Wednesday, November 19, 2008

The Great Mortgage Modification Pump - GOD SAVE US ALL!

(Mr. Mortgage) As you all know, this is a hot topic of mine. All of these proactive loan modification efforts now coming out of the woodwork by every bank, regulator and government agency is destined to keep the housing market completely depressed and home owners trapped, unable to sell or refinance, for decades.

They are rushing out with modification plans because higher paper grades are now defaulting at a staggering rate due to negative equity and home owners finding it better to walk away from all that debt and rent. What’s worse is that over the past five years there was a fundamental shift of how people viewed their home - from a place to live to their single largest investment.

Higher grade loans allowed a 50% debt-to-income ratio and higher due to no income documentation, meaning most of their after-tax income is going out each month to pay bills with the house payment being the largest. This is a tough nut to swallow when your house is down 50% in value and you are 30% upside down in your mortgage…yes, these are 20% down prime borrowers I am talking about. This makes the decision to walk all the easier. The easiest and quickest way for the underwater, over-leveraged home owner to stop the pain is to walk. The new plans are designed to make that less attractive by playing the low monthly payment game.

I have been telling all of you for a long time that they will have to modify every loan in America in order to fix this problem, but I never dreamed they would do it this way. Reworking loans to make ‘payments affordable’ without permanently reducing principal balances is the worst possible thing that can be done because it ensures the housing and foreclosure crisis will be with us for a long time. If these programs are widely accepted, housing is a dead asset class indefinitely.

However, they are accomplishing one thing by keeping borrowers leveraged-up, paying low monthly payments and adding all of that deferred interest and payments to the back of the loan - that’s bailing out the banks.

This style of modification does not sit well with owners of mortgage securities either, which make up the bulk of distressed mortgages. This is because deferred interest, 40-year terms and interest only teaser periods greatly reduces the cash flows and lengthens the duration of the security. For many securities owners, its better to have the home sold in foreclosure so they can recoup at least part of their investment. Again, the new plans only help the banks and the whole loans they own. These plans allow the bank to avoid a write down - the banks get their money cheap enough to offer 1.5% and still make money.

Homeowners - SMARTEN UP! The FDIC program keeps you fully in debt, renting your home for the rest of your life. This is a terrible solution. This is no different than other programs being offered by banks such as Chase, BofA and Wachovia. Why in the world would a sensible person accept such a program?


If you walk away now your credit will be ruined for 5-10 years. So what. It will take much longer than that for home prices to ‘come back’. It will take even longer for borrowers to pay off the original mortgage loan amount, which could be 100% higher than the present value of the property. And if borrowers accept this they will have to pay down the loan because you are upside down and can’t sell!

Think about it folks! If your home value is down or you are underwater by 50%, which is not too bad especially is many areas in the bubble states, YOUR VALUE HAS TO GO UP 100% for you to break even- or for your home price to ‘come back’. Quit dreaming. It ain’t gonna happen.

If house prices stopped going down this very minute and started rising at a historical 5%-7% per year based upon a good overall economy, low interest rates, strong sentiment and rental rates it would take years for prices to get back to where they were. And we don’t have a good economy, low mortgage rates, strong sentiment or rising rental rates.

These mortgage modification efforts only lower monthly payments. They are no better than the toxic loans that caused all of this mess in the first place. They only kick the can down the road. They rely upon ‘extend terms to 40-years, deferred interest and low introductory rates’. THIS IS HOW WE GOT HERE IN THE FIRST PLACE - they were called ‘2/28s’, ‘interest only’ and ‘Pay Option ARMs’.

What they are trying to do is simple - play with monthly payments so borrowers find it easier to stay than walk away and rent. IT IS A TRICK, just like when the car salesman asks ‘how much can you afford to pay each month?‘…then the payment comes in low but your term is 84 months. You never end up getting right side up. As a society we need to break the ‘monthly payment’ habit and get back to reality which is saving money and spending less.

The fact is when you accept this type of modification YOU ARE RENTING. It is WORSE THAN RENTING because when you walk away and rent you don’t have the debt any longer. With these new mortgage modification programs, all of the debt stays with you forever.


It is time for the banks to write down principal.

Home prices only got as high as they did from 2003 through 2007 due to extraordinary leverage created through exotic loan programs and easy credit that never existed before and never will again. From 2003 through 2007 everyone made $150k a year for the purposes of buying a home. Home prices responded by surging higher to meet the new found nationally high affordability level.

Everyone was suckered. Folks who really earned $150k a year went out and bought over priced homes not knowing they were suckered - they are now upside down by 50% in their home and have seen their life savings go up in smoke. They overpaid because the janitor was bidding against them for the $650k home using a stated income 100% interest only combo. Hey, the loan officer at the bank and the Realtor told him that ‘based upon this loan program he qualifies’. Why should he argue with his bank? They know best. They are the experts.

But now everyone knows it was all a fraud and none of those easy credit, high-leverage programs exist any longer. Prices are coming down to the real affordability levels using 15 and 30-year fixed rate loans and a down payment, which has rendered the nations financial institutions and millions of home owners instantly insolvent. The same household that earns $75k per year that two years ago could buy a $650k home with no money down can now buy a $275k home with 10% down. It now takes $150k a year and a large down payment to buy a $650k home.

100% stated interest only and Pay option ARMs will not return. Nor will 100% HELOCs. They were doomed to fail from their creation. The banks had modeling systems that they never stress tested. You mean to tell me that it never occurred to the smartest guys in the room to plug into the model that home prices could actually fall? That was a fatal error that the world is paying for. But the banks will never pay if everyone gets an FDIC or bank designed mortgage modification because they make the borrower take 100% of the hit.


If not for the unregulated institutions providing unlimited credit and leverage to every household in America this never would have happened. It is time for the very same financial institutions that created all of this to do what’s right and re-underwrite every loan originated between 2003 - 2007 using prudent underwriting guidelines. Then, reduce the principal balance to what the borrower really earns using a 28% housing and 36% total debt-to-income ratio at a market rate 30-year fixed loan. When home owners are levered at 28/36 they are able to save money and live a decent lifestyle. If they go upside down in their property who cares - they are still able to save money.

If reducing the principal balance to 28/36 on a market rate 30-year fixed loan is $100k lower than the present value of the home, the bank can take can take the differential through a second mortgage or equity warrant. if the borrower sells or walks away then, the banks gets paid. But the home owner gets all of the upside. If the borrowers can’t prove income, then they need to leave the house and rent. They should have been renters all along. Anything less and the program will fail.

If they don’t do this right, then what one of my readers CR Harrington wrote me as his solution may happen over time. There are already many firms out there performing these types of audits with great success. - Best, Mr Mortgage


Here is my solution to our problem… Give homeowners who are in default on their mortgages, $1000 from the treasury to be payable directly to an attorney who understands predatory lending. If the mortgage closing paperwork audit reveals any violation of Respa, TILA, etc, and further identifies any potential lending violations, especially on exotic mortgages (option ARM, Alt A, Interest only, Neg am, etc.) then allow an additional $9000 flat fee to the attorney to SUE the bank for fraudulent business practices, deceptive loan practices, concealment, theft by deception, whatever…. What if 70% of all loans between 2003-2007 were illegal? What if the banks don’t even own the loans beyond servicing, and the true holder of the note has imploded? Give the homeowners a year in the house during the lawsuit (to save up some money and keep one less house on the market) and then give the homeowners who win their homes in successful lawsuits, a free house - free and clear. Then they can sell their home for 50 - 60 (market value?) cents on the dollar to pay off their credit card bills and whatever is left over can be a sizable down payment on an owner financed home. Also, keep $10,000 at closing to pay back the Treasury to recycle back into the DISTRESSED HOMEOWNER LEGAL BAILOUT FUND!!! Home values will stabilize - (its a start….,) more money from home sales gets put back into the economy, everybody wins (except the criminals on Wall Street and defrauded investors who are going to sue anyways - they then can win and get the leftover homes that weren’t contested.) This is “trickle-up” and makes for a common sense solution that does not burden the tax-payer - very much.

No comments: