lenders reduce principal for under-water borrowers
I think Messr Bernanke's suggestion that lenders start reducing the principal for home-owners with negative equity makes perfect sense. If a lender knows that most borrowers with negative equity are going to just walk away, it only makes sense to reduce their principal to keep them in the house. It is far cheaper to reduce the principal than take the huge cost of a foreclosure, flooding the market with properties that are going to fetch pennies on the dollar.
Please someone, just explain to me how a lender is better off foreclosing and re-selling the property for (much decreased) market values rather than just reducing the principal for the existing owner?
The lender has to take a loss either way.
Another way to look at this problem is to consider the case where the borrower is already delinquent, yet still has the ability to pay. Clearly the home-owner has just decided to walk away in this situation.
Wouldn't it be in the best interest of the lender to just reduce the loan principal in these situations (i.e. where the borrower clearly has the ability to pay) rather than go through foreclosure?
I just don't see how the lender wins by going through foreclosure, particularly when they are facing massive waves of re-posessions, that could drive the real-estate market into the dirt.
http://calculatedrisk.blogspot.com/2008/03/bernanke-to-lenders-reduce-principal.html
Please someone, just explain to me how a lender is better off foreclosing and re-selling the property for (much decreased) market values rather than just reducing the principal for the existing owner?
The lender has to take a loss either way.
Another way to look at this problem is to consider the case where the borrower is already delinquent, yet still has the ability to pay. Clearly the home-owner has just decided to walk away in this situation.
Wouldn't it be in the best interest of the lender to just reduce the loan principal in these situations (i.e. where the borrower clearly has the ability to pay) rather than go through foreclosure?
I just don't see how the lender wins by going through foreclosure, particularly when they are facing massive waves of re-posessions, that could drive the real-estate market into the dirt.
http://calculatedrisk.blogspot.com/2008/03/bernanke-to-lenders-reduce-principal.html
Comments
One thing brought up on NPR was the specuvestors that may have bought several Las Vegas condos using no-money-down sub-prime loans. Certainly we can all agree that these are the types of buyers who least deserve to be bailed out, but how do you go about separating the specuvestors from families who are just trying to stay in their own home?
My neighbor, who has owned his house for 25 years, has re-fi'd 4 times in the last 5 years, extracting equity each time (which he promptly blows on new cars/trucks/RVs/boats/motorcycles for himself and his kid). He now has a loan with 10-year interest-only payments (don't know what the details are, maybe a balloon payment out there somewhere?), and realizes that he's never going to get ahead on it, and has mentioned maybe having to sell this summer. He's a nice guy, but has and continues to make some incredibly poor financial choices. There is no darn reason why I should pay for this guy to get bailed out, as I choose to drive a 20-year-old car with 213K miles on it that's paid for while he drives around in his nearly-new $35K Chevy truck that he bought with equity extracted from his house.
It's not right, and without letting things correct on their own, we will never get our national financial situation back on track--bailouts now will make things even worse later, and postponing our financial problems into the future is EXACTLY what has gotten us into this mess in the first place.
Just tell me how the lender is better off foreclosing on a place that has negative equity if they know the borrower is able to make payments on a re-worked loan? The loss incured going through foreclosure will absolutely be greater than the loss of reducing the loan principal.
I think this is a key point. Whether the lender, the borrower, or both are damaged by their poor decisions is not our place to decide. If both parties can find an equitable position where total damages are mitigated, then it is not a bailout. If, however, the government uses my tax money in anyway, it becomes a bailout. The question is how much of my money can they reasonably spend. A little bit for counseling may be alright, while a lump sum paid to scum isn't.
True, we will have a bail-out when the government starts stumping up cash for either struggling home-owners or lenders. But this doesn't change the calculus for lenders trying to decide whether to reduce a loan principal or foreclose. The lender will have to incur a los either way, making them more in need of a possible government bail-out (i.e. at some point the losses become too great to allow the lender to remain solvent).
the root of the problem (IMHO) is the uneven returns on the mortgage as an option. As structured, the borrower has a call on all the upside, and a put to the lender on the downside - with the cost of the option being their down payment. Banks screwed up by selling these options for little or nothing when they reduced LTVs to nothing. (oops) If you're going to restructure, I think you have to change how returns are divided as well or people will continue to game the system. Since you can't get a downpayment out of a turnip, then you need to give more upside to the option writer.
Note that there are a bunch of proposals being floated about similar to this, but in all cases they have the GOVERNMENT as the buyer of the mortgage (at a discount) and then the restructuring occurs as I have indicated. (such as the one from Mark Zandi that I heard about on the radio this morning) I am not sure why the bank needs to sell the loan to the government. If it is such a good idea, seems to me they could fund it themselves.
Well, if the borrower isn't making payments then the lender either has to foreclose or come to some arrangement to keep the borrower in the house. Unfortunately, the borrowers hold all the cards here. The lender is faced with having to go through the terrible expense of foreclosure, AND take another hit when they re-sell for a price far less than the mortgage. I can't see why a lender wouldn't view it preferable to just reduce the loan principal and keep the borrower in the home (provided the lender could be completely satisfied the borrower had the ability to make the new payments).
If it comes to a choice between foreclosure and reducing the principal, principal reduction wins every time.
The lenders are, in effect, pension funds, insurance funds, municipalities, etc.
When the bank held the note, it WAS in the bank's best interests to keep the homeowner in the house (George Bailey anyone?).
But with all these CDO's owning all these mortgages and claiming big returns to their investors, who gets to make the decision to lower the principal? If the fund managers elect to do it, then we are talking potentially MAJOR lawsuits from the investors (an international group mind you). Besides, some of these funds are insured. If the investment gets lost through voluntary principal reduction, will the insurance company payoff (ignoring how many insurance companies stand to fall as a result of THEIR investment in these CDO's)?
It's easy to argue that the investors would rather take a voluntary hit now than lose it all, but if you have a AAA insured fund, why would you want to bother when you can get your investment back through insurance if it all fails, providing the insurance co. is still solvent?
Either way, reducing principal and the ensuing loss will likely be deducted from their taxes, so we still would pay, albeit indirectly.
I don't like it at all, for the same reasons as others. If this IS offered on non-CDO mortgages (are there any left?), it should be a ONE TIME deal, for ONE property, intended for someone who actually resides there as a primary residence. They must pass a financial means test, and yeah, any possible equity gain from that point on will be used to make up the difference to the lender when sold. If the mortgage is paid off before selling, the forgiven amount could then be added as a secondary mortagage, and all equity would revert back to the homeowner.
Go ahead, pick that one apart. I am just throwing it out there.
I don't see why tax-payers would be hurt anymore from a reduction in a borrower's loan principal than a foreclosure and REO sale. Losses are incurred either way, they are just a little less in the case of a principal reduction.
It may well be that some loans can't be reworked due to restrictions on CDOs, etc. However, there are many loans that don't fall into this category. Most banks, for example, still have a substantial amount of mortgages directly on their own books, and they are completely free to manage those mortgages however they see fit.
Hey, many lenders have been working out payment plans and principal reductions on many forms of debt (e.g. credit cards, etc) on an ad-hoc basis for decades, so I don't see why a reduction of mortgage principal should be any different. There are plenty of cases where a lender works out a deal to get 60% of a credit card paid off rather than just take a complete write-off.
I am sure the lenders would want to be completely satisfied that the borrower could make the payments on the revised loan, but provided everything checks out, a principal reduction that successfully keeps a borrower in the home is vastly cheaper than a foreclosure.
From BB's speech today to the Board of Governors
http://www.federalreserve.gov/newsevent ... 80304a.htm
Here's a radical idea. As I see it, the main driver of foreclosure for the "appreciation dependant" folks is not being able to sell at bloated bubble prices. Further subsidizing them is like throwing money at never profitable dot-coms to prop up the NASDAQ in 2000.
Rather than "throw good money after bad" on low credit score, zero/negative equity, poor financial decision people; I would propose lenders subsidize good credit score, 20% down, good financial decision types.
Thus if the latter would only reasonably pay "x" for a house, the lender would kick in the rest. Presto, with the same subsidy, you now have mortgages in the hands of borrowers that make sense for lenders/investors.
Please pass this on to Messrs. Bernake and Paulson.
However...if they do lower the principal for a homeowner, there should be strings attached...such as...it should be on ONE house only. Not on extra houses/condos bought for speculation and profit by flippers and investor landlords/floplords.
Not for vacation homes either....last time I checked there were plenty of rentals available for vacation. Too many people fell into the vanity trap of needing that "ski-in ski-out condo" or "cabin on the lake" wherever it might have been.
No quit claiming extra homes/condos/vacation homes to your cousin Fred who rents so that Fred can receive the benefit of the "cram down" on the investors behalf.
And no cramdown for anybody who refi'd a 250k house into a 600k mortgage to spend on useless STUFF. Their gluttony should be punished.
Just my 2c
An interesting idea, but just how many people are there that:
Plus, I think the idea is not to reduce the principal by as much the market would. For instance, you have a home bought for $500k. You determine that it would probably sell on the market if you foreclosed at $350k. However, you also figure the borrower could afford to keep the loan if it were reduced to $400k. In this situation, which is what I think they are talking about, it makes no sense to foreclose and you wouldn't find any takers for picking up the house at $400k because similar houses are on the market for less.
Who gives a rip about the lenders? If they were stupid enough to make all these bad loans then let them go down the drain. This is an ethical issue. People who had no business buying a house beyond their means should lose it. Period. Whether that "hurts more" for the bank is moot. Who cares?
Why is it the capitalistic slogans about "free trade" and "let the market handle it" are crammed down the throats of everyone in this world repeatedly by the FED, WTO, and big finance. Yet when push comes to shove and THEY are threatened, all of a sudden a protectionist policy is opted for in favor of "free market economics?"...looks like somebody wants it both ways to their own advantage.
We need the bubble to pop and a recession and associated pain so we can start the "healing process". Things got out of hand and now our glorious leaders are trying not to protect the prudent financially conservative people of this country who had no hand in the bubble, but the very flippers, scammers, idiots, and oinking bankers who caused this whole mess!
This actions speaks volumes about the FED.....go ahead and gamble, Uncle Ben will take of you. Makes me wonder why I try and be responsible.....
I don't really care about the lenders, but it is important to consider what does, or does not, benefit them since they will be the ones making the decisions about whether or not to do principal reductions.
Lenders will reduce the principal if they feel that it is cheaper (over-all) for them than just foreclosing. What we might think about the subject is irrelevant since it is the lenders who will make the decision.