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Analyzing the Popular Proposals for Mortgage Principal Writedowns, Part I
Note: This article is from The Managing Partners of Peterson Bliss Advisors with help from Jordan S. Terry, Founder & Managing Director of Stone Street Advisors LLC.
This is the first in a series of articles intended to review the matter of principal reductions for “underwater” residential mortgages. In a few installments, we will discuss:
• The numbers quoted in the proposal as stated in the media
• The issues surrounding the stated numbers
• The costs to the Borrowers
• The costs to the Taxpayers
• The costs to the Banks (and eventually the Taxpayers) and Timing
• The “fairness” of the proposal
• The most recent proposal from banks to a “finite number of current borrowers”
• The ultimate solution to the decline in home values
Today, we're going to focus on the first two points. Enjoy reading and please leave your thoughts in the comments section, as we know this is a rather contentious debate.
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Recently there has been a lot of talk from the likes of #OccupyWallSreet, Elizabeth Warren in an ABC News segment and Martin Feldstein in a New York Times Op-Ed piece about the residential housing sector and the “need for principal reductions”. They (the pundits and politicians) toss this “solution” out as a panacea for the national residential market that will cure the continued decline in home values. The thinking then turns to the magical notion that increasing home prices and increasing sales volume will result in a decline in the unemployment rate and the national economy will be reinvigorated.
Well, we don’t buy what they are trying to sell. This will get a bit long winded, but let us examine some of the “facts” they introduce and try to see what this really means in dollar terms for borrowers and banks.
The numbers quoted in the proposal as stated in the media
As the New York Times Op-Ed piece states, we could easily write these mortgages down to save borrowers a ton of money ($350 billion!) and the banks will only need to eat half that as the government (read: tax payers) will take on the rest. Maybe the largest issue with this principal reduction scheme is when people try to throw out numbers and rely on the sheer size of the numbers to impress people in to believing that this will make a magical impact on their monthly expenses. Let’s dive in to the nitty-gritty of these calculations before we get in to all the other reasons this is a horrible idea.
First, we need to get some statistics to base our assumptions on. We pulled ours from the US Census Bureau and a particular Saxo Bank Capital Markets study from August 2009 that we think does a god job of tackling a large issue and giving some solid data to the reader.
The US housing market is made up of approximately 160 million households living in somewhere between 115 and 130 million housing units. Roughly 90 million of these housing units are of the single-family residence (SFR) type and approximately 80 million are occupied full time (primary residences). Of these 80 million housing units approximately 27 million are owned free and clear of debt while the other 53 million are encumbered by a mortgage of some sort. The total value of residential real estate in the US is approximately $19.3 trillion. This total housing stock value breaks down as $8.7 trillion in equity and $10.6 trillion in outstanding mortgage debt. If 53 million housing units have $10.6 trillion in debt that equates to an average of $200,000 in debt per housing unit.
The issues surrounding the stated numbers
Given these statistics we can start to make some very general assumptions. It is important to note that these assumptions will be imperfect as you would need much more accurate micro level statistics to create a true representation of the markets we are discussing, however, for the purposes of this article these numbers will suffice to have the conversation. Additionally, using the same simplistic math as the people backing this principal reduction scheme is kind of fun as it shows how wrong they can be when using their own facts.
These articles and politicians cite that 15 million homeowners are underwater on their mortgages, having a loan to value (LTV) of greater than 100%. 15 million sounds like a lot, but it is 9% of the total households and 19% of the primary residences, a minority whichever way you slice and dice it. Of these 15 million underwater borrowers, 11 million have LTVs greater than 110% and nearly 7.5 million have LTVs greater than 130%. This means that $3 trillion in outstanding mortgages have LTVs greater than 100%, $2.2 trillion greater than 110% and $1.5 trillion greater than 130%. So roughly 10% of homeowners made some really poor choices by jumping in to the market at the top of the valuation bubble and didn’t have adequate (or any) equity to invest as their down payment.
The grand principal reduction idea suggests that we take the most underwater borrowers (those that made the worst purchases with the least to put down) and we should have their principal reduced to an LTV of 110% in exchange for granting personal recourse of the loans (meaning they can be sued for the amount of the mortgage they don’t repay, in contrast to the current system wherein the bank forecloses and sells your home). The real sales pitch here is that “If everyone eligible participated, the one-time cost would be under $350 billion.” A quick calculation shows that an average reduction of 16% (all the loans with LTVs greater than 110% reduced to 110%) to the 11 million underwater mortgages will indeed total $352 billion. The caveat being what we stated in a previous paragraph, where these are incredibly generic assumptions as most of these underwater mortgages do not have a $200,000 balance. A significantly larger balance, probably on the order of an approximate $300,000 average, with a huge proportion being even larger than that when figuring that the largest valuation declines were in higher valuation states such as California, New York, Arizona, Nevada and Florida, is to be expected. Should the average underwater loan amount be $400,000 this would immediately double the costs to $700 billion.
Are you starting to see why the principal reduction scheme won’t function nearly as the back of napkin math would have you believe? It’s dependent on overly simplified averages, not the accurate micro level numbers.
Later this week we'll delve into the further issues mentioned at the beginning of this post so stay tuned!
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My question is...Why should a hit to the banks be a hit to us, the chump tapayers??? That is capitalism??? Banks are not allowed to go broke the way normal businesses are?
You people have been peddling this crap for years now, "Give the banks the profits and socialize the losses".
The rest of us will make do if some of the worst banks get their books blown out. None of us will die if Citi, GS, MS, BOA, WF go belly up and get reorganized. You boys will get hurt I guess, since you seem to be pushing your own book. And...Sorry, I don't care.
Don't whine too loudly, your boy is in the WH and you'll get your commissions. Lord, it is difficult to bear boot-licking toads. Do you guys grin when you swallow?
Can't imagine that ONLY 19% are underwater. Probably double or triple that. Excessive refinancing due to lower and lower interest rates is the reason, not poor decisions.
And if Greece got 50% off, so should everyone else.
What about the smartest who didn't fall for the debt slave ponzi scheme...why should they have to share in the burden? Let the whole thing collapse and let prices fall to supply and demand levels again. Then watch as the animal spirits take off. The impetous for a real estate revival is: Jobs, credit and a secondary market. We don't even have one of these so let it collapse, crumble and allow real capitalism to be reborn again...and without any currupt crony government involvement!
It would be very difficult to take any action against a homeowner when the parties have no legal interest in the property, have no right to foreclose or modify, no right to collect payments for something the homeowner has no further obligation after having been paid for more than once in one of 6 bailouts. Did you forget the banks are working a RICO scheme to get signatures of dumb ass homeowners so that all their rights to litigation vanish when they mod or do anything with the bank? You know attorneys aren't allowed to represent clients in these procedures?
Are you plain ignorant or is this part of an agenda?
Lowering the principal to 110% of the LTV would help people in the high stress markets. I can not get a bid on my house in Florida with the asking price cheaper than the purchase price in 2003 (let alone the $50K in upgrades after closing). The problem is the banks have been churning foreclosures for three + years with strike prices in the gutter ( as in 1995 home price levels)... so the area appraisals drop to the 'recent sale' values and everyones LTV goes to hell regardless of any wrong doing. A principal reduction to 110% LTV would actually level my playing field with the banks.... otherwise they own the total market from A-Z and everyone else is frozen out.
Allowing responsible consumers to move on with life would be a far greater stimulus to America than banks continuing to pollute local housing markets for years to window dress their Loan Loss Reserve ratios.
I have no problem paying my mortgage, however I think it is insane that the borrowing costs are so astronomically high considering I will pay $125k in interest on a $130k loan. That pretty much guarantees a massive amount of inflation as my home will never sell for $250k unless the average income in my area doubles as well. Somehow I doubt in 30 years the average income will be $100k or more. In the past 30 years the dollar value of average income has stayed the same but the purchasing power of said income has declined substantially. Is that really going to change in 30 years? If things keep going the way they are I will have paid $250k for a home over 30 years because of a contract and when I own the asset free and clear it might be worth $25k if I'm lucky.
It was easier to find a $50k job in 1985 than it is to find a $50k a year job now. Homes will be like cars. You buy one and use it for a time and then you are left with a rotting pile of junk you can sell for $1000 after you paid $20k for it.
The idea that a home should continually increase in value has always been a deeply flawed concept. If anything a home should merely maintain its value. For a long time that is how the real estate market worked up until the NAR conspired to increase commissions by raising home values and selling the public on the idea of a home as an investment. The same pump and dump con job of the stock market dominated housing for almost 50 years. Only a true fool can believe home prices will increase outside a hyper inflationary environment. In that case prices will go up but value will plummet.
The only solution is a complete wipeout of the banking system. Maybe we'll get back community building and loans. Perhaps someone will institute a flat rate mortgage system where the bank makes 20% over a period of ten years. You'll own your home in ten years and your payment will be about the same as a bullshit 30 year 5% loan. A 20% return on a 10 year investment is pretty damn good. I'd take it. Of course exotic MBS products wont be as attractive without a total return close to 100% over the life of the loan.
Only real solutions will fix this mess. Anything coming from the government or the banks will only trap us further down the crushing abyss.
This is like one of those nightmares where you keep thinking you wake up but are still in just another nightmare.
Nobody jailed for creating this disaster.
15 million units underwater is 28% of units with mortgages, not 9%. And the point would hardly be to recoup the 'outstanding' - as far as I understood the concept, the govt. merely transfers primary risk to itself rather engage in supporting a Financial sector, ad nauseum...there's also the non-monetary benefit whereby banks needn't foreclose and force people out of their homes - as a result of creating the MBS fiasco. - Stone Blind Advisors, more like
The perspective of the micro enviroment. So our savings, equity investment, never a late payment, and lifestyle choices to make this all happen are for nothing. Yeah, boo F&*(in hoo. Life's not fair. The truly disgusting fact is that my wife and I could divorce on paper, I could buy a new home for $100, walk away from the old one and come out way ahead. I don't want my principal written down, eventhough my morgage is one of two debts I have. The other a tractor.
The "fairness" I want is for contracts to be honored. To not be faced with a decision where I can destroy my ethical underpinnings to get ahead or be punished for living up to my obligations. In any market buying a potentially depreciating asset with zero equity is crazy. The masses need to learn basic common sense economics or dare I say the Austrian perspective.
We choose not to participate to the degree possible and moving in this direction is THE top priority for our family. We have gone Galt. We make only just enough to pay our contracts and save hard currency for the future.
How many otherwise uber-productive people are sitting on the sidlines, hedging, while the fools play their games? I was not born into wealth, so I am content to have actual skills and hard assets to ride this out. Someday, this insanity must end, and myself, my wife and our children will pick up the pieces.
"Capitalism is about profit and loss, if you bail out the losers, theres no end to the cost"
"Capitalism is about profit and loss, if you bail out the losers, theres no end to the cost"
Agreed. The loser banks and loser government have proven this, as they take and take and take . . . there's no end to the cost to the average citizen.
The puppet's plan just extends the debt slavery for those who don't know any better and the real biggie is that most of these homes have no legitimate title and are worthless, to either the homeowner or MORE IMPORTANTLY, THE LENDER. I'm sure that under the gov't program, a new mortgage and court approved title will miraculously appear with the banks now with a real asset and free from criminal fraud prosecution.
Win for the banksters; loss for the poor sucker that agrees to sign on the dotted line.
The homeowner is the only party that ever put a dime into the deal, and the only party that can show title in a court under US and state law. If you believe the bank loaned anything, you will lose. The parties on the documents acting as lender weren't listed after 96. Every deed of trust or mortgage may be void because of a simple violation of origination. It really is that simple. Only party with skin in the game is being made to run away from a debt they don't owe.
Think about this: since fiat Federal Reserve Notes are unconstitutional, no one has legitimate title to anything denominated in FRN. Or try this: eventually, things purchased by FRNs, or debts owed in FRNs will again become the thin air out of which FRNs were created. This is the way of this world. Not even Timmay can change it. On a long enough time line.......
Chignos
I have one of those underwater loans, and i put down 25%!!! still owe 209,000+- and at 6% i could save a nice monthly amount, but i will not refinance if it means my new loan will be a recourse loan! that’s about as dumb as taking out a student loan guaranteed by the government! i can walk any time i want to and i plan too, as soon as I retire,.. the home is never coming back to what i paid , at least not in my lifetime. As i see it it is just one more way for us to be a guaranteed slave.
fuck em
ps: As for walking, It’s strictly business , I have a contract,.. if I fail to pay (which I have not) they can take the house. I’ve already lost my down payment and lucky for me it’s only underwater by about $30,000 below my mortgage.
did you actually buy a house around the peak?? did you not look at the soaring price charts and say WTF??? did you think we were already in hyperinflation mode or something?? throwing 25% down in that climate as well?? you should be smacked
By the time homes return to their former value (if they ever do), we will be on a new currency system.
new currency system...
One can certainly Hope!
End the fed, start producing US notes and constitutionally mandated intrinsically valuable coinage redeemable at face value for same.
The idea of having face, intrinsic and numismatic values so completely obfuscated, (check out the 5 oz silver bullion "quarter dollar") in US government issued currency is the very definition of insanity!
Why this is so difficult to understand remains one of the greatest mysteries of life. imho.
China owns Fannie and Freddie bonds as well as some still held by banks because they had some on hand.
Punish banks.
Fckover China.
Punish politicians.
I think the focus of loan restructuring programs needs to be on the most probable to pay their mortgage back after the restructuring. The way I see it there are people who hit the wall in say 2008....and have through effort or luck or skill been able to at least partially "recover." Recover means be able to pay a mortgage at all. Those are the "houses" we need to "save."
It makes no sense to write down the "most underwater houses." Well it probably makes sense to someone...let me see who could that be...oh the Banks.
I do not see it as saving the housing stock as much as I see a loan restructuring program as "saving homeowners."
In the real business world...as opposed to the insanity we have now...if you make a deal and the world goes upside down...(force majeure).typcially the party on the other side will make some accomodation.
No matter what side of this you are on I think we can all agree the world has gone upside down since 2008. Right now homeowners have no one to actually talk to other than loan servicers who on average want to foreclose and pick up the government check (thank you very much taxpayers) from Fannie or Freddie.
Servicers "advance payments" to investors when a homeowner does not pay. They carry large credit lines which of course they pay interest on. What servicers want is a foreclosure and to get their money back...as fast as possible.
So...what makes the most sense if you are going to do any of this...target the homeowners who can actually make payments. Imagine that...not which houses are the "most upside down." I wonder what that does to the potential costs?
An advance auction of stolen goods. Must be an election year.
Write down principal for all or none. We debt slaves must be all in it together.
JUBILEE BITCHEZ!
I can here the jitney jingle right now!