one family lives in a house they rent, no one is underwater, and someone is out $100k. So, what makes my plan crazy, but Bernanke's plan something that lots of PhD economists consider seriously? This is an honest question.... I'd like to understand this better!

sdrenter:

The difference between your plan and Bernanke's is the difference between forigivng 100k out of 400k in principal on a debt owed far in the future (probably thirty years from now) and handing over 100k in cash now. In your example, contrary to what you say, nobody is giving the Jones's 100k. The bank is simply forgiving the Jones's obligation to pay 100k slowly over the next thirty years instead of taking a 100k loss on the foreclosure in the present.

It's an argument for stability, at the expense of fairness. Why talk seriously about citizenship for illegal immigrants who are already here, while declining a legal applicant at the embassy in Thailand? And why are some institutions "too big to fail," when the failure would result from their own mistakes?

Not pleasant; if you didn't buy a house for a stupid price, then you lose, and if you did (or if you bought their mortgage) then you win. But if the destabilizing consequences are bad enough, then you might be better off with the bailout, even if you don't benefit directly.

Manoa:

A 400k mortgage trades (at par) for 400k at the time that it was written. If you can use a 400k mortgage to buy a 400k house, then it couldn't be any other way.

The total payments, over the life of the loan, will sum to more than 400k. If the loan is modified from a 400k balance to 300k, then over the term of the loan, the borrower's payments will be reduced by more than 100k.

Unless you have some time preference for money that is not reflected in the interest rate charged on the loan, then 100k cash now vs. a 100k reduction in the loan balance is exactly equivalent. (After all, if you gave the lender 100k, then they would reduce your balance by 100k.)

The only real argument why the Jones's should have the cash, and not sdrenter, is frictional.

"The only real argument why the Jones's should have the cash, and not sdrenter, is frictional."

That's what I was afraid of. I'm not really worried about the fairness issue here, so long as there's a long-term benefit to the society that my kids and I live in. I'm a good liberal. I don't mind paying taxes and seeing my money go to social programs that I don't use myself, nor do I think debtors need to be punished. But I'm having a real hard time getting my mind around why I should be making sacrifices to keep real estate prices propped up!

You're not keeping real estate prices propped up. They are falling, and will continue to fall no matter what happens next -- that's why the Joneses now owe more than their house is worth. The investors who warped the market are demanding to be propped up, holding the entire banking system in front of them as a hostage.

The Bernake proposal made no reference to the phantom income created by forgiveness of indebtedness. Or is this not an issue? I thought that absent a bankruptcy filing when an individual had debt forgiven they are supposed to receive a 1099? Doesn't his proposal just trade a mortgage problem for an IRS problem?

It trades a huge mortgage problem for a smaller IRS problem. Better to owe the IRS 15% on a forgiven debt of $100,000 than to owe the entire $100,000, plus interest.

sdrenter:

As much as it be cool for everyone to give you a 100k for no good reason I don’t think a Mortgage Co. cutting $100k would be the same. 1. This would be an unrealized loss. 2. It probably won’t ever be realized. Why? Because if a debtor eventually pays off the loan say 30 years down the line the Mortgage Co. will still profit! At the end of the 30 years a typical debtor will pay 3X what he borrowed. The Mortgage co. just will not profit as much.

rwilliams:

It is true as far as the 1099 and loan forgiveness but if it is done in the Bankruptcy context the IRS cannot charge taxes on the 1099 if the debtors were insolvent at the time of the loan forgiveness.

Jason:

When you talk to real people who are in financial turmoil every day and not looking at it from a distance you will find your proof. Just got off the phone with a debtor in distress who was contemplating the very idea. He was so fed up with the servicer and the run around they were giving him that he just wanted to chunk it all. I was trying to suggest alternatives but the one that would have helped him and his credit the most (selling for a profit) was not available to him due to negative equity. In the past 3 months I have had to break more bad news to debtors than I ever had to in the past 14 years. People are walking away and all you have to do is review Chapter 7 and Chapter 13 schedules. I work for a volume consumer bankruptcy firm and I have seen more surrenders that I ever have for the 14 years I have been doing this. Even though we do volume work our “sample” of the total amount of people doing what our debtors are doing is relatively tiny.

I stand corrected. It is a frictional cost issue, but there is a big frictional cost difference between marking down an asset and originating a fresh 100k, doing a purchase and sale of real property, and retiring one loan and originating another.

Who realizes those frictional costs? In the context of “loan forgiveness” no one it seems. You have got to read “Misbehavior and Mistake in Bankruptcy Mortgage Claims” ole Katie Porter along with several other bloggers ie. Elizabeth Warren, Robert Lawless etc…. Servicers profit from shoddy bookkeeping illegal fees.

sdrenter:
This is why (in addition to above) the original homeowner and not you should get the $100 K write off
1) There are not enough of you who have financial soundness to be placed into every house that can foreclose in this country (10 MM)
2) Its not fair. You are also a speculator like the original homeowner. Unlike a stock for you a house is must have. If you are prefering to rent then you are speculating prices will decline. Unfortunately thats what houses became - dammed if you do dammed if you don't.
3) As a whole the new homeowners (not individually) have a case against whole lot of banks and down the money chain for causing the artificial real estate bubble while all they are doing is putting a roof over their families head. Granted there are abuses by buyers, most people bought a house to live in before prices went up even further- that is speculating just like 2) above. But its also a necessacity - my kids don't wait to grow up. I need a house when they are 5-18 not after retirement.
4) Prices should come down (by writing off debt) not artificially subsidizing. What is your problem if your friend got 100 K write off. You can still buy the house for 300 K - the new price.

"But its also a necessacity - my kids don't wait to grow up. I need a house when they are 5-18 not after retirement."

I have kids too, and they also need a house. Fortunately, they have one. I don't own it, but it keeps the rain off their toys just the same. I really don't see, though, what either of our kids have to do with this.

"Prices should come down (by writing off debt) not artificially subsidizing. What is your problem if your friend got 100 K write off. You can still buy the house for 300 K - the new price."

Now you've lost me. I can't buy the house for $300,000, because it's not on the market anymore. The Jones's don't need to sell. And since lots and lots of underwater Jones's's don't need to sell, it relieves the downward pressure on prices and I stay a renter.

OK, so, suppose instead of giving me $100k in cash as an "artificial subsidy" (I'd probably blow it at the track anyway -- you know how renters are!), you give me a voucher that I can use as part of a down payment to discharge the seller's negative equity. Then we'd be talking debt write-off, no? Or, to make this easier, skip the voucher. The bank could just let the current owners sell for less than they owe and write off the difference. How is that fundamentally any different from my modest proposal (setting aside the frictional costs)?

In fact, as I understand it, that's pretty much how things are supposed to work now. I can imagine that there are plenty of ways the whole short-sale process could be improved, to make it cheaper for the bank and less traumatic for the seller, but that's not what this is about. This is a super-streamlined short sale that skips the whole "sale" part, and so skips the part where we'd find out what the house really and truly is worth.

Won't the banks figure out how to maximize their rate of return across their portfolio? That they are unwilling to refinance implies that they believe that they will get more for their money by doing a short sale. This in turn implies that they think that people won't be able to pay even if they refinanced to a reasonable rate. If someone couldn't afford a fixed-rate mortgage and needed an option ARM in the first place, why would they be able to afford one now?

For instance, in the case of a $400K house where the borrower needed an option ARM with a 2% payment rate that would be $1478.48/mo (calculated as payment on a 30-year fixed rate mortgage). In order to get that payment with the $300K mortgage, they would need an interest rate of 4.265% - no way they can get that. In order to get that payment at 7%, they would need an initial principal of $222K. As a lender I should foreclose and sell the house for $300K to either an investor or someone who was smart enough to sit out the market when prices exceeded 6X annual income. Even with a 6% rate for transaction fees (likely much smaller), I would be ahead $60K at closing. At the end of the loan, I would make up that 6% closing anyways.

Federal law was changed in Dec 2007 to eliminate taxes on income from forgiveness of debt on a primary residence, for any gains between Jan 2007 and Dec 2009. No bankruptcy filing required.

Here's a random link from google which explains the changes...

H.R. 3648, The Mortgage Debt Relief Act of 2007
http://www.homesalessandiego.com/blog/mortgage-debt-forgiveness-law/

sdrenter,
If houses don't sell for 300 K in that area then the home ownwer cannot get write off. He can sell the house to get out of problems. (yes transaction costs - those can be subsidized - who needs an agent anyway). No one is talking of write off more than current market price in that area.

You forget there are always homes to sell (there may be more homes in US right now than families).

So its possible you can get a $300 k house and your friend get a $100 K write off.

You wrote: "The latest numbers are out: One in ten homeowners has no equity in the family home. The data show that...."

There are no "numbers" at all; only an estimate from Moody's....with no facts cited in the linked AP article; no numbers, no data, just an estimate from an anonymous person whose evidence and education you do not know.

Are you really this gullible?

If you're not careful, you'll start to believe what you read in the NYTimes. ;-)

To: 1099

Thanks for that. The most popular form I see that in is credit card debt. But the the link is helpful and will in turn help me help someone else. The whole point of this whole blogging thing. Not to put down other people but to help and also to get a sense of what the "dark side" of the force is thinking.

Thank you

Patches.....

TO Ken:

From what I’m seeing a lot of people who received ARM’s were subprime borrowers. The majority of those subprime borrowers went in to get pre-qualified and lo and behold they qualified for more house then they thought. What a surprise! Not! The majority of theses subprime borrowers if asked how to re-route plumbing or fix an alternator would have been more than fluent in the terms needed to navigate such an undertaking. But when you take them out of their pond and then immerse them in the Ocean of “financial terminology” they understandably are fish out of water. If asked “Why didn’t you just get a HUD backed loan?”. They will tell you 1. They were told that they needed no money down. 2. A seller would be most likely to accept their offer if they didn’t go with a HUD backed loan. 3. They could eventually build up their credit and by that time, with the way values were increasing, would be able to refinance with a lower fixed rate mortgage in 2-3 years. Those were all half truths.

I don’t know how many homes in 05-07 my wife and I were out bid for because of the easy credit out there. Of course my wife and I were not going to get into a bad loan, but we both work consumer bankruptcies and are familiar with the terminology. A lot of people we see in bankruptcy do not even know they have a ARM. They make decent money in what they do but again are well below the curve when it comes to finances. They should have been prime loans with looking at what their credit used to be.

I see a lot of the following situation also: The debtors go in to buy a home and at closing all of a sudden the lender says I had to change the loan and this is the only way I can get you in, otherwise you will have to come up with X amount. I think that’s what car salesmen call “de horsing”. They are pressured into these bad loans for fear of losing the home that they have been pulling their hair out to get.
We can’t cookie cut the situations we find debtors in. I don’t ever remember a high school or college class “Pitfalls of Mortgage Lending”. Lets look at real solutions for these people after all they are the ones that drive our economy not the upper crust who often are just the ones who benefit.

If we're going to think about giving away $100K chunks of money to prop up house prices, then in all fairness, I, too, should get a free $100K, so I can buy a home. I lost my home the old fashioned way: extended unemployment + illness and death of spouse from cancer. The latter was a devastating loss beyond all description by itself, but it also meant the 2nd income was gone, too. I got a new job but not with anything close to my former pay. With insufficient income to form a repayment plan for arrearages on secured debt under the OLD bankruptcy code and no desire on the part of the mortgage holder to renegotiate the loan without a substantial all cash payment that I simply didn't have, it was eviction city for me! This was well before the so-called subprime mortgage crisis -- I didn't have one! I know now that all the blather we sometimes hear about saving mortgages and preserving homes is just noise... just so much sugar coating while your home is taken away, even when a renegotiation is possible because even though the mortgage may be for 15, 20 or 30 years, the only figure that matters is the one on the bottom line of the upcoming quarterly results. It doesn't matter that profitability can be restored and even enhanced over the years, the motto and watchword is "Give me my money now you deadbeat!"

The current hue and cry and wringing of hands is even more stupid. It's all about the fact that mortgage holders desperately want a gigantic intervention to maintain overinflated housing values. Understandably, homeowners want it, too, but the market is in the middle of a long overdue correction. A lot of people are going to get hurt, never mind all those who already have been, but this sort of nonsense should not have been allowed to happen in the first place. If intervention is desirable now, then, in the form of regulation, it was desirable before we got into such a deep hole. Equivalently, if run-away speculation and bubble investment are great ideas, then the inevitable crashes that we know perfectly well go along with 'em are, too.

The depression in housing prices will help me buy a new home in due time. If, on the other hand, you're going to prop'em up, I want my handout, too.

Isn't this all about market-smoothing and panic? The Jones' house is "worth" what the market will pay. I took the point of the initial post to mean that if, hypothetically, 10% of the market were liquidated, there would be a panic-effect depression of prices, well below what the "mere correction" should be. As such, there is a theoretical argument for stability that overcomes fairness objections. I defer for now whether I accept it (I probably do), but that's at least the theory, isn't it?

Hmmm... There was an assertion that if the 10% of homeowners who have no equity in their homes "walked away" from their mortgages, "the national--and world--economy will seize up." I presume because the mortgage backed securities into which the mortgages have been bundled or "securitized" as the euphemism went, would be drastically reduced in value. No argument is made for that assertion, it looks like it was just put forward as a fact.

Federal Reserve Chairman Bernanke proposed that "mortgage lenders and investors ... reduce the principal on loans for many people whose homes are no longer worth as much as the amount they still have to repay." Secretary of the Treasury Paulson, on the other hand, "has pushed the industry to freeze interest rates for at least some subprime borrowers whose low teaser rates are about to expire." The proposed modification to the bankruptcy law removes the restriction on modifying the interest rate on a mortgage for a principle home (interest rates or 2nd homes and investment properties may still be modified). The bankruptcy modification proposal would not necessarily apply to everyone, though. The idea is that only those who "can't pay what they agreed but can pay more than their lenders could net from foreclosure" would receive such relief. The quotes and other info above comes from various of the linked articles.

All of the proposals call for the mortgage holders to assume some of the pain in exchange for a somewhat lower loss rate. From what I can see, only Chairman Bernanke's proposal addresses the reduced value of home directly. The others give it no countenance, but the Mortgage Banker's Association will have none of it. I can't see what they want. A bailout? Doubt that'll happen and it shouldn't. It looks to me like some mortgage backed securities must lose value, but that's investing isn't it? That's what I heard, you can gain or you can lose. No guarantees.

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