New mortgage aid idea: debt forgiveness, but with strings
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The idea of forgiving some of the debt of people whose houses are worth less than their mortgages has become perhaps the most divisive issue of the real estate crash.
Loan modifications aimed at keeping struggling homeowners in their properties have mostly involved temporary reductions in monthly payments. Lenders have largely resisted the idea of forgiving debt, for obvious reasons.
In a column I wrote in June (go here to read it) I noted that some housing experts believe the only way to stop the tidal wave of walkaways is to reduce the loan principal of homeowners who are underwater and facing default -- to cut their monthly payments and give them a shot at having an equity stake again. Some people, of course, never had an equity stake to begin with, depending on their loan terms.
Understandably, the idea of any kind of loan forgiveness for potential walkaways triggers a visceral response in people who didn’t buy into the housing bubble and who are continuing to make their mortgage payments.
Now, Martin Feldstein, a Harvard professor who was chairman of the Council of Economic Advisers under President Reagan, has a new proposal to extend loan forgiveness across the spectrum of underwater homeowners.
Feldstein detailed his plan in the Wall Street Journal over the weekend as an idea that ‘homeowners and creditors could both welcome, that is fair to taxpayers, and that would help the economy.’
The basic concept: Underwater homeowners would get help in return for rewriting their mortgages to allow lenders to legally pursue more than just the house if the owners decided to walk away. In other words, if you bolt on the loan the lender could seek to grab your car, your savings and other assets besides the house.
Here’s how Feldstein presented the plan in the Journal:
‘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.’
Like all proposals for mortgage relief, Feldstein’s is presented as a potential boost for all homeowners, because he believes that a broad-based reduction in default risk would assure that housing doesn’t begin another downward spiral.
‘Everyone benefits because with a stabilized housing market the recovery is more secure,’ he wrote.
But I’m sure that plenty of renters who are hoping for lower real estate prices wouldn’t agree with the idea that ‘everyone benefits.’ And I wonder how many people who are thinking about walking away would agree to a new loan that would allow the bank to take everthing they have if they still ended up defaulting.
What about the cost to taxpayers? I’m not sure how he calculated this, but Feldstein asserts that ‘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.’
-- Tom Petruno