Mortgage Bailout – Who is getting bailed out?
I have met with some pretty smart people in the last few days. Today I met with a partner at a private equity firm and a week ago I was with a fairly senior World Bank employee. The bail out was top of mind. For my private equity discussion, I was asked what I thought about the bailout and the impact it would have on advertising in 2009. The World Bank discussion, I was asked about the mortgage situation. I have been thinking a lot about that discussion - and more so today considering the sketchy details of how the TARP plan is going to help homeowners. Here’s waht we discussed.
Lets forget that the banks underwrote the risks of the buyers relative to their assets, their ability to pay and the property values based on the term of the loan. Lets talk about the cycle of defaults, people spending less, massive layoffs, people spending less, more layoffs, and an increased propensity for default on mortgages and foreclosures.
Whether people have interest only loans, convertible arms or fixed mortgages, many have paid for a number of years. If nothing is done to help the homeowner and the interest rate, amount and term remain as they are per the mortgage agreement, many more will default and many owners will lose equity and homes in addition to their jobs. And the banks will be in more trouble. Sadly, many mortgages are locked in at property values and interest rates that are higher than what either are today. And the homeowners would not qualify for a traditional refi.
Today one can get a Convertible Arm mortgage – the rate stays the same for a period (3, 5, 7 or 10 years and then fluctuates by an amount (maybe up or down 2% a year) for the rest or the term. It is ludicrous to me that one can get a Convertible ARM that is fixed in term with a fluctuating rate, but not one that is fixed in rate with a fluctuating term. At
An existing mortgage is based on a valuation done at the time of the initiation of the mortgage. So if the mortgage continued, the valuation it was based on is somewhat irrelevant as would be a current valuation as the mortgage continues – provided the mortgage payments continue. I know the banks will disagree with this, but if I were to continue paying my mortgage, the valuation should not impact them if I keep paying. If I stop paying the valuation is critical – so the bank should find a way to have the owner continue making payments. I am guessing that the present value of the loans will change on the institutions books, but the diminution in value will pale in comparison to the loss from foreclosed properties. And they will have cash flow and not the ridiculous fees to close out the properties and the actual losses.
My concern is that the cycle outlined above is going to increase the rate of default. With layoffs continuing and retail nowhere near recovery, more distressed sales and foreclosure actions are coming. By enabling a way to distribute over time or deflect the focus from now when we are in the eye of the storm, the lifeline to both consumers and banks will IMHO facilitate a greater measure of stability. But what do I know?
Rather than have the defaults,as a way to
- Keep owners in their homes
- Stem the default rate
- keep banks in business without giving them money to finance these bailouts
The banks underwrote the loans at a certain value – they need to live with it. Rather than foreclose, how about an “amnesty” refi that is in some sense similar to chapter 11 for the mortgage. Unless I misunderstand, does not require Govt funding or at a minimum requires way less funding. Here’s the plan for folks who meet certain qualifications:
- The property value in the mortgage is held constant.
- Any loan rate that is more than a certain amount (.25% or .5%) higher than prevailing rates, is refi’d at the lower prevailing rate (this could be the current plus an eighth to compensate the bank).
- Term is extended to a number that brings down the monthly payment to a point where people can make payments. The maximum term is extended beyond 30 years to 40 or 45 years. e.g. – if a laon has 25 years to term, the loan gets refi’d at a 30, 35 and 40 year term and the shortest term that enables the person not to default, is agreed to.
So the principal stays the same, the rate stays the same or is lowered and the term of the loan is extended. Basically by extending the term, the mortgage is paid off over a longer term with less in each payment. Although each payment is lowered, more payments are made. Additional amounts could go to the bank for doing this – either as a fee that is added to the mortgage (like points which are deductible). The banks earn interest for the longer term. The person keeps their equity, and they continue to pay down on their home ownership. Why not?
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