Time to Quarantine the Foreclosure Epidemic
In 1902, faced with an outbreak of smallpox, the City of Cambridge, Massachusetts, adopted a mandatory vaccination law. Challenged by a Mr. Henning Jacobson as an unconstitutional infringement upon his liberties, this intrusion on individual rights was nonetheless upheld by the U.S. Supreme Court. Even more intrusive quarantines have been found lawful as a means to stop the spread of plague, influenza, and other cascading threats to the public health and well-being.
Today, our country faces a different kind of epidemic. With house prices having plunged again in November at possibly an all-time record rapid drop, roughly 12 million borrowers now owe more than their homes are worth--double the number from a year earlier and expected to rise to nearly 15 million this year--while another 8.1 million foreclosures are expected over the next four years. Over 1 in 10 Americans are in mortgage default. It is time to re-evaluate how we think of the situation.
By any reasonable measure, we confront a spreading foreclosure epidemic that is eating away at the core of the nation's economic health. However well-intentioned, private and governmental efforts to date have not contained the damage. In the early stages of a public health crisis, voluntary treatment of the ill also fails to stop the spread of disease. What makes certain epidemics so devastating is that normal delivery systems for patient treatment are overwhelmed by the sheer number of cases all happening virtually at once.
Moreover, epidemics often infect health workers themselves, further weakening the normal recovery systems. And when rising illness rates and falling resources combine, the health care system is further left unable to help other ill patients, who themselves then get sicker than they might in normal times.
Looking at the current foreclosure crisis as an epidemic, the parallels emerge. At a normal rate of borrower defaults, the financial system can "clear," in industry parlance, bad assets such as troubled home mortgages through workouts and occasional foreclosures. Today, however, it is abundantly clear that multiple foreclosures in many communities are infecting neighboring homes with rapid value dissipation. If left unchecked, this will lead to further community malaise due to lost tax revenues, increased crime and fire prevention, and a general draining of public resources.
Similarly, some players in the financial system who could have addressed scattered defaults themselves are "sickened" when foreclosures soar. Over 100 mortgage companies that originated many of the subprime mortgages are now out of business, and servicers who remain suffer capacity shortages to deal effectively with all the borrowers in need. Finally, homeowners with prime mortgages or good incomes who might have not gone into default in normal times now see themselves also "upside down," owing more on their home than it is worth in the market, leading to home equity lines being called, or lacking home equity to deal with what would otherwise be normal borrowing for unexpected setbacks, college tuitions, and the like.
The upshot: Entire communities have become economic casualties of the main epidemic, and this plague continues spreading. Consequently, it is time we consider stronger measures--the economic equivalents of a quarantine. What can be done? Several extraordinary actions for extraordinary times need to be given greater urgency.
Exploding REMICS
Over nine months ago, the Center for American Progress put forward a proposal by Michael Barr and James Feldman to modify the Real Estate Mortgage Investment Conduit, or REMIC rules to open a path for the servicers of loans to accelerate modifications and prevent unnecessary foreclosures. In 2009, we need to go a step further than simply implementing these needed changes.
REMIC status offers an enormous tax benefit to investors in the residential mortgage trusts that hold millions of mortgages. Many individual mortgages held in these pools are heading toward foreclosure. Recognizing that REMIC status is a special privilege, it is time to revoke REMIC status for any residential home mortgage loan-holding entity that forecloses on more than a certain percentage of all of its mortgages.
This step, alongside other REMIC and accounting changes outlined in the CAP proposal and elsewhere, would free up the ability of mortgage service companies that collect individual mortgage payments and distribute them to their investors to modify troubled home mortgage loans, or sell them off at a discount. The potential revocation of REMIC status would dramatically incentivize loan servicers to halt foreclosures and restructure loans to affordable levels, or sell them to those willing to do so Getting defaulted mortgages out of the hands of mortgage servicers so that systematic modifications based on sustainable principal and interest payments is perhaps the only broad-based approach likely to turn around the current price plunge. Congress already authorized the Treasury Department through its Troubled Assets Relief Program to buy up troubled mortgages, and previously funded the Federal Housing Administration as a source of refinancing. But to date, servicers have not been sellers. The economy cannot afford any longer to wait for them to decide to seek the economic equivalent of medical help. We need to put mortgages into temporary foreclosure quarantine.
National foreclosure moratorium
In the 1930s, state after state adopted moratoriums on foreclosures, dramatic action upheld by the U.S. Supreme Court. While hardly the best course of action in normal times, barring foreclosures to stem the downward spiral is a necessary part of a quarantine approach.
Even with the REMIC law changes, the sale of mortgages into the control of parties motivated to make lasting loan modifications will take some time under the best of circumstances. Congress could begin with a six-month moratorium, a reasonable time for transfers to occur and extendable if the situation has not improved. But given the national economic consequences of the current foreclosure wildfire, a federal moratorium approach is justified both to stop further price declines and to make more aggressive loan modifications a better alternative.
Even the bankruptcy playing field
As an adjunct to these other measures, granting borrowers in bankruptcy proceedings the same mortgage modification rights enjoyed by commercial real estate owners and even second-home owners is long overdue. Currently, judges have no authority to force a lender to restructure a homeowner's mortgage on a primary residence to a level that reflects the current home value. This puts all the burden of the loss--which clearly under today's circumstances is a loss in value beyond what either party could have anticipated--only on the consumer.
Giving homeowners the same bankruptcy options as enjoyed by Donald Trump is a fairer way to spread the burden of the current downturn and gives lenders a needed incentive to reach a more realistic modification to avoid the bankruptcy courts to begin with. Even those in the financial services and related sectors that have long opposed such a move, among them Citigroup Inc., the National Association of Home Builders, and the American Bankers Association, recognize this course of action may now be needed. Indeed, serious studies have concluded that "mortgage markets are indifferent to bankruptcy modification risk."
Stronger government interventions in the market such as these will inevitably raise objections. Some will argue that any change in the current status quo will amount to a "taking" of private property. The power to take such actions, however, was upheld in the Depression era, and in other cases of economic necessity in the past. Indeed, forcing the sale of mortgages outright by invoking eminent domain using existing statutory powers was recently advocated by Harvard Law School Professor Howell Jackson.
In the end, the takings issue boils down, in the situation of a frozen malfunctioning market, of whether the government is paying owners just compensation. The financial complexity and split ownership of mortgage-backed securities in which most mortgages are now bundled, combined with buyers sitting on the sidelines while prices plunge, makes it almost impossible for the marketplace to function properly. Market dysfunction requires government action even though this may be contentious, and our legal system has well-established mechanisms for looking back and valuing property after it is taken.
Others will assert that some of the proposed actions will distort the market, but that talismanic argument is belied by recent financial history. If swifter action by regulatory authorities had been taken initially to prevent the widespread selling of poor mortgage products, and then to recognize the full scope of the home mortgage crisis and prevent foreclosures, then our government would not have had to intervene in the economy in a manner so forceful that it could hardly have been imagined just 12 months ago. Given widespread current market failure, bolder actions are necessary in the short term precisely because we need the government to help restart a normally functioning market balance between sellers and buyers of homes along with a stable home mortgage finance system.
Finally, a common argument against intervention is the refrain that since 90 percent of borrowers are still paying their mortgages, any action to help defaulted borrowers avoid foreclosures will somehow induce more borrowers to go into default. Yet the vast majority of the 90 percent who have not yet defaulted will not be eligible for any modification as they still have reasonable equity cushions above their mortgage balance, and/or their loan payments relative to income are below the modification guidelines.
It is possible that at the margin, some borrowers looking ahead to a time when they expect to hit trouble may default sooner. But defaulting still comes at a great cost to the homeowner--a bad credit rating, very time-consuming workout process, and heavy financial scrutiny. And of course it is not as if we don't do these interventions, then no more borrowers will go into default. The cost of staying on the current course is almost certainly millions more foreclosures, and a dramatic further drop in values for the rest of us.
As with a health epidemic, there is no way to perfectly match those who need treatment with the remedies necessary under extreme circumstances. Some who may get pulled into the quarantine who would have recovered without it. But if conventional remedies were working, then things would not have reached today's epidemic proportions.
David Abromowitz is a Senior Fellow at the Center for American Progress, www.americanprogress.org, where this column first appeared.
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Guess you will stop unemployment too ?
"Over 1 in 10 Americans are in mortgage default. It is time to re-evaluate how we think of the situation."
This kind of careless rhetoric reduces the credibility of your recommendations. It's most likely that you mean "1 in 10 mortgages are in default". That's a number I have seen, but it is very different than 1 in 10 *Americans*.
Rough numbers I have seen:
Total housing units = 111 Million
Total mortgages = 42 Million
1 in 10 mortgages in default = 4.2 Million
So, 4.2 / 111 = 3.8 percent of households have mortgages in default, or 1 in about 26.
So: 1 in 26 "Americans" are in mortgage default (not 1 in 10).
The problem isn't the foreclosures. The problem is that housing ballooned in cost (thanks to Greenspan's manipulation of interest). The value of property is inflated and it must come down. Most Americans can no longer afford to buy because of this radical increase in the cost of housing. Many Americans now routinely pay over 50% of their take-home just in a mortgage. That is an intolerable ratio, so that when problems in other areas arise, people have no savings and lose the home.
What should happen is that all the foreclosures should be completed rapidly. A house that sold for $500,000 (no money down) and has lost 40% of its value is now only worth $300,000. So foreclose. The "buyers" put nothing into the house except a dream, and with tax breaks paid no more than renters. They should walk away and come back in a year or two and buy essentially the same house for $300,000. It does them no good to "fight" to continue paying $500,000 for a house that in fairness is only worth $300,000.
Running up the cost of housing so radically is just another way to bankrupt Americans. The cost must come down to a rate that is affordable. In 1960 houses sold for 3-4 x gross. By 2000 that was up to 10 x gross in many areas. That is the problem.
The problem with your proposal is that people will not want to pay more for something that it is worth less and also the higher interest involved in that unworthy property. A moratorium would not work and a readjustment of mortgage rates will not work. The only thing that will work is to write down the value of the homes to the level they should be at. This means paying mortgages on pre-bubble prices. That is the only way, as people will tend to lose more money by staying in the game. I am amazed at how stupid people are, thinking that the average homeowner does not have the sense to bail even if it means a bad credit rating. The hell with the credit rating it's the money that counts. Every good businessperson knows this. Thats why they are all going bankrupt. Cash in hand is worth more more than any stupid credit rating at this point in the game. the average homeowner realizes that they are better off leaving their obligations so they can have a future. I say, leave the banks and the investors in a lurch and let them burn.
If you're upside down in your house, say you bought it at the peak of the boom in 04-05. If you're in Michigan, Florida, California, etc. your house is worth 50% of what you owe on it. Prices may not rebound for 5-10 years. Meanwhile, before gas prices dropped, you were spending $1,000 a month on gas just to get to work, because you didn't see $4 a gallon gas coming either when bought your car in 05. You walk away from this mess, knowing that at one time or another, you made sound decisions. Until the the world turned upside down on a dime. Americans are encouraged save for a rainy day, not a tropical storm.
"Prices may not rebound for 5-10 years. "
You don't know that.
"You walk away from this mess"
And destroy your chances to use any form of credit for the next 5-6 years.
"Meanwhile, before gas prices dropped, you were spending $1,000 a month on gas just to get to work,"
Ridiculous.
Conclusion: don't listen to the easily panicked. If you can afford payments--stay put, cut expenses, preserve your credit rating. You will need it.
The "Free Market" eliminated jobs and many people couldn't afford their houses that they could afford before Neocons sent ALL the jobs overseas. They were tricked by the bankers to sell their soul and the rest is history.
I strongly agree with your posting on all points, David. And it is very well-written.
In simple terms, "no 'reasonable man' would pay, nor wish to hold, any debt that is now secured by collateral that is valued at, say, less than one-half the price of the debt." That debt is effectively worthless, and neither the debtor nor any holder in due course will want to have anything to do with it.
Foreclosure, however, is not the answer: now the bank is stuck with something else that it does not want and cannot sustain ... an expensive, empty, probably unsalable piece of collateral. Houses degrade very quickly when vacant, and they're quite frequently burned to the ground.
Banks, and the mortgage holding trusts, unfortunately need to be --forced-- to negotiate with the debtors, in a good-faith attempt to make the mortgage "good" again. This means, forgiving debt.
Let's say a person owes $400K on a house that's appraised at $200K. We forgive $220K of his debt: now he's got a $180K mortgage and $20K in equity! We further stipulate that he must not sell the house in so-many years, lest he "flip" it for a cool $20K. And what do we have? A smaller loss than we would have had, AND a performing loan.
This makes good business sense, under these circumstances. It needs to be forced to happen.
If your proposal makes such good business sense, one would think that banks and other mortgage holders would implement it voluntarily, and not have to be "--forced--" to do so.
It's not just the stupid that are in trouble. I have paid all of my bills, am never late, take care of my home, pay my taxes. My house has lost more than 1/3 of its value because the forclosures have depressed the home values of everyone. If I wanted to get a home equity line of credit to say, put in new windows to save energy, I can't do it because the value of my home is now less than my mortgage, (which by the way I put 20% down on 13 years ago.)
Home values should be reset at some point in time before the big meltdown so most people can stay in their homes. It's to no one's advantage to put people on the streets so the lending institutions are stuck with empty homes left rotting in our neighborhoods.
There is a lot of weight hanging on the branches of the American Tree of prosperity. There are many issues that need answers. The answers are out there, but does anyone really want to know what they are? What most ordinary people want is to have their own problem solved. Climate change, species extinction, tyranny around the globe just doesn't occupy many neurons. They will take advantage of opportunities offered, and run with the herd, even against common sense and instinct. I use to blame W, the snake oil salesman's great-grandson, for pushing America over the event horizon into bankruptcy, but now, I'm thinking it's just the natural course of events, and he just catalyzed it. Texas can rise again, and the western world can lose their Christian Atlas status of trying to save poor people from themselves. China can rise up, and like that famous guy from the past, Genghis Khan, take the Muslims out of the world picture for awhile.
You can boil all of what you wrote down to...
"Once more the smart have to bail out the stupid."
Sigh.
I don't agree with that, "Kill." Things go up, and things go down. Sometimes the water comes up to the roofline of your house and you'd better get into a boat... quick. The investment and mortgage and banking businesses are like that, just as surely as any other.
Right now, "neither you nor your bank can have the resolution that you want, nor that you at one time (in good faith) contemplated." The reality is forced upon you both. Foreclosure means that you lose everything ... but, so does the bank. Re-negotiation, imposed upon both parties by law or by fiat, means that both of you lose something but that both of you lose "less than everything."
When I came to the US in 1998 friends of mine pointed out to me how the neighbor's home sold for over $800,000 while they thought it could not possibly be worth more than $500k. I am sure that the same home at the peak went for well over $1.3 million.
We had a bubble blown up by greed and stupidity. And all of us will have to pay for it even if we didn't participate.
The Roman historian Livy wrote that one of the best things Rome ever did was to make a law that people could not be forced into slavery to cover their debts. We could extend the limits of debt claims to cover shelter. Some of our bloggers seem to recommend Depression era laws suspending foreclosures. Speaking from the political instinct to go half way, we might limit the claims upon the resident of a home who is paying up a mortgage. That is, in any foreclosure, each person to be ejected would get a housing allowance settlement, perhaps $15 000. This may be a little high; it exceeds the average price that homes in Detroit are selling for (the Detroit suburbs sell at an average price closer to $140 000). This would be a principle to endure through good times and bad. It would affect the acceptable down payment and should make property ownership more attractive (causing home prices to be justifiably higher). It is the kind of fundamental revision that has ramifications.
I ahve never been late on my mortgage. If the goverement stops foreclosures I will stop all my payments. Why should I pay my debt if nobody else does?
I almost hate to agree with anybody that proudly lists themselves as a NeoCon,... but I do anyway at least on this one point.
Again,... the responsible who made smarter decisions, that are living more-or-less within their means, that are continuing to act like responsible adults will get nothing EXCEPT helping those that were irresponsible not be held accountable.
The only thing I will get out of bailing out homeowners under forclosure is part of their bill, and ending up being slightly less underwater on my own mortgage than I would otherwise be.
The foreclosure sunami is one thing, but what about credit rules? Millions and millions of Americans are in serious credit trouble (scores below 600) due to the "Free Market" job exodus coupled with the 8 years of Ponzi-scheme damage.
The economic penalties in employment and insurance qualification for low credit scores are great in scope and depth (Draconian) and prove crippling to the working class. Shouldn't these rules be revised? Maybe 2 years for Chapter-7/Foreclosure as opposed to 7 or 10? Force insurance companies and employers to not discriminate based on credit?
HOw about 20 year instead of 7 so next time people do not borrow what they can not repay
not all jobs should be decided on credit. i agree. but some should.
jobs like bank tellers, anything to do with financial investments, any job where you will be in contact or close to financial transactions, sensitive information. should all be done with background check and credit check.
i hope i dont have to explain why so. if you need explainin, happy to do so.
Does anyone have any insurance coverage on the empty houses? Empty houses go down hill quickly because of no upkeep. A small leak in the roof will bring the house down.
These houses need to be occupied-for everybody's best interest.
Homes are a long term investment, the prices may be down now but what are they going to be in 20-30 years? It's pretty hard to believe that a home won't be worth several times its current value. Terror alert level! Bird flu! Sars! Falling home prices! In the words of j.garcia, "We will get by"
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