Mortgage Restructuring Is Not Enough

Let’s be honest with ourselves.  Even if the outgoing Bush team or the incoming Obama administration can work out a scalable nationwide mortgage restructuring scheme, we will still have a housing problem in the U.S..  Specifically, we should expect a high proportion of restructured mortgages to default again within a year.  In a piece that appeared on Bloomberg this morning, Alex Stricker and I suggest that a more centralized process is needed to manage the flow of foreclosed properties onto the market, and we discuss some alternative ways to implement this idea.

There may be better ways to do this and we are completely open to suggestions – please post as comments here.  We only insist that this is one dimension of U.S housing that needs further careful consideration.

8 thoughts on “Mortgage Restructuring Is Not Enough

  1. The Bloomberg article proposes some creative solutions to the foreclosure problem.

    I am a little perplexed about how solutions one and two in the article can be implemented. Maybe I don’t correctly understand the structuring of the mortgage-holding securities.

    My understanding is that the mortgages are held in a pool and that the pools are divided into tranches. Each tranche may hold hundreds or thousands of mortgages. Each tranche also has multiple securities issued which represent ownership of the mortgages in the tranche. This means that each mortgage in a tranche can be owned partially by many security holders. If a mortage in a tranche goes into default, then all the partial owners of the mortgage (all the holders of the securities issued for that tranche) must agree before the mortgage can be renegotiated. If this is a correct summary of the process, then it seems like an almost impossible task to renegotiate and restructure mortgages which have been securiticized. Please correct me, if I have erred in ascertaining the situation.

    The apparent difficulty in adjusting mortgages after they become part of a security is one reason why I think an effort should be made, as suggested by Patrick and Taylor in the NYTs article, to totally undo the securitization of subprime mortgages. If the Federal government buys out all these mortgages, then adjustments can be made without the complex headache of trying to get multiple investors to agree on adjustments for each mortgage.

    It is also the reason that I think collateralized mortgage obligations (CMOs) should only be allowed in the future if they are structuted in such a way that the loan servicer has the option of renegotiating the mortgage should the servicer feel this appropriate.

  2. Without first-hand experience, I would guess that one problem with even un-securitized mortgages is balance due on sale clauses. This was not a problem when house prices were increasing because there was usually a positive balance. With a negative equity, the homeowner cannot move without coming up with the difference. This should lead to all kinds of market inefficiencies.

    Theoretically (I think) it should be possible to swap houses with others who are similarly situated – a like-kind exchange without tax consequences. It is easiest when mortgage amounts, value of the houses, and credit worthiness of the mortgagees are identical. An economist needs to figure out how to make adjustments when this is not the case. Legislation may be necessary to facilitate such swaps without jeopardizing the fiduciary duties of the mortgage holder to various constituents.

  3. “While housing prices do have to fall to rational levels, it is in everyone’s interest for prices not to overshoot on the downside. ”

    Certainly in this market (a different one from the one you’re writing about, as I live in the UK, but one suffering similar problems), there’s little chance of that happening any time soon; when mortgages have been demanding income multiples of 5, 6, 7 times salary, they have a long way to drop before they even begin to resemble “rational”.

    Lenders have tightened up–sticking to 3-4 times salary–but house prices haven’t yet dropped accordingly. It’s no wonder the property market has slowed down; houses are still far too expensive, and this time around we don’t even have insane mortgages to make up the shortfall.

  4. Tom K: When the government was still planning to buy mortgage-backed securities, that was one solution: if the government owns all of a particular tranche, the securitization problem goes away.

    Options 1 and 2 make the investor a landlord, which the investor may not be prepared to be. These options happen only when the borrower is no longer legally tied to the home through a mortgage or deed. Option 3 is a suggestion for Treasury, FDIC, or other federal regulators to start thinking about what will be the best next step for many local housing markets if and when the current piecemeal approach to loan modifications fails to stop foreclosures. Private investors who cannot or will not participate in options 1 or 2 might be able to funnel the foreclosed property through a central clearing house. The government may consider providing incentives for investors to participate.

    Mark Douma: The idea of transferable or assumable mortgages has been around for a long time in the industry but has never caught on. Our understanding of mortgage notes is that switching borrowers would break the contract and a new mortgage would be needed. As for the idea of pulling delinquent mortgages out of asset-backed securities and inserting current mortgages, this has been done by the GSEs and could be explored further in the private label market.

    DrPizza: We don’t really know what rational levels of prices are. Slowing the decline of house prices might protect markets from over correcting too far wherever that might be.

  5. > We don’t really know what rational levels of prices are.

    But we do know that the income multiples houses are currently trading at are only viable with extremely low interest rates (as we’ve had for the past decade or so), and we also know that these extremely low interest rates carry with them many risks (too many people borrow too much).

    Overcorrection would be bad, I suppose, but it’s sufficiently far off that I don’t see it as too great a concern.

  6. Making mortgages assumable might be a step in the right direction. A portion of the friction (costs) that come from the foreclosure/remarketing process comes in the form of fees associated with real estate transfers. Let buyers with significant new equity simply pick up where the defaulting mortgagor left off, bypassing all of the ancillary costs.

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