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More Misguided Housing Plans


Postpone payments, but don't forget.

Yesterday I took a look at the latest misguided plan to save housing. It came from the Office of Thrift Supervision. Since they did not name the plan, I decided to call it the Postpone But Don't Forget Plan.

There were more questions than answers as details were sketchy, but the bottom line is that it was just another attempt to prevent people from walking away. Here are the essentials:

Instead of having lenders forgive the difference between the old mortgage and a house's current resale value, called a short sale, the OTS advises that lenders issue a warrant or "negative amortization certificate" for the difference. If a home regains its market value and is then sold, lenders have first claims to the profits.

Another Free Option

From yesterday's piece, here is one way it might backfire:

Assume you are a homeowner $100,000 in the hole on a house now worth $250,000. Perhaps you are attached to the house and want to stay. You agree to participate in this scheme. Then out of the blue (or negotiated in advance) you find someone willing to pay $250,000 for it. Like magic, you suddenly become unattached to the house. You accept the terms and sell the house for $250,000. Voilà! You escaped the debt trap. You owe the bank nothing, there was no short sale, and your credit is not even impaired.

In the above scenario the bank will be left holding a worthless "negative amortization certificate" while the homeowners can execute "a free PUT option" at any time, with seemingly less dire consequences (as far as their credit history is concerned) than the current walking away process. What a deal.

The driving idea of this scheme might be an attempt to prevent further writedowns by allowing banks to mark those certificates at full value on the books, but it will do no such thing.

Minyan "DF" has come to the same conclusion.

Minyan DF writes:

The OTS is a primary regulator charged with the responsibility of maintaining the safety and soundness of our nations thrift institutions. They are in fact, encouraging these institutions to write down the balance on the loan, but rather than charging off the loss, they will "invent" this new document that allows them to possibly recover at a later date. That document obviously will be booked as an asset and the capital of the institution will not be adversely affected.

What all of this frenetic, frantic, ill conceived babbling by "the smartest people in the room" says to me is... this thing is so huge and has so many ramifications and tentacles attached to it that our brightest and best do not have a solution....delay the inevitable is all they can do

What about maintenance and improvements? I missed the upkeep angle but a couple of sharp readers did not.

Minyan Mark Writes:

The glory part would be paying taxes, insurance and repairs on a house that the bank owned the appreciation on.

Minyan SGL Writes:

I agree with Mark who noted the incentive to do any repairs or upgrades goes away. if anyone accepted this offer, and stayed in the house for a 5 yrs, why would they spend money to fix dry rot, upgrade the kitchen, repaint the exterior, etc, when they wouldn't benefit from the price appreciation? This is yet another example of desperation, and not thinking through the implications and consequences.

To date, all attempts to "fix" this problem have doing nothing but make matters worse, at least from the perspective of the banks. When Bush signed into law the "Mortgage Forgiveness Act" it was begging people to walk away. I talked about this in Mortgage Forgiveness Act: The Seen and Unseen.

This is a further extension of that act and it amounts to giving homeowners another free option that some will use to their advantage. Others will just choose to walk away anyway.

The Real Solution

The only real solution is time and price. Prices will have to fall much further before they are affordable, and it will take some time for that to happen.

The good thing about the Mortgage Forgiveness Act and the Postpone But Don't Forget Plan (should the latter be implemented) is they may speed up the timeline, even though that is clearly not the intent. The quicker things bottom the better off everyone will be.

Other proposals by the Fed and regulators (notably attempts to bail out the monolines) are acting to slow the writeoff process and will drag things out, perhaps for years longer than necessary should a bailout be "successful". In the meantime, the velocity of money is plunging.

Professor Depew touched on these themes in Five Things You Need to Know: Not Your Father's Stagflation.

Ironically, government intervention and regulation, everything from splitting up the bond insurers to expanding the roles played by Fannie Mae (FNM) and Freddie Mac (FRE), will have the perverse effect of slowing the velocity of money.

Take for example the Office of Thrift Supervision proposal outlined yesterday of issuing "negative equity certificates" to homeowners that are redeemable at a later date if the home is sold at a higher price; part of a plan to prevent homeowners from walking away from their mortgages.

Although foreclosures make up a fraction of the total housing market, it would be a mistake to underestimate the socioeconomic significance of the repudiation of debt and credit manifest in homeowners voluntarily choosing to walk away from their mortgages. The fact people are walking away from their mortgages is not a moral failure, but a warning sign that this type of credit unwind is extraordinarily deflationary. The fact an increasing number of people are not interested in protecting their ability to access credit, their credit rating, is a harbinger of how bad things have yet to get. That means, socioeconomically, that people have already repudiated credit and are no longer interested in accessing it.

That is bad news for the Federal Reserve because at the end of the day it doesn't matter how much credit is made available; it matters how many people are willing to take it

Time and price are the keys. We are a long ways away on both counts.
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