2009 Feb 17th

Help to Homeowners – Is It Fair? Is It Necessary? Will It Work?

By Lori Turoff  ([email protected])

 

Is A Cram Down Coming Our Way?hoboken cram down

More than 9% of all mortgages nationally are either delinquent or in default according to the Mortgage Bankers Association. Over 2.3 million loans went into foreclosure last year, more than twice the volume of 2006. Estimates are for 3 million foreclosures in 2009 unless something drastic is done by the government to change things.

The NY Times reports Obama’s $50 billion plan for help to homeowners to be announced tomorrow may include government subsidies to reduce a borrower’s interest rate, which the lender would have to match with its own money. Banks might refuse to cooperate, though, if they still see these borrowers as bad risks. Under current law, a borrower cannot use bankruptcy to restructure a mortgage but must seek foreclosure. If legistlation is enacted to change the power of bankruptcy courts, allowing what is sometimes called a “cram down”, it would increase the borrower’s ability to negotiate new loan terms with the lender. Some fear that investors will stop funding mortgages if the terms can later unilaterally be changed in bankruptcy. There are also fears that bond holders will sue the issuers of bundled mortgages if the value of mortgage backed securities are affected. Yet few would disagree that home foreclosures are a root cause of the economic meltdown.

J.P. Morgan and Citi have implemented a temporary freeze on new foreclosure filings, according to the Wall St. Journal. Freddy and Fannie will restructure only when borrowers are already 90 days late with payments. Something has to be done, it is agreed but what is the right course of action for the government to take to prevent the snowball of failing mortgages from continuing to grow?

There’s A Moral Hazard Here, Too

Even if we were to agree that mortgage defaults are a huge problem and that something has to be done about it there is another issue at stake here.

“This puts the whole moral-hazard issue front and center,” said Howard Glaser, a former Clinton administration official and now a financial consultant.

“This is the equivalent of having the government write a check to both the borrowers and the banks, who both made bad decisions,” he said. “But if you are going to do something, regardless of the mechanism, you are going to have to cross the Rubicon to direct federal assistance. It’s a sign of how very few options are left.”

Many feel that the government is using taxpayers’ billions to bail out borrowers who make bad decisions. While some borrowers were deceived and even defrauded, others knowingly borrowed more than they could afford. The family home became a convenient ATM. A bailout helps the banks who make bad loans, and the borrowers who made bad decisions but does nothing to help the frugal and responsible borrowers and homeowners who are current in their payments. In the midst of an economic recession of unknown and increasing severity why should the frugal, responsible borrowers get nothing? Does it pay to act foolishly? Should we all stop making our mortgage payments if we can get a lower rate? Of course, the argument can be made that by bailing out the reckless banks and borrowers the tide of failures is stemmed even greater catastrophe prevented, ultimately benefiting everyone in the long run. What do you think of this?

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  1. D$

    Stemming foreclosures is vitally important to preventing the economy from slipping deeper into recession.

    First, the economic cost of a foreclosure is generally higher to both the bank and homeowner than working out the loan in some other way. If the government and banking industry leaders can generate alternatives to foreclosure, kudos to them.

    Second, housing over-supply due to increased foreclosures further lowers home prices. Until we see a housing bottom, there will be no economic recovery. The cost of a deeper, prolonged recession to U.S. taxpayers is far more than $50 billion.

    Third, the average American is financially illiterate. As for the banks, most were simply staying competitive and following market headwinds, and their common shareholders are paying. Both parties are not exactly clinking champagne glasses right now saying “Woo hoo, bailout – We got away with it.” Bailed-out homeowners will likely face credit score markdowns which will result in decreased availability / increased credit costs for years. Not to mention the stress and pain of being in this predicament in the first place. Bailed-out bank stockholders have to recover from a 70%+ drop in the share prices from 52-week high (see KBW Bank Index).

    Obama is doing the right thing at the right time for the right people. The only mistake his administration is making is on the PR front.

  2. stan

    d$-

    not going to happen. It will only prolong the housing downturn…What about an investor who is expecting the individual to live up to his end of the bargain and pay rates laid out in the contract. Where is the moral hazard…I realize the administration’s goal is redistribution of wealth but this won’t work.

    Why would I buy a home if i found out the idiot next door couldnt manage his finances and just received a 30% discount.

    The market will always win, all gv’t intervention does is kick the can down the street a bit.

  3. Tiger

    I have mixed feelings about bailouts in general, this one in particular. On one hand, I don’t see why I, the responsible taxpayer, would have to bail out banks, businesses, individuals, and cities (Hello Hoboken) who messed up. It’s not my problem. On another hand, I know that if that’s not done, we’ll slip deeper into this, so like D$ said, it seems to be a reasonable amount to pay to prevent a bigger disaster.

    The way I see it is, bail them out, but put restrictions on it. Encourage people to refinance (reduced or no closing costs) to traditional 30 year mortgages (heck, introduce 45 or 60 years, if that’s what they can afford). In return, I say put severe restrictions on ‘get cash now’ option from the home. I don’t care if you want to redo the basement or buy a 90 inch plasma TV, your home is not a credit card.

    I wish I was less responsible and lacked moral integrity, I would have been bailed out.

  4. Tiger

    Stan, that’s a valid arguement, but isn’t it really why we pay taxes in general? for redistribution of wealth? I guess it’s easy to turn this into a discussion of the centuries-old question of individual responsibility towards the society, but isn’t that what we do anyway? Your taxes go into all sorts of things, that’s the government’s work lol.

    No size will fit all, and no single bail out would resolve it all. To your question about the next door idiot who couldn’t manage his finances, hopefully with the discount he will hold on to his home and live in it. Some investors, some individuals will fail unfortunatley, bailed out or not, and we will all have to swallow this. Invstors file for bankruptcy, individuals file for foreclosures.

  5. Lori Turoff

    You know, I had a whole paragraph on the “individual vs. the group” issue and pulled it before I hit publish. That is precisely the issue, though.

  6. DKzzzzdkzzzzdkzzzz

    Market should adjust to mean. Artificially propping banks or borrowers is idiotic. If they cannot afford “3000sq.feet” house they should size down-proportionately to their income!
    If government comes and bails them then effectively it will reset the values of those “3000sq.feet” houses. (they cannot magically restructure loans without adjusting principal). This will introduce one more variable into RE valuations as well as Mortgage Based Securities valuations.
    It will be a disaster.
    Sq. foot in Hoboken will be $50 bucks.:)

  7. D$

    Stan – Distressed homeowners will not receive a 30% discount on a home already purchased. My understanding (which may very well be outdated) of the current language is that payments would be normalized to about one-third of the borrower’s gross income for a period of time. They’re still stuck with the over-valued house, but not the over-inflated monthly payments. If it works, home prices will stabilize and debt-to-income will normalize over time eventually removing the need for government subsidization.

    I agree with you that the free market would correct everything in time. However, right now we’re dealing with an irrational and inefficient market; so I’m not so sure your logic holds in these wild and crazy times. What the Obama administration is trying to do is put mechanisms in place to help “normalize” the free market so the free market can do its job correctly.

  8. D$

    DKzzzz – I’ve posted on this blog a few times and I’m sticking to my guns. There’s an opportunity cost to buying a home and it’s called renting. As long as there are folks willing to pay $X.xx per month to rent a two bedroom apartment in Hoboken, there will be potential buyers at comparable economic price levels. My ongoing analysis reveals that Hoboken prices have about 10% – 15% to go. If rental prices decline, then it could go down further; but it is near-impossible in my eyes that we will see condo prices fall below $400 per square foot in Hoboken.

  9. Tiger

    Only a couple of hours young and this topic is already on fire :-)

    DKzzzz – I understood it the way D$ did, government help would be meaningless if it ends up resetting the value of the 3000 sq ft home. The bailout works only if it gives certain people a certain ‘advantage’ over the rest of us, an advantage that we will be paying for btw, but nonetheless I don’t think it would drive the value further down (it already went down btw, and these are loses we all have to swallow, renters or owners).

    D$, to your point — I agree regarding rentals. I am sticking to my guns too to say I don’t think the recent drops in our market is different than say Florida. I don’t think we have the ‘overdevelopment’ problem the rest of the country is having, this area in general is still very desirable to live in, except that now people are scared / cannot afford it here. I might be naieve in my assumption, but just like we were the last to be hit, I hope we will be the first to recover.

  10. Willy

    Unfortunately, the debates get lost as soon as we differentiate between “taxpayer” and “investor.” That is an outdated approach. The two are intertwined as much as economies around the world are with each other.

    When we see clear through that, we will more likely agree that there is little choice but to prop up the weak even though it is unfair to the strong. In fact, at that point, the tide raises all boats!

  11. Lori Turoff

    If a rising tide raises all ships why not prop up the strong rather than the weak? What if the government were to let all homeowners who were never late on their mortgage payment and who have a credit score over 700 the opportunity to refinance at a below market interest rate? This would let those people have lower monthly payments and free up cash flow for other investment opportunities (like buying up the foreclosures). Why not let the responsible home owners and investors be the ones with extra cash to spend instead of the dead beats. Let the people who played by the rules pump up the economy and reap the rewards. Is that not more fair?

  12. JF

    First let me say I am not pro Republican or Democrat.
    If you look at the first 30 days of the Obama Administration you will discover what Wall Street has discovered over the last week, there is a difference between campaigning and governing. Where as Bush got it right when he stood on the wreckage of the WTC and said “those who did this will hear from all of us” and then continued to disappoint for the remainder of his term, Obama has been given the ball in the 4thQ with 10 seconds left and fumbled and now it has become evident his treasury sec hasn’t got a clue, his most important appointment can’t even sell himself.

    What does this mean for real estate? Probably further declines from these levels.The govt can’t stop this bubble from popping and the more band-aids they put on it will discourage the private sector from putting money into the market which ultimately enables banks to to make loans. It is impossible for the Govt. to hold off the adverse effects of 25 years of binging on easy credit..oh but how they try.

    Like Lori said, why not reward the people who played by the rules?…Totally afree with her…unfortunatly this is not going to be the case as we move to socialism in the banking sector. Take a look how thats playing out for Russia’s market.

    The fuel theat drove Hoboken prices(insert Vegas, Cali,FL here) to $600 per sf is gone,$500 per sf is happening in “west Hoboken”,$450 per sf non waterfront could happen as banks continue to require 25% down for condos in this area causing more supply as buyers become few and far between. Low interest rates won’t mean much to you if your income is reduced or taken away, has 5.5% 30year fixed rates caused a buying frenzy here.. 500 or so condos up for sale, don’t think so. If there is no fuel to drive demand, prices will continue to drop..$400 per sf here,maybe not..but I wouldn’t bet my life on it.

    Had dinner with a friend who works for one of the Banks at the center of all this and he actually said with fear in his eyes”The ARM’s that will reset from 04/05 are on the horizon,this will make what we just went through look like good times”

  13. Willy

    Completely agree! Fairness is not at issue here. These are desperate times and will need desperate measures. Some helpful, some not; but measures nonetheless and we are just in the beginning innings of a long game. There seems to be very little public understanding of credit crises in the real estate realm. Comparisons to past pricing cycles have little relevance here. In my estimation, $450 per sq ft is a done deal and will look rich within a year!

  14. Tiger

    Lori – I agree, it is actually grossly unfair. Part of me still cannot fathom why my taxes will skyrocket in a couple of years or so to pay for all this, and that’s the better option btw, cause otherwise, our dollar will sink further in inflation. Someone has to pay for this mess. I guess nothing new though, it’s always the responsible taking care of the less responsible, that’s what taxation is all about.

    JF – I slightly disagree with you. The fuel that drove Vegas/Cali/Florida is completely different than the fuel that drove Hoboken and NYC metro in general, that’s why it held up well, and in fact is slowly dropping unlike the almost overnight 30% drops in Nevada in particular.

    Also, luckily for us ARM resets -for the most part- is no longer a major issue thanks to the already low interest rates:
    http://money.cnn.com/2009/02/05/real_estate/ARM_reset_lower/

    I think the new reality of things is that we saw a bad year (2008) overall, and we still have to see a couple of years of this. NOTHING, and I mean NOTHING will pay off. Not stocks, not bonds, no investment really. Hey, at least I can live in my condo :-)

    RE: Hoboken I find it interesting that folks with different theories feel that it will settle on a $400 – $450 per sq ft. To be honest, that’s not bad at all, given that our average now is in the $500+? We should be grateful afterall.

  15. JC

    looks like responsible folks with LTV at 105% or less will be able to refinance according to obama. I wonder at what terms.

  16. patk14

    Government interference will just delay the inevitable. Real estate prices have historically been highly correlated to incomes. Just like stock prices are tied to earnings. When incomes/earnings are declining and risk is increasing (probability of job loss), the only way the market will allow prices to go is down. The government can try and fight this but are they going to create high paying financial sector jobs in our area? Highly unlikely and many high paying jobs have been destroyed forever. Those 28 year-old 1st time home buyers have just seen their bonus slashed and either been fired or come to realize that they are at high risk. It is crazy to think that they will step forward and buy in Hoboken right now. More rental properties will come on the market while owners hope to wait out the downturn. Potential renters will seek smaller/cheaper rentals (roommates anyone?) due to lower incomes/insecurity. This places strong downward pressure on rental rates.

  17. DKzzzzdkzzzzdkzzzz

    Why change rates and introduce chaos into valuations, why not just stretch the payment? Give bums 50-years mortgages, so they can stay in their houses.

  18. Mark

    The ARM reset for subprime only isn’t an issue anymore, no need to fear that, but Alt-A and Pay Option ARMS will be:
    http://globaleconomicanalysis.blogspot.com/2008/04/closer-look-at-arms-reset-problem.html

  19. Lori Turoff

    If any of you are trying to post links that are too long and are being overwritten by the sidebar, go to tinyurl.com and you can change the link into a tiny url. It’s a great trick for posting links to facebook & other sites, too. (Sorry – we think it’s a WordPress glitch and can’t change it).

    Anyway – I love the 50 year mortgage idea!

  20. JF

    Arm resets are the Tsunami…why? Because property values across the contry have dropped, arms will eventually rest at high levels once interest rates rise, and if your condo is worth 50k less than you paid for it, your not going to come up with the cash to get into a 30 year fix..fortunatley people have been lucky and have experienced a slight reprive because rates are low…but it is a lifeboat with a hole in it.
    http://money.cnn.com/2009/02/05/real_estate/ARM_reset_lower/

    I agree that not too many arms are in the Hoboken area,but what happens to the banks as a result of the FL, Vegas, Cali fall out directly impacts their willingsless or their ability to lend.

    Tiger, I agree that our little corner of the US has held up well..but has it? It’s been a slow leak, but a leak just the same. I see 1 bd’s(non water front) w/parking that sold 3 years ago for 520k asking 455k and sitting on the market. Factor in realtor fees and higher taxes, your close to 100k loss on a unit you could have rented the same for $2400 per month, easily 1000 per month savings by not carrying the loan. Not the sudden drop for sure, but vert painfull for would be sellers of the same.

    Not trying to be doom and gloom but when you can get a seat on the 740 am ferry to downtown with no problem at all…people with bags of cash willing to buy property here are becoming rare bird indeed. “The Spring Season” will really tell us how bad it is/isnt..don’t you think Lori?

    The cram down will kill real estate because soon the only one that will be willing to securitize a loan will be the US GOV, they simply can’t do this and prices will fall further as the secondary market evaporates because of the fear of changing the rules…why would the private sector invest in mortgages? They wont, that’s why the tax payers are going to get the shaft, both from the federal level and Ironically, from the Hoboken level as well.

    Again, Thanks to Lori for having such an honest and open forum!

  21. Tiger

    JF – That’s a good point regarding private sector not investing in mortgages, but then again, this ship has sailed long time ago- it will take years, if it ever happens, for the private sector to gain that much interest in investing in real estate.

    Interesting times, definitely! I think we’ll survive it and tell our kids how it all worked out. For the time being though, I’m holding on to what I have and hiding everything under the mattress. You never know lol :-)

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