I wish I had written this:
“Eliminating failure is the surest way to kill success.”
Note to my mortgage-holder – As long as you’re thinking about cutting principal amounts, I’d like the principal on my mortgage cut in half, please. Please note that I’m not being greedy; I just don’t feel like paying anymore.
Chairman Bernanke stated this morning:
But the current housing difficulties differ from those in the past, largely because of the pervasiveness of negative equity positions. With low or negative equity, as I have mentioned, a stressed borrower has less ability (because there is no home equity to tap) and less financial incentive to try to remain in the home. In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure.
Lenders tell us that they are reluctant to write down principal. They say that if they were to write down the principal and house prices were to fall further, they could feel pressured to write down principal again. Moreover, were house prices instead to rise subsequently, the lender would not share in the gains. In an environment of falling house prices, however, whether a reduction in the interest rate is preferable to a principal writedown is not immediately clear. Both types of modification involve a concession of payments, are susceptible to additional pressures to write down again, and result in the same payments to the lender if the mortgage pays to maturity. The fact that most mortgages terminate before maturity either by prepayment or default may favor an interest rate reduction. However, as I have noted, when the mortgage is “under water,” a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure.
Debt, shmet. Honor, shmonor.
If I have to stop paying my mortgage in order to qualify for the principal reduction, please let me know so I can start spending the money I have budgeted for “mortgage” elsewhere. I’d really like a new television. Maybe I’ll start ordering the fancy coffees rather than brewing my own, or perhaps go buy a new expensive car and then ask for the principal to be “written down” as soon as I drive it off the lot.
Apparently I’ve spouted the ethical and contractual obligations that borrowers have to repay their obligations for too long.
More at Behind the Mortgage, the WSJ and make sure to read the comments at CR.
Honor and personal responsibility should have a place in our society. Sadly, that seems not to be the case.
Technorati Tags: economics, armageddon, real estate
I hear you and most US citizens are not happy about this either. Unless you suffered some sort of terminal illness or job loss due to layoffs and deferment extention ran out I don’t think we should bail them out either.
I feel like I am be penalized by living within my means. For those who got an Hybrid or Option ARM and couldn’t pay when it went up what were you doing not planning on it happening.
I hold lenders equally responsible for putting someone who couldn’t afford the ARM into that type of loan.
“Lenders tell us that they are reluctant to write down principal.” Bernanke
Is that right, Captain Obvious.
What is this country coming to.
Alright, so let me try to cut the morality out of this for a moment. Let’s view this from the cold, hard perspective of a bank holding a lot of paper from mortgagees who are upside-down right now (i.e., owing more on the mortgage than the house is worth). If things keep going the way they have been for the past 18 mos., more and more of these folks are just going to walk away from the house. In many states mortgage loans are non-recourse: the bank can’t go after you for any losses it incurs once they sell the house. And even in states where mortgages are made “with recourse”, it ain’t happening, for two reasons: (1) suing to get the money from the hapless former homeowner is expensive, and (2) most Americans have very little non-housing wealth and you can’t draw blood from a stone.
Under these circumstances, it’s much better for the banks to “forgive” some principal, in an effort to get people to stay in the house and keep paying something rather than walking away and throwing the bank into the most unattractive situation — foreclosure in a market that’s tanking. Cutting principal is just good business sense from the bank’s viewpoint. And maybe it’s even better if the bank, in cutting the deal, restructures its loan agreement with the client to provide that if the homeowner eventually sells the property at a profit, the bank gets a cut, in addition to repayment of the lowered principal.
Now, one final word. My overall take on this is that the banks are getting exactly what they asked for. You loan some guy 100% of the value of his house, and he’s got no skin in the game. The house loses value, and looks like it will continue to lose value, and he’ll walk rather than be stuck with the place. Banks made owning a house more like owning a stock, and folks are simply responding to the incentives that have been laid out for them.
When a business does this — like, for example, by laying off a bunch of folks in a downturn — it doesn’t seem to bother us. When individuals do something conceptually similar — i.e., act ruthlessly in the face of adversity — all the sudden we’re up in arms.
Well, in both cases, it’s just capitalism. Or, to put it more precisely, it’s capitalism as it’s practiced in the US in the early 21st century — i.e., badly.
AC
“I feel like I am be penalized by living within my means.”
Exactly. And you’ve already been penalized by inflated home values, which have made it even more difficult to live within your means.
I agree with AC that the banks brought this on themselves. Additionally, so did the homeowners. Both parties should pay, but not the rest of us.
Mark and BRMLFS – I’m with you guys – the willingness on the part of the banks and some borrowers to engage in this unsustainable debt madness has already penalized those of us unwilling to commit financial suicide. If we’re going to allow lenders and borrowers to enjoy the rewards of the “unfettered free market” of laxly regulated lending practices, then they will have to accept the consequences of that market as well.
AC – you are likely right from a business perpective – a bird in hand is worth two in the bush. Banks will be far better off modifying these loans and avoiding FC. However, I suspect that they won’t be able to do that for very many loans – that’s one of the big problems with the hash process of bundling mortgages into asset groups and then slicing them up into securities and selling them off to investors. You have to get those investors to sign off on the modification, and for any given mortgage, it’s possible there are now hundreds of “owners” of the note, any one of whom may opt to sue in the event the servicer does make a modification. I suspect banks are pretty aggressively re-structuring “problem” loans they’ve kept in their book. Unfortunately, the problems in the mortgage market are the result of “lenders” (originators) NOT keeping the paper in their own book, and therefore not exercising the same scrutiny about the quality of the loans as they might otherwise have.
I think the biggest problem with all this is that, in addition to the “moral hazard” issue, such a move will backfire by having the unintended consequence of increasing the risk for lenders. Lenders will want a much higher risk premium for making a loan, if they know the courts could (arbitrarily) modify the terms at some future date. That leaves the housing market in the same pickle it’s in now.
Scott — yup, you are right about the problem of restructuring once the loans have been packaged — it’s a nightmare that’s taking forever to deal with, because the banks, investment banks, pension funds and hedge funds all have to come together to agree on who is going to take the hit from principal “forgiveness”. For loans that have been collateralized, it’s really messy.
There are still, however, a lot of loans on banks’ books that are in or about to be default. Principal forgiveness is (in principle) do-able for these. And I think banks are going to start down this road. But you are right that this creates a moral hazard problem. On this level the housing/housing finance crisis is a lot like our situation in Iraq — there are no “good” solutions; rather we’re faced with a menu of ugly and damaging choices and our decision involves where to take the hit. I promise to refrain in future from use of these non-housing metaphors, but you get the point.
Ultimately, I think the most valuable take-away from this crisis is that we’re seeing the limits of financial “innovation”. The whole scheme of mortgage collateralization that’s unfolded over the past 10 years is in shambles. Yes, it allowed people who never would have qualified in the past for a huge mortgage to get one. And yes, opening the credit spigot helped drive the updraft in housing prices, and this created some nice knock-on economic effects, like increased employment in the housing improvement sector. But now we see the down-side — all these loans were made not because we figured out how to lower the risk of default, but because we figured out how to *hide* the risk of default.
AC
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Thanks for the great comments everyone. You make this blog worthwhile. I sincerely appreciate your time.
The question I can’t get out of my head is this – assuming they do reduce the respective principal mounts, when do they reduce them?
For example, Harry and Jane Homeowner bought their house for $500k and put down $25k. It’s now worth $450k. Does the bank write it down now? What if it drops in value in another six months (God forbid)? Do they write it down again?