I found a good article today that was published in the WSJ in August 7, 2009. How to Save an ‘Underwater’ Mortgage
By MARTIN FELDSTEIN
An epidemic of mortgage defaults and foreclosures is threatening the economic recovery.
The problem is serious and getting worse. More than three million homes are now in serious default (nonpayment for 90 days or more) or foreclosure, nearly double the number a year ago. Sales of properties in foreclosure or serious default made up one third of all home sales in May and June.
Despite a slight uptick in house prices in some markets recently, the sales of foreclosed properties continue to dampen house prices and weaken banks’ balance sheets. The uncertain pace of future losses makes banks nervous about the adequacy of their capital, which discourages bank lending and economic growth.
There are two separate but mutually reinforcing reasons for the surge in defaults and foreclosures: the reduced affordability of mortgage payments and the high loan-to-value ratios of many houses.
full story here
The administration should work with creditors and homeowners to reduce the principal on mortgages that are at risk of default.
This would not appeal to every homeowner with negative equity, but it may induce enough of them with high loan-to-value mortgages not to default, and thus prevent or reduce the downward spiral of home prices.
Here’s how such a plan might work in a way that homeowners and creditors could both welcome, that is fair to taxpayers, and that would help the economy:
Any homeowner with a loan-to-value ratio over 120% could apply for a reduction in his mortgage balance. The government and the creditor would then share equally in the cost of writing the loan balance down to 120% of the value of the home. But the homeowner who opts for this write-down would be obliged to convert the remaining mortgage to a loan with full recourse that could not be discharged in bankruptcy. Federal legislation would be needed to modify state mortgage and bankruptcy rules to allow homeowners to obtain the new type of mortgage.
An example shows how this would work. Consider someone with a home worth $200,000 and a mortgage of $280,000, i.e., a loan-to-value ratio of 140%. If the borrower and the creditor both agree, the loan could be reduced by $40,000 to $240,000 (120% of the home value.) The government would give the creditor $20,000 to offset half of the write-down. The homeowner would convert the remaining $240,000 mortgage to a bank loan with full recourse that could not be discharged in bankruptcy.
The bank takes a $20,000 loss (as part of the $40,000 mortgage write-down). But it would be better off, because it has a more legally secure loan of $240,000. The homeowner owes less, but he is now personally responsible to repay the loan in full.
All other homeowners would also benefit from such a plan because reducing defaults stabilizes house prices. Indeed, everyone benefits because with a stabilized housing market the recovery is more secure.
If this plan succeeds in stabilizing house prices at the present level, the one-time cost to the taxpayers would be capped at $200 billion, even if every homeowner with a loan-to-value ratio over 120% accepted the government-assisted write-down. That $200 billion is less than a 2% fall in house values.
Slowing the downward spiral of house prices will protect the solvency of the banks and the net worth of households. The failure to do that could mean a deeper and longer recession that imposes much higher costs to the government.
Mr. Feldstein, chairman of the Council of Economic Advisers under President Ronald Reagan, is a professor at Harvard and a member of The Wall Street Journal’s board of contributors.
-Feldstein makes A great point regarding the issues with negative LTV. Again this was 2009 and nothing regarding principal balance reduction has been initiated by the fed or the banks. Now the Banks do have solvency problems that are being covered up by magical accounting.
Housing prices have declined over the past year and they have not hit bottom yet. There is no single greater drag on our economy than having a large percentage of homeowners in a substantial negative equity position. This is especially devastating if the economy is faltering and home prices falling.
It is impossible to give that person enough security for them to spend they way the spend when they have a nest egg of equity in their home. It is great for the economy to have real estate performing as an appreciating asset even if it appreciates at the rate of inflation. It is a hope generator. It gives the average person a positive, safe and attainable way to save for retirement.
Why would anyone agree to this deal in today’s economy? The trading $40, 000 for a life long debt on a home that may be in negative equity position 5 years from now makes little sense. There is an incentive for the bank because they can lock in $240,000 or ruin the borrower’s life in the event of a major issue, such as job loss or medical bills, etc.
The idea of non recourse loans being converted just to get the bank to do what they should be doing anyway seems again like an abuse by the bank. They are getting collateral for the loan; you can’t expect people to put their entire life at risk to aid in solving a problem that was created by the Banks and the MBS, CDO s, etc.
I admire the effort to give a workable solution but this way to biased against the homeowner. So many people choose to participate in the housing market because it was supposed to be one of the few stable ways to build a nest egg.
