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The Permanent Foreclosure Crisis and Obama's Refinancing Obsession

posted by Alan White

For the umpteenth time, President Obama has announced that his solution to the foreclosure crisis is to encourage "responsible" homeowners to refinance at lower interest rates.  Adopting the Tea Party rhetoric and blaming home buyers who got houses in 2006 for their inability to foresee what few economists foresaw, Obama has steadfastly refused to push for principal reductions and payment suspensions for homeowners behind in payments, lest their luckier neighbors who bought at lower prices become resentful.  As a result, he continues to offer help to homeowners who need it least.

Behind the rhetoric is an important policy choice: who will bear the billions of mortgage losses that have yet to be flushed out of the system.  Principal reduction modifications for defaulted borrowers would distribute the losses among taxpayers (via Fannie and Freddie), private investors and banks (who hold non-GSE loans), and give underwater homeowners some relief.  More importantly, principal modifications mitigate the aggregate losses to the system while accelerating the necessary deleveraging. Refinancing current borrowers does nothing to prevent the huge deadweight losses from continuing foreclosures, at 50% loss severities, on homes whose owners are delinquent.  Choosing to do no more for the 7 million or so delinquent mortgage debtors means maximizing losses to those homeowners, but also to taxpayers and investors.  It would certainly help to continue driving down home prices, which does benefit new first-time buyers, but at a huge aggregate cost. 

In fact, as conservator of the nationalized Fannie Mae and Freddie Mac, the federal government could make the needed modifications of delinquent mortgages happen with a stroke of the pen, more or less. Instead, the Administration proposes the dubious strategy of loading up the FHA portfolio with 4% mortgages at 125% loan-to-value ratios, thus continuing the process of transferring future mortgage losses from banks to taxpayers, and amplifying those losses, while letting the foreclosure crisis continue, just as Mitt Romney proposes.  Nothing about the refinancing strategy moves forward the process of realigning mortgage debt to home values.  Instead, the strategy relies on the doubtful proposition that home values will soon return to rising at their pre-2007 clip.

Pacta sunt servanda and the housing market and broader economy be damned. 

Comments

Of course foreclosure and bankruptcy would ALSO assign losses to creditors. THAT'S what you have to realize the these programs are designed to minimize. You have to keep those that can still pay from becoming discouraged and quitting. If you want debt forgiveness we HAVE a program for that. In exchange you're branded with a scarlet "B" as a warning to others of your history of borrowing more money than you are able or willing to pay. But I also don't have much sympathy for lenders who desperately try to keep people who have NO reasonable ability to repay in debt peonage forever. Everybody should learn from their mistakes and move on.

Bankruptcy is NOT the end of the world. It doesn't mean that you're evil. If corporations use it as a cash management tool, then they lose all right to be in high dudgeon when consumers threaten to default.

Hi, I thought I would remind you we live in a nation that has elections as well as a Constitution that makes it next to impossible for the federal government to write down debts owed to private creditors without issuing its own in replacement. The post shows no grasp of either the politics or the Constitutional hurdle.

Ignoring the fact that neither House is going to pass a princiipal writedown bill, and just thinking about the Presidential election, elections are largely won by winning the centrist likely voter, although it is important to turn out your base and not trigger turnout by your opponents' base. In the US, most people are paying their mortgage. To give the least well off debtors a benefit is going to trigger, as it did in 2009, a serious backlash among the larger group and the more well off group and the latter is more likely to make it a point to get out and vote and to make that a factor in voting. That experiment was run in 2009. Learn from facts. A refi program is the best available option.

This post is a bit all over the place. Scorning the Tea Party in the first paragraph, but in the last paragraph adopting the Tea Party's policy stance (solely to criticize President Obama) against gov't bailouts of banks.

It is disingenuous to disparage homeowners who are not underwater as "luckier"; I do not think that word means what you think it means.

There was a simple program for principal reduction that was rejected.

It was cram down in Chapter 13, with some limits on the reduction in principal so that it would be less than the expected losses from the foreclosure of copper stripped, water damaged, weed-choked properties.

If the politicians and bankers had consciences, they would be losing sleep over the mistake they made in not getting behind a Chapter 13 based program when the fecal matter was hitting the whirling blades.

But, I am sure they sleep just fine. The sleep of the just . . . don't think about who's responsible for this mess.

go get a securitization audit at http://www.inspectoraudit.com and give them a taste of there own medicine

Great post. Of course, I'm saying that because I agree with it, but it is still great. Many of us who are actually IN the real estate business are very much in favor of principal writedowns, and the CURRENT lenders need to be on the hook for their errors. As one of the commenters posted, this was actually suggested as a modification of the Bankruptcy Code when the bailouts were being considered. I think (personally) that the program of principal writedowns should have been linked to a "most favored bank" program (a bank that won't participate doesn't get to use the Fed's discount window, or gets "dinged" on rates), and the receipt of bailout monies. But that's just me. And in case you wondered, I haven't missed a payment, and I haven't been late, on my home.

In fact, as conservator of the nationalized Fannie Mae and Freddie Mac, the federal government could make the needed modifications of delinquent mortgages happen with a stroke of the pen, more or less.

Who has this power: the President, Congress, the
Conservator???

Is the Fannie/Freddie Conservator under Executive control.


Principal writedowns are a give away to irresponsible borrowers just like the bailouts were a give a way to the banks. Neither should happen. There's a reason there are bankruptcy laws are in place in this country - namely to keep irresponsible people away from borrowed money. Granted a home owner who got way in over their head doesn't have the connections or campaign contributions of a Wall Street CEO but that still doesn't make something that is wrong - principal writedowns - any less wrong. The irrational presumption is that if somebody gets foreclosed on they go homeless which is bunk. They lose the home but they can still rent like the rest of us. Just like if the government let Goldman go under in 2008; Blankfein would be out of a job but he could go work at Walmart like the rest of us.

AMC, I am with you 101%.I do not think, in retrospect and even today including the Government, understood what mortgage, mortgage servicer, bond holders meant.While dealing with all three, consumers are in deep water concerning mortgage defaults. OK documentation is an issue and will continue to be one so to AMC's comment bring back cram dowm but lets try to balance the system as well and reduce language that allows such a diversity of opinion.One plus one equals two...not eleven.

Thank you for putting so succinctly into words my reaction to the announcement. The Obama Administration has been loathe to ask that the banks bear losses for their bad decisions, and continues to hammer this "responsible homeowner" meme that is just plain false.

I'd say he's a DINO, but the reality is that there's just very little difference in the policy prescriptions being offered by Democrats and Republicans. Catering to the finance crowd is just as popular a pastime for the Dems as it is for the Republicans.

"Nothing about the refinancing strategy moves forward the process of realigning mortgage debt to home values."

Good piece. The above is absolutely true, although it does help to line the pockets of mortgage brokers and banks as the refi-boom rages on...

Obama's motivation in proposing this refi plan is most likely not to solve the mortgage crisis but to generate some stealth economic stimulus in an election year by increasing hitherto unable-to-refinance homeowners' disposable income.

Ritholtz (http://www.ritholtz.com/blog/2012/02/a-modern-pecora-commission-could-right-wall-street-wrongs/) has a list of many misbehaviors that happened in the mortgage crisis. The list doesn't include mortgage originators lying to private mortgage insurance companies that they maintained their published due diligence standards while abandoning them.

A lot of this falls back on the banks who originated and serviced the mortgages. Then look at the FDIC Advisory Committee discussing FDIC's powers under Dodd-Frank to resolve the "too big to fail" banks when they fail (http://www.fdic.gov/about/srac/2012/2012_01_25_agenda.html). Now, imagine that all the big banks get hit with all the costs of fixing up their fraud and other misbehavior, and imagine the economic effects when this happens. Many of them probably deserve having their executive rows moved into prison cell blocks together with the lawyers who set up the robosigning operations and other fraud factories. But how do you bring these people to justice without doing another number on the struggling economy?

It doesn't take much imagination or awareness of the current political environment in this Country to realize that any idea of disturbing the RMBS markets further will not get through Congress. The market makers in RMBS issues have too much money invested to allow any further "hit" to their bottom lines.

The idea that the loss would be spread is fine so long as it does not affect the value of the securities that own the mortgage notes. As I wrote 3 years ago, the only way to have dealt with this issue would have been to have Congress state that all of the contracts for RMBS, Pooling Agreements, Trust Agreements, Assignments etc were voidable upon audit and national need.

Of course I realized that the one time this has happened was during the Depression years but the Supreme Court supported the legislation. Further, I knew that there was no possibility that anything like that would even be thought about again. Money ruled and continues to do so. The arguments about "they deserve to lose their home because they can't afford it" (ad nauseam) no longer resonates based on the significant jobs losses some very responsible people have suffered.

We are in an election cycle, and one that appears to be one of the nastiest yet. We are still in a horrid financial crisis, both within and without the Country. No one will convince the financial community that they should take a loss for the national good. Profit first - that's capitalism, really a corruption of the model but the one that resonates with most people.

From the start, none of the programs could work; none had mandates from the central government; everything was a recommendation or guideline. When companies handling the modification process did not do modifications, they were instructed to do better and that their progress would be made available to the public. Accordingly, anything that was sent from Treasury, the Fed, FDIC, OCC, was ignored at will.

The President can do very little with a gridlocked Congress. He cannot order principal reductions, he cannot order anything. Look to Congress for leadership - there is none. There is no solution that is acceptable to all and yet viable.

There are no easy answers - we are allowing the on-going failure of the economy determine the outcome of the housing debacle rather than the other way around.

Richard Isacoff
rii@isacofflaw.com

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