In my previous post about the fundamentals of the housing market I suggested that the next thing to come from the government would be the paydown of mortgage principals to keep individuals from walking away. There were a lot of individuals that disagreed with that statement because they felt that politicians would never be able to get away with it, that the banks would not want to realize losses, that the securitized products did not allow that flexibility etc. Well, the FDIC thinks it’s possible:
“The Federal Deposit Insurance Corp. is developing a program to test whether cutting the mortgage balances of distressed borrowers who owe significantly more than their homes are worth is an effective method for saving homeowners from foreclosure.
The program would be aimed at a growing population of homeowners who are underwater on their loans, estimated at more than 20 percent of borrowers, or 11 million homeowners. Economists consider these borrowers among the most vulnerable to foreclosure, and some industry officials worry that more of them will simply walk away from their mortgages, or “strategically default,” rather than spend a decade or more trying to regain positive equity.”
The FDIC program would only encompass the loans acquired by the FDIC through failed banks, but this still represents 1% of mortgages outstanding and would be a growing number as more banks fail.
In addition to the FDIC, the Fannie and Freddie announcement of buyouts on delinquent mortgages will leave them as strong candidates to try the same strategy with the loans that they bought out of the agency MBS structures. Those individual loans will then reside with Fannie and Freddie to do with what they want, and what they want is heavily driven by the desires of the government and more specifically the Federal reserve.
Let us also not forget how terribly destructive the foreclosure process can be to the value of the homes and subsequent bank losses:
“When I see I owe $160,000 on a home valued at $350,000, and someone decides they want to take it – no, I wasn’t going to stand for that, so I took it down,” Hoskins said.
What does it mean that he took it down? Well…
“The Moscow man used a bulldozer two weeks ago to level the home he’d built, and the sprawling country home is now rubble, buried under a coating of snow.
“As far as what the bank is going to get, I plan on giving them back what was on this hill exactly (as) it was,” Hoskins said. “I brought it out of the ground and I plan on putting it back in the ground.”
Hoskins’ business in Amelia is scheduled to go up for auction on March 2, and he told Fuller he’s considering leveling that building, too.”
If I owned a bunch of mortgage loans, I might think about paying principals down as well. I am not for the idea of paying down mortgages, you know clearly my views on moral hazard, but from the economics of the situation it sometimes makes sense for the lenders. After a foreclosure, the lender must sit with a vacant property vulnerable to theft and vandalism and then try to sell the property at a fire-sale price which can force the lender to realize tremendous losses. If the lender can instead paydown the mortgage to a level that makes the owner occupant still interested in making payments and the cost of that paydown is less than the cost of going through the foreclosure process, then the lender has an easy economic decision.