New rush to modify home loans raises 'moral hazard' issue

How far would people go to get better terms on their mortgage?

Would you feign financial trouble to qualify for a loan-modification plan?

As the government and private lenders face more pressure to aid struggling borrowers in a worsening economy, they’ll inevitably have to deal with the "moral hazard" issue: They may be encouraging applications for help from people who could otherwise scrape by without assistance.

On Tuesday the Treasury announced a new loan-modification effort for mortgages held by Fannie Mae and Freddie Mac, which the government took over in September.

My colleague Maura Reynolds describes the program in this story. Basically, the plan would reduce a homeowner’s payment to no more than 38% of monthly gross income, by cutting the interest rate, deferring payments or extending the loan term.

To pre-qualify, a homeowner would have to miss at least three loan payments and must still be solvent, at least in theory (i.e., you can’t have filed for bankruptcy protection). Apparently, your loan would have to be for at least 90% of your home’s value.

See more of the plan's specifics here. (There's a Q&A on pages 4 to 7.)

As usual with these programs, the onus is on the borrower to contact the lender, to see what can be worked out.

Brian Montgomery, assistant secretary of Housing and Urban Development, insisted in a statement that loan modifications under the Fannie Mae/Freddie Mac program "are not a gift." A principal reduction on the front end of a loan, he said, would be repaid at the end of the loan. "This is not loan forgiveness; the loans will be paid, but under terms that are affordable to borrowers."

But if a loan's interest rate is reduced, the loan holder (in this case, Fannie or Freddie, and therefore taxpayers) would be forgiving part of the expected return on the mortgage, unless the interest savings were added to the loan principal.

Is there really a big moral-hazard risk in this plan?

If you believe that many people will try to cheat their way to a modification, you will be interested in the views of the well-known libertarian investment manager Peter Schiff of Euro Pacific Capital.

Here’s his take, which he sent by e-mail Tuesday:

By offering to reduce mortgage payments to 38% of household income for homeowners who are 90 days delinquent, the mortgage program announced today will spark a new wave of delinquencies. In a classic case of unintended consequences, the plan will encourage homeowners to rearrange their finances to qualify for the benefit. Those who could conceivably economize to meet their existing obligations will now have a strong reason to forgo such sacrifices.

The intentional reduction of income is also a possibility. In many cases dual-income families may decide to eliminate one job altogether as reduced mortgage payments combined with lower child care and other work-related expenses will likely exceed the after-tax value of the lost paycheck.

It may also be tempting for some homeowners to temporarily quit high-paying jobs, or delay job searches, and accept low-paying jobs while the creditors consider their fate. Once their mortgage payments have been modified to fit their diminished incomes, these homeowners would then be free to pursue better-paying jobs. With mortgage payments reduced to a fraction of their prior payments, these workers will have much more employment flexibility than those foolishly struggling to meet non-modified mortgages.

Way too cynical a view?

And even if some people are going to cheat  -- as some obviously did to qualify for their mortgage in the first place -- do lenders really have any choice but to get more aggressive with loan modifications rather than risk an even bigger wave of foreclosures?

Photo credit: Damian Dovarganes / Associated Press

Comments

[A Rothman, Los Angeles, CA]

The biggest problem I have with all these bailouts is that it hurts the responsible and rewards the irresponsible. Whether that be wall street or your neighbor in a foreclosure neighborhood. Companies and individuals need to take responsibility for their actions. Everyone who accepts a loan modification needs to have their name printed in the paper. If they quietly get bailed out of their problem, they are doomed to make bad financial decisions in the future. They need embarrassment and a little humiliation. Nothing like a public flogging to stop people and make them think twice.

[Al Rodbell]

People won't cheat. And Wall Street Firms will put their responsibility to society ahead of their desire for wealth.

Surely you jest.

This is beyond moral hazard, it is a moral absurdity. And this will be the nail in the coffin for a system of taxation that is based on the vast majority of people being honest. With this bailout honesty is transformed to naivete, and being shrewd is rewarded.

Free enterprise is not free of pain. Trying to make it so distorts the system into something much worse. Owning a home is not a public right, like primary education. It is a reward for success, that combination of luck and work that defines our society. Once we try to be "fair" with a given fraction of income defining the payment for a mortgage, why stop there.

Does not a renter deserve the same consideration even though he never jumped into a mortgage he couldn't afford, and by the way, did his part in inflating the bubble.

It's amazing, the New York Times has written dozens of articles lauding a bailout just like is occuring, with tens of thousands of responses like this one. Yet they have never written an article about the publics outrage over being taxed for a neighbors house payments.

This itself is worthy of a major story.

[Richard]

The government should reset all motgages nationally to a 30 year fixed rate at 5%. If you were making your payments you get the break also. If a person can't stay in thier home at 5% fixed, the home should be forclosed upon. No break for the irresponsible without a equal break for the responsible. After all - we will all have to endure the taxes to pay back that $750 billion bailout.

[Lisa Porter]

The way to deal with this issue is to add conditions so that anyone considering accepting help would have to seriously weigh present vs future benefits. Such conditions would be things like requiring that the mortgagee share a certain percentage of any appreciation in equity with the government when the house is sold or adding an upfront fee to paid by the mortagee in the form of a amount added to the mortgage. Also this help should be noted on the mortagee's credit report.

[Dunno]

Why am I paying for someone else's mortgage? Where's *my* bailout? Where's the accountability? The original mortgage applications need to be reviewed and if there was any fraud involved, heads need to roll. And if there was fraud, then that means these people shouldn't be in a home in the first place, so let them get foreclosed. Man this makes me furious.

[Matt]

I don't have a house but I have a lot of student loan debt. I think I should get help too.Why should we reward someone who stretches to buy a house over someone who is a saver (maybe for debt), but may have other kinds of debt.One way to prevent future real estate bubbles is to stop favoring real estate over other types of investment.

[gerrrg]

In my opinion, the answer to distressed homeowners, is to allow them to renegotiate their mortgage rates, one percentage point for each 10% portion of the profit of any sale or any quid pro quo transaction, as required to make the monthly mortgage payment compliant with conventional loan requirements (for maximum allowed per percentage of salary). The maximum would be set at 5 percentage points for 50% share.

As a result, the mortgage is sent directly to Fannie/Freddie, and would be 100% backed by the Federal Government. Terms for buying back from banks/lenders would be set at 115% of the average of the most recent 3 months of the Case-Shiller Index of their specific market.

Homeowners would not be allowed to use their mortgage to leverage for other loans for any purposes at all. Homeowners would not be allowed to dump their mortgage within the first 2 years of the renegotiated terms. The mortgage would not be assignable. If any of these terms were violated by the homeowner, 100% of the profit would be assigned to the Federal Government, and immediate liens would be placed for 100% of the value of the property.

[Figaro]

The major "moral hazard" is bailing out the bankers who made the bad loans in the first place. The problems we are now having were foreseen in August, 2007:

http://www.brasschecktv.com/page/187.html

So perhaps we shouldn't worry about a few poorer individuals trying to "game" the system; rather let's worry about the bankers, hedge fund operators, and other greedy persons. I would also like to recoup some of my retirement savings.

[Enlightenment]

#1 - If your income hasn't ever come close to matching what you stated on your loan application, then no help for you!

#2 - If you don't live in the house that is being loaned,thn no help for you!

#3 - If you own more than one house, then no help for you!

#4 - If you can only afford teaser rate loans, then no help for you!

If you don't like the above statement, then I don't care!!! I am responsible with my money and I don't care that you gambled and loss your ass, no different than if you went to Vegas and made the wrong gamble!!!

[David]

Me personally, I purchased a house I could afford in December of 2004. It has lost so much value I have decided to just walk away (stopped paying about six months ago). Its worth it to take the credit hit. I refuse to get stuck holding the bag on this mess. Although now I really wish I had bought a much more expensive home I couldn't afford. I'd be in a much better position right now.

[Kim Rellahan]

They just don't get it!

Housing costs are so much higher than rental costs, you need a
sharper fall in house prices, a sharp decline that prevents a long term
erosion in house prices, a sharp decline with speed so we can quickly get
closer to the level of rental cost! In this declining price structure,
foreclosures are good as it is best for all parties concerned, get that
existing or about-to-be foreclosed house back into the lending predator's
lap. With a sub-prime borrower having no equity in a house and faced with
further price declines....get out. In Las Vegas, for a mid-sized house,
monthly ownership costs are $1,797, rental costs would be $996, San Diego
$3,162 for ownership, $1,355 for rent, San Fran $4,149 for ownership, $1,592 for rent. Sub-prime owners, it's just a house...the "but, I live there"
excuse just doesn't fly with housing still on the brink of further collapse!

[Peter]

This whole country has been in an entitlement "bubble" for the last 20 years. We need to let the free market be free to shake out the idiots, whiners and slackers who are dragging us into the abyss. People always talk about the American spirit, ingenuity, work ethic. American this and American that bla bla bla ......well look around folks....more like the American Spoiled Rotten Slacker. Drinking 5 dollar coffees, driving cars you can't afford and living off the speculated value of your speculated homes. You've made your bed. Good bye Starbucks, hello dust bowl.

[Chris]

The housing bubble needs to be corrected in a manner not suggested by Paulson ... banks who don't refinance willingly and have subprime need to be hauled into court and eminent domain applied on them - for the good of society. Take the homes from the banks, give them "fair market value" which of course these days means a hefty losss for the bank that puts profit before community responsibility. BTW - for those saying this is not fair, bank X took the loan on good faith... bank X more than likely had the dream of foreclosing and reselling at the high values of past, and now is faced with taking the loss - which most don't want to do.

As far as the consumers who are bailing out of your homes because they are worth less ... who do you think you are? A home is not an investment. A home is not some renta-tv you throw back because you think its not worth your effort. The government needs to ensure people are removed from the credit pool if they choose to do this. The pain of abandoning a property because you can't make your profit, and maintain your lifestyle - please.

Both sides must feel pain - and the government needs to ensure both feel loss. The banks NEED to lose money on every bad bet. Business has no incentive to do anything without a cause forcing them to. No cause - no change.

[worried in america]

I Think Mr. Schiff is right.

we are giving more money to people who were irresponsible in the first place, takin money from the people who created this mess is wrong.Would you take money from a bank robber , a drug dealer , or a loan shark? You need to under stand, that the people running this are criminal at worst &fools at best.Drug dealers , bank robbers & loan sharks don't ever give anything away , unless they want a return on their money of at least 1,000 percent. So if you want to start losing body parts.Then by all means take it . Because if you can't afford to pay your house payment then how are you going to pay that much of a return.Every body is worried about the market crashing. i say let it crash. This whole system needs to be redone anyway.This is the only way we are going to get anything done in washington.These fools in washington & wallstreet don't understand anything but greed & deception. Thats why they run around bailing each other out.Let the market crash, let GM crash,let AIG crash, and let the chips fall where they may. We as Americans are too fat & too lazy.and to used to being bailed out of one thing or another. If aig, the market&all those other (to big to fail outfits)do fail. We Americans would have to pull together work a little harder, save a little more, which would take care of the fat & lazy & bailout thing.

[Steve]

I haven't seen this question, but... what is the money, paid by OUR tax dollars, actually for? They are getting billions of real dollars and offering refinancing to mortgage holders? Anybody else see the problem in this? It's one thing if the Federal Government guarantees the loans and it is quite another thing when the government gives out $700 billion new dollars AND guarantees the loans. It seems as if we, as tax payers, are in double-jeopardy.

Questions we should ask:

1. What is the $700 billion bail-out designed to do as specifically regards a house?

2. If the $700 billion is to prop up the sagging market, are we being told that the monies will be held in escrow until the home mortgages are paid off? If that is the case, who gets the interest on that money?

3. Why couldn't we have taken $100 billion & split it evenly with every eligible adult in the U.S.? No more crises... at all. Mortgages would be paid, taxes would be paid, back-child support, auto loans etc. The ONLY thing that would not happen is that the fat-cat executives would not get their balloon payments for failing their companies.

Just some quick thoughts.

[archyros]

What about people like me, who bought a house, then lost my job due to the onset of a disability? I am filing for chapter 7 because I am currently unable to earn what I used to be able to make...but because my income from disability is so low, I do not qualify to take advantage of this bailout program. I am currently awaiting rehabilitation help from the state, so that hopefully I will be able to begin to work again. I really need to keep my house, since my credit is so bad I don't think any landlord would take me...

[Cowards]

American is full of too many lazy cowards. To us, saving means putting some leftovers in the fridge for tomorrow. We don't want the party to end. We have always taken the notion that America is better than the rest of the World as fact and unchanging. In reality, our prosperity is due in large part to the hard work and sacrifice of our ancestors. American's as a whole have become watered down, lazy and content. We demonstrate this every election cycle. I don't think we have the guts to pick ideas and people over party and popularity anymore. We can't free up enough time between "Lost" and "Dancing with the Stars" to read up on candidates and issues. How much harm can our lazy straight ticket do? Well, we'll soon find out. President aside, did we really intend to replace one party that has lost its way with another that has the checkbook wide open. I'd like to close by saying -- I'm sorry to my Grandparents...

[Tod]

If it was really "just" mortgage debt it would be upsetting enough, but how many people out there have decided to roll their "bills" (read dinners, vacations, big screen tvs, groceries, etc.) into their 30 year note? The person in the following article obviously overspent her income by $10,000 - $15,000 per year for "more than a decade", didn't pay income taxes on it (it was home equity withdrawals), received a deduction (on the "mortgage" interest being paid to finance her "bills"), and now we're going to bail her ilk out!??!

from: http://www.onelocalnews.com/akronfarmreport/stories1/index.php?action=fullnews&id=43503

> Though Martinez bought the house more than a decade ago for only $76,000,
> she now owes about $230,000 because she refinanced her home loan
> several times. "I was trying to borrow some money to pay some bills,"

[Schigolch]

I was a fool to limit myself to a house I could afford.

[Bank workout loan guy]

I handle residential workout loans for a bank and you have no idea how bad the moral hazard has already become. Our country in just one year will not resemble anything we have come to know from just a year ago.

Read and study bible prophecy on the internet at the very least, and accept Christ before it's too late. The end is near. If you doubt this and you're wrong, it could cost you your eternal salvation. God Bless!

[Alice Perry]

Please.... can someone please tell me why we are FORCED to pay taxes... which are illegal to begin with? Why don't we start a real revolution, and stop the IRS from robbing us out of our money!! We ought to get off our computers and fight in person for our rights...otherwise, all the compalining on here is moot!

[A responsible idiot]

I was a "responsible idiot." I save and save and sacrifice many things to be able to buy a house. Why was I so dumb? I could have been irresponsible...buy a house i couldn't afford and wait for the government/other-taxpayers to bail me out.

I think the bailout is a joke...I think the bailout is actually encouraging more and more people to be irresponsible and lazy...forget about working hard and save for a better future...

"Welcome to the new US movement...movement to a socialize market...and oh yeah we reward those who are lazy/irresponsible and punish those who are not."

"It's an American deam to own house"...at the cost of the responsible people's hard earn money.

[Bill Smith]

This is insanity. People who ARE paying their taxes, and ARE paying their mortgages -- as they agreed to -- SHOULD claim financial hardship!

Why? Because otherwise they are subsidizing -- again -- the people who bought houses they could not afford, and should never have bought, but are still going to get all kinds of govt. (TAXPAYER!!) aid as if they'd suffered a flood!!!!!

I am sorry, but losing your house to financial embarrassment is NOT the worst thing that can happen in life. It's a learning opportunity.

YES! Losing the BANK's house you were living in will be an unpleasant pain in the butt. So will hunting for a place to rent, but that's life. The government of MY country was not set up to wipe your, um, nose, and provide for your every need, and rescue you from your own financial folly with OTHER PEOPLE'S MONEY!

CHEATING is what everyone involved in setting up this disaster did.

[Elaine]

Not everybody pays taxes. Nearly 40% of people in the U.S. pay NO taxes at all. That means that the other 60% has a much higher tax burden than they would otherwise, because not everyone is pulling their weight. There are only so many "rich" people that can be soaked for more money (the government keeps defining "rich" downward) and soon there will be no one else left to pay for all the bail outs. The govenrment already has over $10 trillion in debt on budget and who knows how much off budget - somewhere in the tens of trillions I think. There will be lots of Social Security, Medicare and Medicaid coming due in the next few years as baby boomers retire - many trillions there in debt. Now Detroit auto makers also want a piece of the bailout pie, as do numerous other industries. The government just keeps shoveling money out the door to them all. How in the world can the U.S. government ever pay of all this debt? They will probably have to start "monetizing" the debt - that is printing money in effect, causing a high inflation rate. People who saved moeny will lose the value of that money. In the end we might become a one class society - an impoverished class. At least the Social Security crisis is solved - now nobody retires!

[Frustrated in MI]

With all the bail-outs and foreclosed mortgages, the people who are trying to do the right thing are taking the biggest hits. I lost my job in MI due to financial problems for the company that resulted from Gov. Granholme's "tax ourselves to prosperity" plan and the idiots that re-elected her on her "you ain't seen nothing yet" platform after things started getting bad. After a year of looking there, had to take an out-of-state job. Now trying to sell my house that is worth maybe 1/2 - 2/3 what I paid for it. Never been behind and often paid extra, but mortgage company (one of the biggies that helped precipitate the housing mess) won't talk to me about a short sale unless I'm 3 mos behind on payments. No bailouts because I need to leave the area.

Even though the mortgage company will make about 10% on what they loaned me if I short sale (sale price + several years payments), they'd rather foreclose than take the 10% and make me another mortgage that I would faithfully pay like the last one. Several neighbors have sold everything that wasn't nailed down in the house, then walked away. It gets harder and harder to resist the urge to do the same when the people who played a large part in causing the mess (mortgage companies) won't step up to accept any of the consequences of their actions or do right by the people they've hurt in the process.