Dividing and Conquering the Home Mortgage Baby

The housing market today is not any different from any other marketplace in any other time or place. The laws of supply and demand are still in effect. Sellers and buyers are still trying to optimize their outcomes in every transaction, even to the point of seeking a federal bailout. And if the government wades in (further) bringing wheel barrows full of cash, all of the transacting parties will act to serve their own self-interest. At a high enough price all homeowners are sellers and at a low enough price all properties can be sold. If the government acts to lower interest rates, prices for homes will rise because cheaper money reduces the effective price to the buyers (who always prefer a lower price). And if the government intervenes to “cram down” the principle due on a mortgage, homeowners will become sellers because they can turn the write-down of their mortgage into a higher “net price” when they sell. Every action of government impacts the marketplace but does not alter the fundamental rules of the marketplace.

If we are to fabricate or endorse specific types of governmental interventions in the home mortgage market, we should seek to apply the first rule of medicine: “First, do no harm.” To do no harm in this case means to limit waste, corruption and theft. The simple act of changing interest rates or becoming a buyer or seller or lender makes the government a factor and changes the equation for all marketplace participants. So our goal should be to limit fraud, which we can define as someone receiving something of value greater than what they deserve in an honest transaction. In a typical example: you bought your house for $300k four years ago, and you still owe $300k on it but today it is only worth $200k. Your down payment, if you had one, and any equity from any payments that you’ve made, are gone. Your interest rate is high and you can’t refinance to a better rate because you’re “under-water”. The bank is ready to foreclose and you’re prepared to walk away. Not a pleasant scenario.

Let’s establish some facts and make some assumptions that we might use to build a solution to this dilemma. First, in reality, although your name may be on the mailbox, you are not the home owner, you are the home renter. The bank or whoever holds your mortgage or pieces of your mortgage is the owner and what they really own is 1) the net proceeds that they could receive after processing your foreclosure or 2) the value of the rent that they can receive from whoever occupies the house going forward. The second “fact” is that at this point we have an asset on somebody’s books for $300k and a market that only values it at $200k less transaction costs. Someone has a substantial unrealized loss. Third, let’s assume you have to live somewhere and that you’re able and willing to pay something toward your rent or mortgage each month and that you would like to continue living in the same house. Fourth, is to make no judgments. You may have expected to flip your house and make a profit but got “caught” when the market went down, you may have signed a bad mortgage and have been tricked into a larcenous interest rate, or you may have run up second mortgages on cars and vacations with equity that is no longer there. No matter, just simply that if we the taxpayers are going to help you out, then going forward you must live in the house and meet your revised obligations.

My proposal: The federal government or some agency that it funds and empowers steps up and puts $100k, the amount that you are under water, on the table with the following strings attached to limit waste and fraud. The $100k is structured as a personal loan to you to use to pay down your principle on your first or current mortgage(s). To reduce the attractiveness to you of taking the foreclosure route, the loan is offered interest-free, payable over 15 to 30 years. You in turn, offer the $100k to your lender in return for a good interest rate on a new, $200k mortgage, the current market value of your house. The lender is delighted to avoid the loss of more than $100k and gives you a good rate, even though you have zero equity and housing prices might still be declining. You are happy because you’re not homeless and your monthly payment has been substantially reduced. And your local taxing authorities, state and local governments, are happy because you’re still paying property taxes. The old $300k mortgage(s) are paid-in-full and your lender is made whole and can resume his lending business. And the taxpayers are only stuck with the cost of an interest-free loan.

Now, the sticky parts. All is well if you stay in the home and make your low interest payments on your mortgage with your bank and your personal loan with the federal agency. But what if you can’t afford to pay even the reduced monthly payments? Or what if home prices decline further and you choose to default? Or what if home prices rebound somewhat but not enough to cover your two loans? To what extent do we end up putting your bank or the taxpayers (who as the default buyers always want to minimize their costs) at risk?

It is difficult to enforce morality. And there are always extenuating circumstances for even the best-intentioned borrowers.

But my feeling is that your current mortgage balance, less any onerous fees or penalties assessed by your lender, is your responsibility. You can owe it to a bank or to an agency of the government on favorable or unfavorable terms, but it is still your responsibility. Many people in Nevada and Florida made fortunes for years on real estate, building and selling and lending like there was no tomorrow. You may have bought into that game, and if you did, you own it. The people in Kansas and Kentucky who did not see their home values appreciate, should not be obligated to pay your mortgage. You may have gotten a zero down mortgage that reset at some stratospheric level. I feel your pain, and I am willing to underwrite better terms for you going forward, but it is still your balance due, not mine. If taxpayers pay off or pay down your debt and house prices rebound and prices double are you going to come and share the upside with us? Don’t laugh, if inflation ever becomes a serious issue, people who buy cheap houses today at low interest rates will look like geniuses tomorrow.

Any solutions to the mortgage mess that involve wealth transfer are ripe for abuse. If banks are forced to write-down the face-value of their loans, that in effect, transfers that amount from the bank’s owners to the borrowers even though the money is presumably gone. Who in their right mind would ever make a loan for $300k to someone and ask them for only $200k back? And, if the government can intervene in a private contract and dictate new terms favoring one party over the other, are we not introducing enormous uncertainty and the potential for corruption into all future business contracts? If the government forgives your personal debt, doesn’t that represent a transfer of wealth from one group of citizens to another?

In effect, what I am proposing is somewhat like the traditional, low-interest  Student Loan Program. In return for a social good, which in this case is you being able to afford to stay in your home and the resolution of the national mortgage mess, we the taxpayers and the banks will divide your current mortgage into two affordable pieces. Piece one will be a fairly traditional, good interest rate home mortgage with a typical lender, who, if not having perfect terms, at least has much better terms. The second piece will be an interest-free, long-term, unsecured, personal loan to you from your fellow taxpayers. (We know where you live!)

Solomon, in ancient times, in resolving whose baby was living and whose was dead, offered to divide the living baby in two, forcing the mothers to acknowledge the truth. We simply offer to divide the current dead mortgages into two pieces, so that we can breathe life back into the lives of homeowners and banks without killing the taxpayers.