President Obama’s key initiative on the mortgage situation, the Home Affordable Modification Program (HAMP), has serious problems. Besides low modification rates, the biggest problem has to do with borrowers being underwater. It’s well known that being underwater is correlated with higher default rates, defaults that destroy value through foreclosures for homeowners and adds large costs to already struggling municipalities.
It is one thing if these modifications were mostly ineffectual. But, as was found in in a recent report issued by the State Foreclosure Prevention Working Group, 70% of modifications lead to mortgages with a higher balance, and are then deeper underwater than when they started. This is the exact opposite of what we want to happen.
What to do? Allowing bankruptcy judges to write down principal of first mortgages and attached second liens. Allow a “Right-To-Rent” for those who can afford the rental rate of their communities and want to stay, but can’t afford their mortgage, with them losing an equity in the house as a punishment. What else?
Congressman Brad Miller (D-NC) has an additional policy tool that can be used. He has just written a timely piece in the New Republic titled UnHAMPered that you should read, in which he argues that we need to go back and use an item from the New Deal’s playbook:
As part of its initial legislative barrage on the economic crisis, the Roosevelt administration created the Home Owners’ Loan Corporation (“HOLC”) in June of 1933, just three months after entering office. The HOLC purchased distressed mortgages from banks, and then negotiated new, more affordable mortgages with the homeowner. Before it ran out of capital in 1935, the HOLC purchased a little more than one million mortgages, or about one in six of the urban home mortgages. (There was a similar program for farm mortgages).
The new HOLC could buy mortgages by eminent domain…The toxic assets backed by mortgages are impossible to value. The concern that taxpayers would get fleeced buying toxic assets from the financial industry was well justified. Whole mortgages are not hard to value at all. There are frequent, well-publicized auctions of mortgages with a sufficient number of informed, sophisticated buyers….
If the government could purchase, either by voluntary sale or by eminent domain, distressed mortgages for 30 to 50 cents on the dollar, there would be ample room to reduce the principal to make the mortgage affordable. In other cases, the government could buy the home in exchange for cancelling the mortgage and enter into a long-term lease with the former homeowner.
The whole thing is worth reading. James Kwak has an initial reaction. As James mentions, it is worthwhile to note the swift, efficient and effective movements for helping the capital markets, and the lackluster, incompetence we’ve seen in trying to get consumers above water.
The government is good at implementing large, blunt, satisficing solutions to problems. And America, in particular, has the best bankruptcy courts in the world. So why not uses these strengths? Adjusting the legal framework of bankruptcy and property transfer (Right-to-Rent), and then throw some cash targeted straight at the problem, sit on these new mortgages and break even, is the perfect thing for the government to be doing. The idea that you could nudge servicers into doing the right thing with a little bit of cash is designed to fail. (Have you met any servicers?)
And I like eminent domain as a way to get a fair price for the mortgages, indeed to do the job that mark-to-market discipline should be doing if we had a working market. The mortgages are worth 50 cents on the $1, but they are on the books for 90 cents. If foreclosed, they are worth 40 cents. Eminent domain for 60 cents, write down to 75 cents, and then resell after two years for 70 cents. This dodges the obvious problem of using the taxpayer balance sheet as a dumping ground for overvalued loans, like what has likely happened with the GSEs.
What is your take?
Rortybomb 
Eminent domain by the Federal Government is going to walk right into a squabble to end all squabbles in the form of having to contend with the eminent domain laws of each State (and they are all different). States rights? I note merely that the Congress critter chose not to mention the issue, no agenda there of course.
The Federal Government should not be meddling to support house prices (ultimately where this leads).
After the S&L crisis small banks in Texas (I don’t know about other states) did purchase whole loans from portfolios of failed institutions taken by the FDIC (who I believe were all too happy to get rid of them) and renegotiated many with the borrowers with good long term results. I suggest a role for the FDIC would be far more likely to succeed in this lifetime than getting all States corralled where the guvmint wants them. When all is said and done it’s probably quicker and cleaner in the end to let the market handle it. The law of unintended consequences is already at work quite enough.
um… won’t that likely bankrupt the banks who are forced to put them on the books at 1/3 less of the value that they are currently holding them for now?
I don’t object – I think history shows zombie banks are bad and I have no desire to experience a lost decade – but that’s kind of important to know up-front.
Eminent domain would never be applied in that way. Anyone who thinks that would ever be passed into law (eminent domain used in that specific way) must be a very very young naive guy mostly knowledgeable in financial engineering and with very little concept of the real world and how that would fly politically, much less legally.
I’ve got to agree, the eminent domain thing is politically infeasible.
The Right-to-Rent seems to make much more sense to me. The rental rate is the market rate of the house, and the house *should* be worth the discounted stream of value from the house, which is the value of living in the house, which is the rental rate. Granted, the mortgages are usually much bigger than this, as it was a bubble, but this is simply resetting the mortgages to their fundamental value. Much more efficient than foreclosures, easier to implement, and consistent with markets.
It penalizes mortgages holders that gave loans for more than fundamental values, but they’re not supposed to want to do that in any case, as they’re basically loaning someone money to overpay for something.
Plus, it eliminates or postpones amortization payments, which makes it into a *really* long mortgage. This means less equity, but a lot more affordable payments.
Interested to know your take on Hussman’s notion of granting the mortgage security holders “property appreciation rights” to offset the necessary principal reductions. His suggestion is to create a program that allows underwater homeowners to reduce their mortgage obligations to a level they can afford to pay on current income, while granting an offsetting asset to the lender in a balance sheet neutral manner.
The notion stems from the simple fact that many (all?) banks cannot mark down the mortgage principal without taking a current loss, thus potentially drawing the unwanted attention of the FDIC. Presumably that weakness in the balance sheets is the underlying reason more banks are not adjusting more loans.
He goes into detail on how such a program might work (so I won’t), but it strikes me that the basic concept provides a simple litmus test for any and all policy suggestions: does the proposal require banks to book large current losses without receiving any offsetting benefit? If so, the proposal threatens the survival of the lender and is thus less desirable than the current program of extend and pretend.
Right To Rent should be limited to those who did not lie on their mortgage applications; otherwise it rewards those who were complicit in this mess.
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