Friday, November 4, 2011

Mortgage Forgiveness?

Bloomberg published an article today citing investors, funds, and economists who think principal balances should be reduced to help embattled homeowners

Greg Lippmann, of subprime shorting fame (more on him in a moment) says:
Principal reductions are necessary to help ameliorate the housing crisis. The step will also lower losses on loans underlying mortgage bonds
Who the heck is Greg Lippmann
Greg Lippmann worked for Deutsche Bank as was a key figure among those who made millions or billions by shorting subprime mortgages.  A client of his (forget the name at the moment, which is kind of the point) realized that these subprime mortgage bonds weren't worth the paper they were written on and got Deutsche Bank and others to help him position his investments to benefit from the housing bubble bursting.  Lippmann, realizing the opportunity, then brought the idea to others, including John Paulson who ended up as perhaps the face of the "brilliant" investors as he personally made billions of dollars.  I just gave you the quick summary of the book The Big Short by Michael Lewis - spoiler alert.

So Greg thinks he's got a good idea to help mortgage holders and investors in mortgage bonds, and several funds and economists agree with him.

Who would benefit and who would lose
I think the ship has long sailed on the opportunity for Washington to punish Wall Street on this.  Some of Washington's actions in 2008 and 2009 may have actually done some good - TARP being one of them - but that was in the heat of the crisis.  Laws and capitalism could be set aside to avoid a massive meltdown.  So while #OccupyWallStreet is still raging, I don't think DC has the power to force the banks to write down loans.

One major complicating factor that everyone hopefully remembers from a two years ago is that these evil bankers don't actually hold the loans themselves.  My mortgage is a great example - we used a mortgage broker who priced a loan for us based on what he saw in the market making sure he could sell the loan and make a profit for himself.  So our mortgage was originally funded by the broker's company and the investors who back it.  Within a month, as planned, they sold that loan to Chase.  Every month, we will write a check to Chase.  But chances are that Chase won't hold onto that mortgage for 30 years.  Instead, they'll likely pool our mortgage with many others and sell it to investors.  These investors could be Greg Lippmann's fund LibreMax Capital, or the California Public Employees Retirement System (CALPERS), among others.

My check then goes to Chase as the servicer, who pools all the monthly checks together, and distributes the funds to the investors such as CALPERS.

If, somehow Washington decreed that my mortgage principal should be reduced by 20%, the winner would be me, my mortgage broker and Chase would feel no effect, and CALPERS would be the loser.  This would be a transfer of wealth from CALPERS to me - probably not the intended goal.

How to select mortgages to reduce
You clearly can't reduce ALL mortgages by any amount that would be meaningful enough to solve any problems.  Washington also hasn't grown enough wherein you could reduce mortgages on a case-by-case basis.  Therefore, the program would have to be broad enough to be meaningful to the country and the economy / housing market, but have some parameters.

One would be whether you've defaulted or not.  If you've defaulted, that's a pretty good indication that you've hit rough times and could use help.  Is it because you bought your house at the top and have too much debt?  Is it because you lost your job?  Have you defaulted on a 2nd vacation home in Miami that you bought on speculation?

The government could also look at loan to value.  The difficulty here is what is the "value" part of the equation?  Is it based on the appraisal done when you purchased the house - are these appraisals of any use if they are 15 years old or if they told you your one bedroom shack was worth $2 million in 2006?  Or maybe to apply for this process you'd need to get a new appraisal.  Fun.

What would be the end benefit
Individual homeowners would have lower monthly payments and have money to save or spend (the government surely wants you to spend).  Some homes would be saved from foreclosure, which would help the housing market.

My suggestion
Leave it be.  Again, many are suffering because of the housing crisis, but I don't think the government should be getting involved in private transactions and trying to bail out those who made a bad investment.

If a homeowner was defrauded into paying too much for a home, or buying a home they couldn't afford, they should go through the courts individually.

The solution, in my mind, is time - it is going to take years for the housing market to work through the inventory of foreclosed homes which will keep prices depressed.

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