Self-serving non-solution

Wilbur Ross, US’s second largest servicer of subprime mortgages via acquiring American Home Mortgage and Option One, has a self serving non-solution to negative home equity.

Inquiring minds may wish to consider A positive solution to negative equity in America.

The US federal government has tried to stabilise residential real estate, but nationwide prices have dropped by 13 per cent in the past 12 months. Analysts have forecast that by June 30, 10.6m families will have either no equity in their homes or a negative equity.

This problem seems likely to become more severe. The solutions proposed so far have been directed mainly towards helping delinquent borrowers avoid foreclosure, but the incentives have been weak. Remedies are needed to reduce delinquent mortgages to present property values, provide lenders with possible future recovery of the amounts by which they discounted their loans, restore mortgage lender liquidity and make mortgages available for future home buyers.

My Comment: Wilbur Ross does not accurately state the problem. He only states his problem which seems to be the acquisition of American Home Mortgage and Option One. The real problem in the US is that home prices are still too high and those prices need to come down, not propped up by self serving bailouts.

Many lenders would reduce the principal amount of troubled loans to the present value of the house if they could liquefy part of the loan and share in the eventual upturn in property values. To provide some liquidity, the Federal Housing Administration, the government insurer for low-income housing, should be authorised to guarantee $1 of existing troubled mortgages on primary residences for each $1 forgiven by the lender. The lender would be able to resell the guaranteed portion of its principal amount.

The FHA would receive an insurance premium, as it already does on other mortgages, and on the first resale of the home would receive the lesser of 25 per cent of the gain or the amount it guaranteed. The total of the premiums and appreciation on some sales would more than offset losses on foreclosed homes. The FHA would require that government-approved appraisers confirm the house’s market value. Also, if there were a shortfall on foreclosure and resale, the FHA would not pay a lump sum but instead make the payments when originally due. Therefore, at worst the FHA’s payments would be spread over many years and the FHA’s risk would decline whenever the borrower made payments.

My Comment: Ross’s solution is to bailout Ross and spread the risk to taxpayers over a number of years.

Lenders would be able to sell the guaranteed portion of the loan, thereby restoring their liquidity. Lenders also would receive on the first resale of the home the lesser of 25 per cent of the gain or the amount forgiven. This would enable them to recapture some of the principal amount they forgave, thereby providing them with an incentive to restructure the mortgage rather than foreclose. Appreciation sharing would not carry over to the next owner, but qualified home purchasers would be able to assume these favourable mortgages. Thus the resale market for these properties would be largely self-financing for several years and this would stabilise or improve property values. Meanwhile the original borrower would retain 50 per cent or more of the appreciation on a property that otherwise would have been foreclosed. It would be unreasonable for home-owners to expect a totally free ride on concessions granted by lenders, but retaining half of the upside would motivate the homeowner to make monthly payments even though there initially would be no equity value.

My Comment: What’s unreasonable is to expect those not in trouble to bail out those in trouble. As taxpayer I do not want to have the FHA bail out anyone. In fact, I want the FHA to be abolished before more hair brained schemes like Ross’s are considered. Imagine having a $400,000 mortgage but your neighbor in the identical house down the road has a $250,000 mortgage. Guess what Ross’s proposal does? It is begging for all loans to become troubled. Besides, many borrowers are better off walking away where they would have 100% of any future appreciation.

If a mortgage had been $180,000 against an original home value of $200,000 and the loan were now reduced to $160,000, the lender would have lost $20,000. If the home later were sold at its original $200,000 value, the lender would have recovered $10,000, or half of the concession. The FHA would have gained $10,000 and the homeowner would have made $20,000, thereby restoring his original equity position.

This co-operation between public and private sectors would provide both lenders and borrowers with a rational, incentivised alternative to foreclosure.

My Comment: The public sector has no business promoting housing, bailing out housing, or being involved in housing to the likes of what Ross is proposing. Such bailouts are a moral hazard and it was government meddling that created this mess in the first place. With that in mind GSEs should be abolished as well, and the "ownership society" should be put on the scrap heap of history’s bad ideas.

The government’s present voluntary plan of restructuring brings neither added incentives to the lender nor liquidity to the mortgage market. This FHA-based plan would do both. Lenders and borrowers would negotiate interest and repayment terms without government intervention and existing servicers would continue to service the loan. All parties would benefit from stabilisation of housing markets.

My Comment: There should not be a government plan, period. But Ross proposes a plan then states that "Lenders and borrowers would negotiate interest and repayment terms without government intervention". That is of course nonsense. The plan itself is government intervention, and as noted above encourages more people to stop paying their mortgages.

Most important, the process would be voluntary and therefore would not chill the willingness of lenders to make loans in the future. In contrast, the proposed remedies incentivise all parties to negotiate but do not create moral hazard by bailing out reckless lenders or borrowers. The lenders will write down their loans and borrowers initially will lose their original equity. Both will have a chance to recoup and substantial liquidity will be brought back to the mortgage market.

I am disgusted with this self serving bailout proposal by the person who would benefit most: Wilbur Ross. Here is the key phrase: "existing servicers would continue to service the loan." Ross is asking for a bailout of Ross. No one else wins regardless of how much he tries to sugar coat it otherwise. The plan simply has too many flaws.

Mike Morgan at Morgan Florida agrees. His article is Wilbur Ross … "Bail Me Out". Here are a few snips:

Mr. Ross proposes that the FHA guarantee dollar for dollar existing troubled mortgages on primary residences for each dollar forgiven by the lender. And the lender should be able to resell the guaranteed portion of its principal amount. This is absolutely ludicrous. He’s asking for a back-door bail out because he bought what he thought was a bargain. He is now acting no differently than the flippers that bought homes to flip. Instead of pre-construction condos, he bought pools of mortgages to service and flip. So please tell me why taxpayers should have any part in the bail out of Mr. Ross?

I love the part where Mr. Ross downplays the risk to the FHA, when he points out the FHA’s payments on losers would be spread over many years. Big deal. A loss is a loss is a loss. But here we go again trying to creatively hide the loss and give it a little coating of syrup.

Let me bring Mr. Ross around to one other issue in his proposed bail out of his reputation and wallet. His plan is for primary residences only. I get calls from people every week that are losing their primary residences because they bought a dozen condos in Florida, Arizona and Vegas. I get calls from people every week that bought primary residences they couldn’t afford in the first place. I get calls from people every week that used their primary residence like an ATM to buy third cars, vacations, ,jet skis, boats, and you name it.

What’s wrong with America? LOA – Lack Of Accountability. Mr. Ross, in all due respect, you need to take your medicine just like everyone else. C’est la vie Mr. Ross.

Mike "Mish" Shedlock