Homeowner Bailout Around the Corner?

News sources are reporting more details on the possible mortgage restructuring plan for distressed homeowners first mentioned by Sheila Bair in her Congressional testimony last week. The basic outlines of the plan are:

  • Lenders would agree to reduce monthly payments to be affordable, perhaps based on a percentage of the homeowner’s income. The reduction could be achieved by reducing the interest rate, reducing principal, or extending the term.
  • If the amount the homeowner could pay would result in a mortgage worth less than the foreclosure value of the house, the loan would not be modified and the lender could foreclose.
  • The government would then partially guarantee the new mortgage and absorb part of the loss if the homeowner defaulted.
  • The numbers of 3 million homes and $600 billion in total mortgage value are being thrown around.

This is roughly consistent with the principles we outlined earlier: the lender gets more than it would have gotten in foreclosure, the homeowner is better off than being on the street, the community benefits because there are fewer foreclosures. There are three key issues that still need to be negotiated.

  1. How much will homeowners be expected to pay? Too much, and the lenders will not have to write down their loans very much, and the government will be on the hook for risky mortgages; too little, and the lenders will not participate.
  2. How do you solve the securitization problem, that is, the current inability of many servicers to modify loans that are owned by other parties? This may require a new law in and of itself (one suggestion here).
  3. How do you decide which homeowners are eligible? If people who are delinquent get cheaper mortgages and people who are struggling but paying on time don’t, the latter will scream. It is still in the interests and hence within the rights of the lender, the delinquent homeowner, and the government to do the deal, but that won’t reduce the indignation.

There are also a couple of enhancements to the program that could be considered. First, shouldn’t the government – by which we mean the taxpayer – get something for its guarantee (besides the satisfaction of knowing that it’s doing what’s best for the country)? The homeowner and the lender are both better off than they would be otherwise (homeowner on the street, lender forced to foreclose), and the government is worse off (because some of these new mortgages will fail). The government could get a share in the future appreciation of the house, for example.

Second, to protect against default by the homeowner on the new mortgage, the government could secure the loan against his or her future earnings, because the government already has an enforcement mechanism it can use: the IRS. This would protect the taxpayer’s interests.

Finally, one note of caution. Loan modifications should work for some proportion of delinquent homeowners, but there are probably millions of homeowners who have no chance of paying any mortgage on their houses that would be acceptable to their lenders. People with option ARMS who made minimum payments and then saw their mortgage rates reset upward by several percentage points will not be able to pay anything close to what lenders will require not to foreclose. In conjunction with any mortgage restructuring plan, there also has to be a plan to manage the flow of properties onto the market, because a flood of foreclosures will only cause prices to plummet further. It seems like there are so many things to do, but that is the price of the situation we are in.

Update: Here’s another proposed solution to the securitization problem.

One response to “Homeowner Bailout Around the Corner?

  1. David Nowakowski

    Simon, can you think of the unintended consequences here? If a requirement to have your mortgage modified is to miss a payment, it would make sense for anyone with a mortgage payment to miss a payment or two, right away.
    The same banks that encouraged borrowers to go in over their heads will do the minimum possible to get a government guarantee, of course.
    This seems to be very dangerous if it is done in a hasty, ill-considered way.