Mortgage Loan Restructuring
The most important role for public policy is to provide incentives for servicers to restructure and modify loans, to make certain that shared appreciation contracts are part of the policy mix, and to address the legal barriers to modifying securitized loans.
Pointer from Greg Mankiw.
My wife says that I became too angry and agitated at the hearing when Ed Pinto suggested that we need a major effort at loan modifications. I do become angry and agitated every time one of these suggestions gets made.
What are the standards that you are going to use to determine eligibility for loan modification?
Many (most?) of the loans that you would be modifying involve fraud. Sometimes, it was the borrower who deliberately committed fraud. But most of the time, it was the mortgage broker. We won’t be able to sort that out. So let’s assume that fraud gets a free pass.
And, since I’m feeling open-borderish today, I won’t hold it against the borrower if he is an illegal immigrant. That still leaves:
1. Homes that are non-owner-occupied. If somebody bought a house to flip, not because they wanted to live in it, why subsidize them any more than they already have been?
2. Next, consider anyone who bought a home with little or no money down. Doing loan modifications for these people amounts to saying, “You saw a really nice house that you wanted. You didn’t pay anything for it, and now guess what–we’re going to give it to you! We’ll do whatever it takes to make sure that you can afford the payments.”
I don’t think so. The lender owns the house. If the taxpayer is the ultimate lender, then let’s sell it to the highest bidder. For these no-money-down buyers, the only thing taxpayers should help with is a moving truck and holding the door for you as you leave.
3. We also have the cash-out refinancers. These are people who may have had equity at some point, but they chose to take it out to buy a boat or go to Vegas or what have you. They could have stuck to living within their means, but they made a different choice. Do you feel like modifying their loans? Neither do I.
4. Next, we have the serial defaulters. These are people who already have had their loans modified and defaulted. Latest reports say that a majority of people with loan mods are defaulting again. Eliminate those folks.
Advocates of loan restrucuring point out that foreclosure is a costly process. Guess what? Loan modifications, particularly in a market like this one where they are likely to fail, can be even costlier. There is a lot of overhead involved in doing loan mod.
What we need is an honest housing market, with legitimate owners, legitimate renters and prices that balance supply and demand. Loan modifications undermine the honesty of the market. They delay the necessary adjustments. With foreclosures, it might take two years for the housing market to find a bottom. With loan mods, it will take at least ten years.
Why is loan restructuring so popular? I think it’s because people are in denial. They want to think that there is some feel-good way to avoid severe adjustments in housing. But loan restructuring will worsen the pain, not relieve it.