Discovering a subprime solution: Part 2, who shall be saved?
[Continued from yesterday’s Part 1.]
That’s the only thing a lender will refund cheerfully
Yesterday’s blog post reported about the broad-based subprime mortgage-interest-relief program being constructed by the industry and Treasury Secretary Henry Paulsen, almost as if he were reading AHI, and as reported in Friday’s Wall Street Journal.
Top Treasury officials fear that unless creditors agree to relax the terms on many of those mortgages, borrowers will default at a higher pace. About 6.6% of subprime mortgages were in foreclosure as of August, the most recent data available, according to First American LoanPerformance.
While the big picture is clear, the details remain to be specified.
Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups:
1. Those who can continue to make their payments even if rates rise
2. Those who can’t afford their mortgages even if rates stay steady, and
3. Those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates.
Only the third group would be eligible for help.
This is classic triage, following precisely along the lines we suggested in my two-part advice to borrowers post: Why are you in trouble? and What’s the best way forward?
The creditors are likely to look at whether the borrowers have equity in their homes, despite falling house prices, and whether their incomes are holding steady.
If the borrower has equity, then the lender shouldn’t have to take a loss. The home should be sold. As I put it:
Sell the property now and get more than the loan back. Just because you can’t make the loan payments doesn’t mean that the lender must take a loss. You may be over your head.
No, really, I can make those payments!
You may have stretched to get into the house in the first place. Something bad may have happened to your personal finances from which you’re not going to be able to recover.
For the borrower, a house whose value is greater than the loan is a bad-news/ good-news story. It’s bad news because the lender’s almost certainly going to force the house to be sold. It’s good news, however, because if the property can be sold for more than the debt, the current owner has equity. So the homeowner will have to move, but will get something back from his or her down payment.
Evidently the Treasury Secretary thinks the same way we do:
Mr. Paulson, who is philosophically opposed to federal meddling in markets, at first rejected a sweeping approach to loan modifications when the idea was floated by Federal Deposit Insurance Corp. Chairwoman Sheila Bair. But he shifted his position recently. He told The Wall Street Journal last week that it would be impossible to “process the number of workouts and modifications that are going to be necessary doing it just sort of one-off.”
Think like Shatner!
The workload argument is valid, but that’s between lenders and borrowers. As I put it:
As I’ve previously posted, loan modification or workout is a customized activity that depends on the lender’s conclusions about two key questions: (1) Why are you behind? and (2) What’s the best way forward?
The path to foreclosure, which gets worse for the lender as it advances
A better argument is systemic stability.
Borrowers whose loans are resetting are likely to have a tougher time sidestepping the rising payments by refinancing or selling their homes. Lending standards have tightened and many borrowers can’t qualify for refinancing. And falling home prices mean that many borrowers have little or no equity in their homes. Some owe more than their homes are worth.
Even so, an indiscriminate wave of foreclosures is in nobody’s interest, since it would depress prices further.
Officials in
We need silver bullet, kemosabe
Mr. Paulson, who spent 32 years at Goldman Sachs Group Inc., has been on the phone nearly every day in recent months with the heads of financial institutions such as J.P. Morgan Chase & Co., Bank of America Corp. and Lehman Brothers Holdings Inc.
“Yeah, Mr. Secretary, yeah, I get it, yeah, uh huh.”
I should certainly hope so.
“If I ever saw a role for government, it is…to bring the private sector together when innovation has really outrun our ability to deal with it,” Mr. Paulson said. He is expected to talk about the administration’s approach to the housing crisis at a conference Monday.
Let’s go back to the proposed three groups:
Treasury officials say financial institutions are likely to set criteria that divide subprime borrowers into three groups:
1. Those who can continue to make their payments even if rates rise
2. Those who can’t afford their mortgages even if rates stay steady, and
3. Those who could keep their homes if the maturity date of their mortgages were extended or the interest rates remained at the teaser rates.
Triage sorts patients into those who will live regardless of what the doctor does, those who are doomed regardless, and those where intervention means the difference between life and death.
It’s touch and go what intervention will work
The same triage is being applied here:
Group 1 borrowers have equity, and their lenders are fully secured. Relief is not necessary; just sell the home.
Group 2 borrowers are in trouble already, and even relieving the projected increase will make no difference.
Group 3 are those borrowers who are in good standing now, and can stay there, if they don’t get hit with a rate reset.
In short, this is just like AHI drew it up.
That the Treasury proposal converges on AHI’s ideas isn’t surprising. All the mathematics is there, waiting to be discovered, as the mathematicians say. The problem was clear, the timing pressing.
Give the Treasury secretary credit for recognizing the problem and committing to act upon it. Once the action commitment is made, everything else follows.
The criteria should be finalized by the end of year.
Happy New Year?
When the
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