WE all know that most of us don’t tackle problems until they’ve morphed into full-blown crises. Think of all those intersections that get stop signs only after a bunch of accidents have occurred.
Better yet, think about the housing market.
Only now, after it has become all too clear that the government’s feeble efforts to “help” troubled homeowners have failed, are people considering more substantive approaches to tackling the mortgage and real estate mess. Unfortunately, it’s taken the ugly specter of a free fall or deep freeze in many real estate markets to get people talking about bolder alternatives.
One reason the Treasury’s housing programs have caused so much frustration among borrowers — and yielded so few results — is that they seemed intended to safeguard the financial viability of big banks and big lenders at homeowners’ expense.
For example, the government — in order, it believed, to protect the financial system from crumbling — has never forced banks to put a realistic valuation on some of the sketchy mortgage loans they still have on their books (like the $400 billion in second mortgages they hold).
All those loans have been accounted for at artificially lofty levels, and have thereby provided bogus padding on balance sheets of banks that own them. Banks’ refusal to write down these loans has made it harder for average borrowers to reduce their mortgage obligations, leaving them in financial distress or limbo and dinging their ability to be the reliable consumers everyone wants them to be.
Various proposals are being batted around to address the mortgage morass; one is to do nothing and let real estate markets crash. That way, the argument goes, buyers would snap up bargains and housing prices would stabilize.
Yet little about this trillion-dollar problem is so simple. While letting things crash may seem a good idea, there are serious potential complications. Here’s just one: Many lenders and some government agencies bar borrowers who sold their homes for less than the outstanding loan balance — known as a “short sale” — from receiving a new mortgage within a certain period, sometimes a few years.
For example, delinquent borrowers who conducted a short sale are ineligible for a new mortgage insured by the Federal Housing Administration for three years; Fannie Maeblocks such borrowers for at least two years. Private lenders have similar guidelines.
Such rules made sense in normal times, but their current effect is to keep many people out of the market for years. And as home prices have plunged, leaving legions of borrowers underwater on loans, short sales have exploded. CoreLogic, an analytic research firm, estimates that 400,000 short sales are taking place each year.
More can be expected: 68 percent of properties in Nevada are worth less than the outstanding mortgage, CoreLogic said, while half in Arizona and 46 percent in Florida are underwater.
“There is this perception that maybe we should let the market crash and then prices will level off and people will come out and buy,” said Pam Marron, a senior mortgage adviser at the Waterstone Mortgage Corporation near Tampa, Fla. “But where are the buyers going to come from? So many borrowers are underwater and they’re stuck; they can’t buy another home.”
There is no doubt that real estate and mortgage markets remain deeply dysfunctional in many places. Given that the mess was caused by years of poisonous lending, regulatory inaction and outright fraud — and yes, irresponsible borrowing — this is no surprise. Throw in the complexity of working out loans in mortgage pools whose ownership may be unclear, and the problem seems intractable.
The moral hazard associated with helping troubled borrowers while penalizing responsible ones who didn’t take on outsize risks adds to the difficulties.
STILL, there are real, broad economic gains to be had by helping people who are paying their mortgages to remain in their homes. Figuring out how to reduce their payments can reward responsible borrowers while slowing the vicious spiral of foreclosures, falling home prices and more foreclosures. And it just might help restore people’s confidence in the economy and get them buying again.
With that in mind, let’s recall an idea described in this space on Nov. 16, 2008. As conceived by two Wall Street veterans, Thomas H. Patrick, a co-founder of New Vernon Capital, and Macauley Taylor, principal at Verum Capital, the plan calls for refinancing all the nonprime, performing loans held in privately issued mortgage pools (except for Fannie’s and Freddie’s) at a lower rate.
The mass refinancing could have helped borrowers, while retiring mortgage securities at par and thus helping pension funds, banks and other investors in those pools recover paper losses created when prices plummeted. Fannie Mae and Freddie Mac could have financed the deal with debt.
In the fall of 2008, when Mr. Patrick and Mr. Taylor tried to get traction with their proposal, roughly $1.5 trillion in mortgages sat in these pools. Of that, $1.1 trillion was still performing.
Instead of refinancing those mortgages, however, the Washington powers-that-be hurled $750 billion of taxpayer money into the Troubled Asset Relief Program, which bailed out banks instead. Though one goal was to get banks lending again, it hasn’t happened.
Now, almost two years later, $1.065 trillion of nonprime loans is sloshing around in private mortgage pools, according to CoreLogic’s securities database. While CoreLogic doesn’t report the dollar amount of loans that are performing, it said that as of last June, two-thirds of the 1.6 million loans in those pools were 60 days or more delinquent.
That means one-third of the borrowers in these pools are paying their mortgages. But it is likely that many of these people owe more on their loans than their homes are worth and would benefit greatly from an interest-rate cut.
If Fannie and Freddie bought these loans out of the pools at par and reduced their interest rates, additional foreclosures might be avoided. The only downside to the government would be if some loans it purchased went bad.
The benefits of the plan could easily outweigh the risks. Institutions holding these loans would be fully repaid, a lot of borrowers would be helped and additional foreclosures that are so damaging to neighborhoods might be averted.
“Every program that the government has announced was focused on bad credits, but they were trying to fix a hole that is too big,” Mr. Patrick said. “The idea is to try to preserve the decent risks and not let them go bad.”
At the very least, this is a sophisticated and realistic idea that’s still worth considering.