The Mortgage Mess

I'm finding it hard to think originally about how best to fix the mortgage mess; I keep falling back on the homilies of childhood. My Dad used to say it rained on the just and the unjust alike. I accepted that even though I wasn't always sure if the rain was a good thing helping the unjust or a bad thing hurting the just. Sentiment these days seems to be more negative regarding the first option than the second. Those not standing in line for help themselves seem to feel more strongly about not helping the unworthy than about helping the worthy. The Prodigal Son probably wouldn't be welcomed home these days either.

If we had all followed Shakespeare's caution to "neither a borrower nor a lender be," we wouldn't be in this mess, but then again we probably would be even less prosperous than we are. Presumably, until recently, lending and borrowing helped raise our standard of living; but we carried a good thing too far.

Since this feels like a learning moment, let's go to the source for elaboration: Hamlet, Act 1 scene 3:

Neither a borrower nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.
This above all: to thine own self be true,
And it must follow, as the night the day,
Thou canst not then be false to any man.

The solution we are looking for is how to help the truly worthy needy borrower whose predicament is not of his own making without also helping those less innocent. That, of course, is an impossible task for the government, which, almost by definition, must use one-size-fits-all solutions. The Rick Santelli rant on CNBC's Squawk Box reflects the anger this creates in much of the populace.

There are no good options acceptable to all. Probably one of the more effective, but least desirable, options is to authorize bankruptcy judges to change the terms of the mortgage contract for the benefit of the borrower and to the detriment of the lender. That's known as a "cram down" provision. That may be a practical solution since the revised terms may still be more advantageous to the lender than foreclosure, but the price paid by compromising the sanctity of contracts is steep. Apparently, bankruptcy judges already have that authority for homes that are not the owners' primary residence, but that doesn't sit too well either. I guess there's not much desirable about bankruptcy.

Another program the Obama Administration recommends is for the government to split the cost difference with the lender or the mortgage servicer for relaxing the terms of the original mortgage. To provide a reward for good ongoing behavior, a "pay for success feature" would reward servicers if the loan is kept current, up to a $1000 per year.

Another approach recommended by the Administration is for the government to add another $100 billion each to the capital of Fannie Mae and Freddie Mac to "shore up confidence" in these organizations that are already under government control. With more capital and more confidence, Fannie and Freddie would be in a stronger position to help solve the problem with more low-cost mortgage generation and guarantees. Some hair of the dog.

Even mortgage debtors who are current with their payments are to be helped to bring their monthly payments down to no more than 31% of their income. Presumably, these will be people who started off with their debt in good alignment with their income, but whose position worsened with the financial crisis and the declining economy and declining home prices.

Comments (5)

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  1. Money has to be pumped into the sytem to get lenders lending again. I’m not saying that they have to be irresponsible like before, just willing to lend. Here in the UK lenders are not interested. They find all sorts of excuses as to why they can’t lend.

  2. Cannon says:

    This “mortgage mess” is an excellent example of the government doing far too much to encourage consumers to behave in a certain way – in this case it’s home ownership. The fact that politicians were enabling mortgages to be extended to people who weren’t credit worthy through Fannie, Freddie, and other policies is something that has been touched on by parts of the media but not to the extent that it should be.

    Instead, we’re inundated by the notions that runaway capitalism and tax cuts are the primary culprits, and we’re left trying to right the wrongs of the private sector and politicians with more reliance on government. The problems we’re facing are complicated and difficult, and probably require some more efforts from political leaders. However, I would hope that we could exercise some prudence as much of the plans put forth by Congress may well do more harm than good, short and long-term. It’s always difficult to extricate government when its help is no longer needed; political involvement did much to get us here in the first place, in my humble opinion.

  3. Wally K says:

    I bought my first house at the peak in 1986 and was soon underwater when house prices dropped, but so what as I worked nearby and had to live some where. Lately, I haven’t heard anything about putting a lien on houses to recover loaned money if people later make a profit on house sales. Maybe a little “fairness” for the taxpayer would make the great housing give away more palatable.

  4. Jay says:

    Those that think the government is doing too much need to read some of Ambrose Evans-Pritchard writings. Be sure to keep the lights on !

    We are in a deflationary period no matter what the government does so they can probably not do too much. It’s the 70s turned on its head. What stopped inflation was Volker and Reagan. Volker to keep interest rates up now matter what and Reagan to cut the higher bracket taxes. Volkers actions stopped the cycle of inflation by choking business cycle short circuiting the spiral. Reagan rewarded the supply side of the equation by cutting taxes.
    What the prior administration did not understand was that Reagan part II wasn’t going to work. The problems that were there when Reagan came into office didn’t exist anymore. If anything it was the opposite.
    Now we face oversupply of product and labor just like the late 20s and with similar circumstances.
    History does rhyme.
    So the solution now requires the opposite approach to break the deflationary cycle sooner rather than later or we languish into another lost decade.

    Tax cuts that will cause consumption.
    Breaking the cycle of foreclosures and job losses.
    Temporarily printing money.
    and of course
    Suspension of Mark to Market as they did in 1938.

    Timid or half measures will not do.

  5. JustOne says:

    What I find baffling is how the government ever got into the business of backing real estate loans at prices well above the cost of construction just because the “market” was above the cost of construction.

    In Texas the cost of materials is about $25/sqft for a modestly appointed house while land and labor is also about $25/sqft. Profit and overhead for builders brings the selling price of new homes to about $70/sqft or about $140k for a 2000 sqft home. Even very nicely appointed homes on premium land (next to the 18th fairway for example) are routinely sold for under $150/sqft in much of the Dallas Fort Worth metro area.

    I know that labor and materials may be a little higher in other areas but these costs are not hard to determine. Insurance companies have vast databases of construction costs for homes in all areas and amenity levels. The cost of building is not a mystery anywhere in the U.S. as far as I know.

    So why is the FHA or Fannie or Freddie ever backing loans at over $500/sqft anywhere? If a market puts a premium on some properties that is fine. If so, the buyers should take any associated risk in “hot markets” … not the taxpayers.

    Similarly why should the government be backing loans to buyers that do not meet “normal” underwriting criteria for income, debt burden, payment history, assets, job history, etc. Does a “hot” market justify waving the standards just because appreciation of the collateral may offset any risk? That is a risk that is too big not to fail.

    And how did we ever allow “credit default swaps” to be done without capital backing similar to other forms of insurance? And why were the rating agencies unconstrained in their practices so that AAA ratings were granted without adequate risk reserves, underwriting, etc?

    What we are talking about is not just a game. This mess has destroyed the pension funds and life savings of thousands of hard working, honest people like school teachers, firemen and policemen. And it was not all done by schemers like Madoff. It was done by “legitimate” bankers, administrators and fund managers. The culprits should (must) be identified and ill-gotten bonuses confiscated and the illegitimate practices halted.

    It’s time to get back to basics and reality … IMUO.