My Idea for "Fixing" the Housing Market

[moda0306]

I know we have a diverse set here, but I see a few large problems that seem to be self-fulfilling in the housing market and with US household balance sheets in general:

1) There exists a moral hazard, where walking away from a home is starting to appear all-too enticing.

2) People are in a situation where they can't refinance to a lower rate, stuck at 5.5%-6.5%, and don't have enough liquid wealth to pay down their mortgage to a level where they can refinance.  This makes deleveraging very difficult for many people.

3) People are left with unappealing, risky, or low-returning options in their retirement accounts... but can't access this wealth for tax reasons.

My solution is to allow tax/penalty-free distributions from retirement accounts of up to, say, $40k-$50k, if people use those funds to get to 80% LTV on their mortgages and refinance to a lower rate (maybe just the former, as the latter would be the next logical decision).  I know there'd be some red tape involved, but I think things could be made pretty straightforward, and free of any moral hazards.

Meanwhile, if people are now able to take $220k of debt at 6% and turn it into $180 at 4%, I think it would add a great degree of stability to the system, vastly improving cash-flows of households, but not forcing creditors to take a forced renegotiation of their contract.  There would be some people that still wouldn't be able to get themselves out of their situation, but those are probably the ones that aren't viable homeowners at the level that they bought.

[AdamA]

Interesting idea, Moda.

I don't know the numbers (at all) but I wonder what the retirement savings to mortgage money owed ratio is.  I suspect it might be pretty small. 

Even so, it still might be a good option for some.

[Gumby]

Neat idea. But, unfortunately, many people haven't saved enough for retirement. Here is an article from 2010, so it may be a bit outdated...

The percentage of American workers with virtually no retirement savings grew for the third straight year, according to a survey released Tuesday.

The percentage of workers who said they have less than $10,000 in savings grew to 43% in 2010, from 39% in 2009, according to the Employee Benefit Research Institute's annual Retirement Confidence Survey. That excludes the value of primary homes and defined-benefit pension plans.

Workers who said they had less than $1,000 jumped to 27%, from 20% in 2009.

Confidence in ability to save enough for a comfortable retirement hovered at 16% of respondents, the second lowest point in the 20-year history of the survey.

Source: http://money.cnn.com/2010/03/09/pf/reti ... onfidence/

I can't imagine the numbers improved that much in 2011.

EDIT: Here are the details of the 2011 report:

http://www.ebri.org/pdf/surveys/rcs/201 ... 11_RCS.pdf
http://www.dailyfinance.com/2011/03/16/ ... confident/

Doesn't look like most people have been saving enough.

[murphy_p_t]

"but not forcing creditors to take a forced renegotiation of their contract"

why do you want to protect creditors?


"1) There exists a moral hazard, where walking away from a home is starting to appear all-too enticing."

This is interesting...my hypothesis is that those holding mortgages should do what's in their financial interest. If that means returning the keys to the bank, they should do so. The loan is secured by the property...so the bank can have back their property. My hypothesis is that this will fix the moral hazard of banks making reckless loans if they won't be bailed out or be able to shift bad paper thru secularization of loans.

My view is that the market needs to clear, the sooner the better...maybe I'll come into market then.

[moda0306]

Gumby,

It would appear that those savings numbers don't include defined contribution (aka, 401k and IRA) plans.  I agree people still haven't saved enough for retirement, but there are some with the wealth to adjust their LTV and significantly improve their monthly cash flows.

EDIT... nope, it appears you're right...So maybe the 401k funds I thought were there simply aren't.

Murphy,

I wasn't suggesting that we "protect" creditors, but some suggestions out of the white house is that we force them to accept a refi well above 80% LTV.  I'm all in favor of letting people that simply can't afford their home acknowledge that situation, but foreclosing on people with $50k in a retirement account that they are willing to use to delever their mortgage is a mistake, IMO.

If letting the market "clear" means managed bankruptcies for people that simply have no way of affording their home, then I agree... but if someone could take wealth they own to significantly improve their cash flows and stay in their homes (preventing bank ownership that leads to the home deteriorating) then I think we should create a streamline for them to do it with their own money.

Many would find it appealing, and even if it decreased the under-water homes out there by 20%, I think you'd see a lot more stability reenter the market if people were able to delever the debt AND refinance to low rates.

[Storm]

2) People are in a situation where they can't refinance to a lower rate, stuck at 5.5%-6.5%, and don't have enough liquid wealth to pay down their mortgage to a level where they can refinance.  This makes deleveraging very difficult for many people.

But moda, this is where you're wrong.  People can refinance if they are only willing.  Freddie Mac publicly states that they will refinance any mortgage even if the loan to value is greater than 105%, as long as the homeowner is currently making payments.  If they're not making payments, a refi won't help them.

http://www.freddiemac.com/sell/factshee ... ccess.html

The question is: is someone willing to keep making payments on an underwater house?  If they aren't willing, all of the programs in the world won't help them, unless the banks finally agree to take haircuts on the loans.

The housing crisis is just a giant game of chicken with underwater borrowers and banks driving towards each other at full speed.  The borrowers are saying "we'll stop making payments" and the banks are saying "we'll never take a haircut" and it's a big waiting game to see who blinks first.  In another year or two, who knows, maybe the banks will take a haircut.

[PP67]

Here is Mish's take on Obama's State of the Union address on the housing crisis:

Obama: "And while Government can’t fix the problem on its own, responsible homeowners shouldn’t have to sit and wait for the housing market to hit bottom to get some relief.

That’s why I’m sending this Congress a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low interest rates. No more red tape. No more runaround from the banks. A small fee on the largest financial institutions will ensure that it won’t add to the deficit, and will give banks that were rescued by taxpayers a chance to repay a deficit of trust.

Let’s never forget: Millions of Americans who work hard and play by the rules every day deserve a Government and a financial system that do the same. It’s time to apply the same rules from top to bottom: No bailouts, no handouts, and no copouts. An America built to last insists on responsibility from everybody."

Mish: "While reading the first paragraph above I knew without a doubt a huge bailout proposal was coming up.

Sure enough, the very next paragraph contained a massive bailout proposal and in more ways than is readily apparent at first glance. For starters "responsible homeowners" don't need mortgage relief. Secondly, $300 a month is a lot of dough so I would like to see an accounting.

Finally, and most importantly, every loan that is refinanced will be paid off in full. Thus, any bank, hedge fund, mortgage provider, or GSE that is paid off on a nonperforming loan will be immediately made whole.

This is a massive backdoor bailout of banks, mortgage companies, hedge funds, foreign banks, and anyone else holding mortgage related garbage.

In case you were wondering about the big rally in bank shares this year, this proposal just might have something to do with it.

The Orwellian irony of it all comes in the third paragraph with Obama's bald-faced lie "It’s time to apply the same rules from top to bottom: No bailouts, no handouts, and no copouts."

[moda0306]

Storm,

I didn't realize this program had been enacted, and you're mostly right in your description of the situation.  I wonder, though, if there's not more red tape, high interest rates, or PMI that we're not realizing about these Freddie Mac loans.

What you point out about the game of chicken wouldn't be nearly as true for some households if they had more liquid access to their retirement funds with which to get them to a refinancing point... in fact, if this Freddie Mac piece weren't out there it probably would make the payoff more attractive.

At the very least it could maybe be a starting point with which homeowners can bargain for principal reduction & rate reduction on their loans.  I simply see this as the least expensive, least intrusive way to allow people to free up some of their wealth to get them out of the game of chicken.  I agree many other people would still play, but we should do the easy things first and then see where things go from their.

I really don't think banks owning a large percentage of the homes out there is going to help anything... and as home prices drop further, this leaves more and more people eligible for the game of chicken.

Do you think a better solution would be some kind of fast-tracked bankruptcy system?  I think some sort of debt liquidation is a must, but between homes and student loan debt realities simply aren't being acknowledged.  How do we get them to be?

[Storm]

Storm,

I didn't realize this program had been enacted, and you're mostly right in your description of the situation.  I wonder, though, if there's not more red tape, high interest rates, or PMI that we're not realizing about these Freddie Mac loans.

What you point out about the game of chicken wouldn't be nearly as true for some households if they had more liquid access to their retirement funds with which to get them to a refinancing point... in fact, if this Freddie Mac piece weren't out there it probably would make the payoff more attractive.

At the very least it could maybe be a starting point with which homeowners can bargain for principal reduction & rate reduction on their loans.  I simply see this as the least expensive, least intrusive way to allow people to free up some of their wealth to get them out of the game of chicken.  I agree many other people would still play, but we should do the easy things first and then see where things go from their.

I really don't think banks owning a large percentage of the homes out there is going to help anything... and as home prices drop further, this leaves more and more people eligible for the game of chicken.

Do you think a better solution would be some kind of fast-tracked bankruptcy system?  I think some sort of debt liquidation is a must, but between homes and student loan debt realities simply aren't being acknowledged.  How do we get them to be?

I think the only real way to fix the housing market is to force the banks to clear their books of all the bad loans, take the loss, foreclose, and sell them at firesale prices.  It will cause the housing market to take a dump for a couple years, but all the half-measures just prolong the deleveraging process.  Right now the banks don't want to do anything because it will make their balance sheets look like crap and force the FDIC to liquidate them.  Liquidate the zombie banks and force them to liquidate their troubled assets.  That's the only real long term solution.

We'll probably take the Japanese approach though instead, and keep the zombie banks on life support for the next 2 decades.

[moda0306]

PP67,

Allowing people to refinance from 6% to 4% on a $200k mortgage would bring them to $333/month in savings.  Simple math... and it could be larger for other homeowners.

What if the holders of the old mortgages themselves were the ones required to refinance?  I had assumed this was how it would work.

If not, Mish is right... this is a huge bank bail out, and a semi-moderate household bailout (do they come in any other form??)...

Unless these mortgages face principal reduction, somewhat through organized bankruptcy and in some instances foreclosure, the banks won't learn.

[moda0306]

Storm,

I can agree with you up until you say "foreclose."  The bank is in no position to manage this inventory, and if you're talking about fire-sale prices, then you are talking about millions more with under-water loans that weren't before.... then we're at the same place we just were with the same game of chicken.  I don't think it's even fathomable that this problem would work itself out quickly.  Would banks even remain solvent enough to manage these things at all, much less the piss-poor way they've been doing it so far?

I think in a lot of these cases, some kind of streamlined bankruptcy where most people (depending on ability to pay new loan at reduced principal) get to stay in their homes.  I don't think anyone benefits from having a few bank-owned homes on every block.  I'd like to see an example of where ahousing market "is in the dumps for a few years," due to massive foreclosures and it doesn't create long-term problems.

Most of these places that stay under bank ownership for a year are trash by the end of that year... I don't think we can count on this system of sustaining solid neighborhoods. 

Banks are in the business of making loans.... people tend to take reasonable care of homes.  Trying to get a bank to take good care of a home is incredibly difficult if you use the last few years as evidence.  Basically, I think both the bank AND the homeowner would rather have the government come in and organize a "streamlined default" process where instead of the bank having to take on housing inventory to realize some sort of value out of the bonds they lost,  and a person being kicked out of their home to liquidate the debt they acquired, they both agree to new principal and interest rate, somewhere around 95% LTV... I think this would be much more pleasant than the game of chicken they're playing now. 

Isn't this better than Full-blown default, foreclosure, and millions of bank-managed homes? 

[Storm]

Yes, moda, I agree that the best scenario would be the banks taking a haircut down to 80-90% LTV (95 is a bit high) and the borrowers refinancing and making their payments on time.

The reasons this will never happen are many, banks don't want to take a haircut, show it on their books as a loss, etc, so I'm fairly confident this will never happen.  Unfortunately what I see happening is pretty much what Mish predicts.  Japanese style deflation because the government will keep bailing out zombie banks and letting them keep the bad loans on their books as long as possible.

[jackely]

My solution is to allow tax/penalty-free distributions from retirement accounts of up to, say, $40k-$50k, if people use those funds to get to 80% LTV on their mortgages and refinance to a lower rate (maybe just the former, as the latter would be the next logical decision).  I know there'd be some red tape involved, but I think things could be made pretty straightforward, and free of any moral hazards.

Interesting idea but......

I DO have an underwater mortgage and I DO have enough liquid wealth to pay it down and be able to refinance but I have no intention of doing it. The idea of taking $50k out of my PP earning at the average rate of 9.7% to bring a mortgage rate down from 6.25% to 4% and save $333/month does not sound very appealing to me. Are you also going to guarantee me that I won't be dropping that $50k down another rat hole?

Maybe after I've met my goal of retirement savings I'll be willing to do this (if it's still even necessary), but definitely not now.

[moda0306]

jackh,

First, how confident are you that the PP, with stocks at a P/E-10 of over 20, and bond yields at between 0-3%, will continue to return 9.7%?... or 4.5% real?  I love the PP, but I think getting some guaranteed return going forward might be worth looking at.

The ROI on refinancing can be extremely appealing after looking a little more closely at the #'s... Let's assume, for now, that pay down is your only way out... that walking away or renegotiating is out of the question, just so we can put that on the back burner for a second.

If you are at 6.25%, this means that ANY paydown of your mortgage is going to relieve you of interest expense of 6.25% (we'll look at tax-benefits after...).  This means $50,000*6.25%=$3,125 per year that will now be principal-paydown on the mortgage, not interest expense.  This won't be cash in your pocket, but it will be improvement of your balance sheet.  This could be significantly higher if you're still carrying PMI that you could eliminate.

Now let's take it a step further, you will now refinance... let's say you paid down $48k, and $2k was for Loan Origination Fees, and you refinanced into something that would have you pay down over the same period... you'll now be paying 2.25% less on the rest of the balance.  Let's just assume $200k for now.  That's $4,500 less in interest every year.

So with $50,000, you're paying down your mortgage $3,000 faster every year, and your payments are $4,500 less every year.

That's $7,500/$50,000... 15%.  Yeah, there's some loan origination fees in there, but it's minor.  Adjust that down by your federal & state tax rates, and you're still maybe at 10%.

I'm not saying you don't want to look at other options, because I know there's big doubts about whether you will have other options with the mortgage, but it's good to at least "pretend" just so you know what you're dealing with.

I'd add as a final note, if the gov't is going to step in to help stabilize things and keep people like you and banks from getting into destabilizing situations where you walk away and they have to manage a property, I think if the gov't came in and said that if you're willing to make 1/2 of the paydown sacrifice, they have to make the other half and refinance down to 4% or something.

I am kind of forming this as it goes, but I'm not a complete skeptic of the gov'ts ability to add stability to this situation.  Combine this with allowing tax/penalty-free retirement distributions, and you allow people even more flexibility to make things better for everyone involved.

[jackely]

jackh,

First, how confident are you that the PP, with stocks at a P/E-10 of over 20, and bond yields at between 0-3%, will continue to return 9.7%?... or 4.5% real?  I love the PP, but I think getting some guaranteed return going forward might be worth looking at.

Thanks for doing the math for me.

I would probably feel a lot different about it if I intended to pay the mortgage off and live in the home when I retire. That was never my intention however (and retirement isn't that far away - I'm 62).  I'm not speaking for everyone but it just doesn't seem to make sense in my situation.

As for my confidence in the PP I'll just say it's higher than my confidence in ever recovering the money it would cost me to pay down the mortgage given the time frame we are talking about.

You are definitely right about the "moral hazard" that this situation has created. Before I bought this house it would have never occurred to me to walk away from a mortgage unless I absolutely had to but now I have to admit to becoming somewhat squishy on the idea. From my point of view, the government and the banks worked together to create the housing bubble and then when things went south, the government bailed out the banks but left us homeowners holding the bag. Something just things wrong with this picture to me.

[moda0306]

jackh,

You bet it's a raw deal for homeowners vs bond holders & banks...

I'm just at a point where I want to see the game of chicken end, and banks to take a decent brunt of the hit.  If our balance sheets are where they are, homeowners can leave, but it'll just make the situation bad for other homeowners.

I don't think our neighborhoods or society benefits from swaths bank-owned homes.  If we can create some sort of legal framework, even if a bit coercive towards banks, that lets each party take a chunk of the hit, mostly banks in my estimation, and get people back above water... or at least enough where a moral hazard isn't looming over entire neighborhoods... then I think things will look less like a game of chicken and more like people making decisions based on fundamentals, not on fear.  I have to think the new residential developments of 2004-2007 are in the worst spot, as they are almost by definition underwater, adjusted for any sales in the last few years.

[jackely]

You bet it's a raw deal for homeowners vs bond holders & banks...

I was on a website touting some government programs for underwater mortgage holders a while ago and the program they were talking about was only open to Fannie Mae and Freddie Mac mortgages. I said to myself that this rules me out but they had a place to key in your address to see if you had a Fannie Mae/Freddie Mac mortgage so I keyed mine in and lo and behold, to my complete surprise, I do. How in the hell that ever happened I have no clue. I don't remember ever hearing the names Fannie Mae and Freddie Mac when I took out the loan. All I know is that the mortgage company I've sent my payments to changed three times to my knowledge (probably even more not to my knowledge) and now it is the bailed-out Wells Fargo bank (who also holds my 401K BTW).

(And also, BTW, after I keyed my name and address into that website I started getting lots of letters from lawyers specializing in "strategic defaults").

I read further on the website and the government program was only open to mortgage holders who were behind on their payments. Well, excuuuse me for making all my payments on time.

Wells Fargo eventually sent me a letter asking me if I would be interesting in re-financing according to some terms that hurt my head to read. I don't know why but my gut told me to just throw it in the trash which I did. I later learned that Wells Fargo was only doing this to get some kind of credit for complying with some other government program but ultimately ended up denying the refinance applications, so my gut was right.

So meanwhile, back to the subject of moral hazard. My conclusion is that when they say "moral hazard" the only hazard they are really talking about in the mortgage industry is that people like me might quit paying their mortgages. Seems to me the rest of them moved far beyond the subject of morality a long time ago.