Daniel Alpert

Next Generation Thinking about the Mortgage Mess

In a post a few weeks ago I argued that policymakers were going to have to attack our core economic challenges we face with much more creativity and vigor than we have seen so far.   The Times today has an excellent op-ed by Daniel Alpert which offers up some such next generation thinking about how to get out of the mortgage mess - a critical part of any emerging national economic strategy - equal in size and scope to the problem itself.   

It begins: 

BY providing financial institutions with enough capital to survive (and even thrive) over the past year, the federal government prevented the global economy from grinding to a halt. But it may also have unwittingly encouraged banks to slow the resolution of delinquent, defaulted and underwater loans secured by homes and commercial real estate. Such “extend and pretend” behavior does little except delay losses — which helps explain the recent crop of prediction-beating, market-rallying bank earnings reports — while prolonging and worsening the damage done by bad loans.

Just this week, the White House met with a gaggle of mortgage company executives to discuss why their loan modification programs have been so ineffective. In fact, a recent study by the National Bureau of Economic Research illustrates that these programs haven’t been ineffective so much as unused: only 8 percent of seriously delinquent borrowers have received any form of mortgage modification and fewer than 3 percent of such borrowers received a concession on principal or interest payments from their lender. By contrast, about 50 percent of those seriously delinquent loans had foreclosure proceedings initiated against them. That’s a record rate of 1.9 million foreclosure filings in the first half of this year.

Banks, of course, typically lose more money by foreclosing on a home than by renegotiating the principal of a loan — but, as foreclosure timelines often run 12 to 18 months, that loss takes far longer to show up on their balance sheets. As a result, banks are pushing the mess (and the attendant additional losses) well into 2010 while they maintain the fiction that borrowers will be able to repay severely underwater loans in full. Banks are even beginning to turn down borrower requests for immediate “short sales,” in which homeowners sell for whatever they can get and then give all proceeds to the lender, because this, too, means that the bank must record a principal loss at once, rather than down the road.

The sheer magnitude of the debt bubble — doubling to $11 trillion in home loans and adding tens of trillions in total American debt in the past decade — along with the collapse of real estate prices, make it extremely unlikely that any of these houses will recover their value soon enough to mitigate the losses embedded in banks’ balance sheets. And by stretching out the time over which banks will continue to have their capitalization hit by losses, banks cannot soon fulfill their mission of providing new capital for the recovery and growth of the economy. Fearing for their own solvency, banks are instead salting away enormous, record-setting reserves.

To put the bubble behind us, we need to place mortgage lenders on a path to settling up with underwater homeowners. One of the few viable ways to do this is for banks to accept the voluntary surrender of deeds and then lease the homes back to their former owners. The former homeowners should then retain a right to purchase their homes back at fair market value, after, say, five years, during which time they would need to get their financial affairs in order.

Congress could pass legislation, within the bounds of constitutional protection of contracts, that would require lenders to provide such a lease-back arrangement to any borrower who wants one. The former homeowners would pay rents set in accordance with local rates (which in almost all cases would be considerably lower than the total of their former bubble-era mortgage payments, taxes and insurance premiums).

Count me as one of those who believe that for the national to see broad-based prosperity in the years ahead the banks will have to take some kind of "haircut" on consumer debt. Restructuring, deleveraging, or whatever we are going to call the process of lessening the debt load of consumers will at some point become seen as a requirement for the future success of the American economy and not some malevolent form of "moral hazard."  Until American consumers can get back in the economic game "recovery" will be more wish than reality. 

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