The real cost of government intervention into mortgage markets, via programs like HAMP? We’ve managed to convince untold thousands that in the face of unmanageable debt loads, their best option is to try to tread water just a little bit longer. The healthy alternative, of course, is to simply wipe the slate clean and liquidate bad debt.
Instead, we’re seeing borrowers do previously unheard of things, like defaulting on their mortgage while paying on every other outstanding debt. The reasons for this change in behavior aren’t hard to fathom: it’s where the incentives lie. No other class of debt has such favored status politically, or has seen the government throw so many billions of dollars at it in an attempt to paper over the more general problem of households buckling under the weight of too much debt.
Yes, consumers have been deleveraging throughout the financial crisis and subsequent recovery. But it’s clear at this point that any deleveraging thus far hasn’t been enough to allow the economy to post the really strong post-recession growth pattern we’re accustomed to seeing. Without a healthy consumer, there won’t be a robust economic recovery. And so long as our government remains content to tell troubled borrowers to hang onto their bad debt, we risk seeing this cycle drag itself out.
We’ve all been had
Some consumers are starting to wake up to the ruse put upon them by our government, realizing that turning bad debt they can’t afford into less-bad debt they still can’t afford isn’t really a cure for over-leveraging. Lawsuits are starting to come in, a trickle sure to become a flood in the months ahead, in which borrowers are suing their servicers — either claiming that they were entitled to a government-sponsored loan modification, or that they defaulted on their mortgage in reliance upon their assumed eligibility for a loan modification.
The outcome here is a classic illustration of horribly maligned incentives, thanks to a government policy that yet fails to understand the mechanics of the market it’s been trying to “help.”
We know that people tend to respond to whatever incentives they are presented with. So let’s consider the incentives a delinquent borrower is often presented with: a reduction in interest rate to often well below-market rates, deferral of principal, and extended maturity. Some lucky delinquent borrowers are able to exit from their home for less than they paid for it, too, while others are receiving outright forgiveness of principal on their loans. And still others are given the chance to simply hand over their deed and move on.
A recent Bank of America mod offered to a troubled borrower
, for example, offers a 2% rate with roughly 1/3 of the unpaid principal balance deferred for the term of the loan (and not accruing interest), via a 40-year term. The monthly payment reduction here is significant. The only thing that might have been better for the borrower here was outright forgiveness of $118,108 of their $339,214 debt, rather than deferment on that same amount.
But that’s really nitpicking, relative to the lack of incentives offered to performing borrowers. What incentives do performing borrowers really have to keep performing, beyond the prospects of better credit for loans that most consumers no longer want or need?
I suppose many still get to file their mortgage interest deduction each year, but even that may soon be relegated to the dustbins of history
. But with more than 11 million U.S. households now holding a mortgage worth more than their home according to CoreLogic
data -- giving them a clear incentive to default -- it’s a question worth considering. Because the vast majority of these 11 million are still performing as agreed on their note.
That’s 11 million homeowners that aren’t able to refinance, that can’t buy their next move-up home, can’t consider a job somewhere outside of the town they live in — and aren't able to contribute to a mortgage market that would love dearly to see more customers. And there are another 2.5 million borrowers, according to the same CoreLogic data, that are within 5% of being underwater; that’s effectively underwater, given the typical transaction costs of reselling a home.
Because this group of 13.5 million borrowers can’t refinance their existing loan or move without incurring substantial costs, they are putting comparatively far more of their money into their mortgage, and comparatively less into the more general economy. That may help some investors, but it doesn’t help GDP figures a whole heck of a lot.
It’s worth considering here, too, that refinance volume is every bit as important as purchase volume to the U.S. mortgage market. Consider that Des Moines-based iEmergent
, a market analysis and consulting firm, is projecting that 4.80 million loans worth $903.8 billion will be originated in 2011. Of that total, 2.18 million loans worth $412.9 billion would come in the form of refinancing activity.
Imagine if the current group of performing-yet-underwater borrowers — effectively more than 14 million strong, or roughly three times the annual estimate for all mortgage market activity — were actually able to sell or refinance their home. Talk about introducing legitimate demand into a market quite literally starved for it. It’d be instant stimulus. It’d be the right kind of stimulus. And we’d not be hearing about a housing depression any further, either, as homes started to really move.
We can debate the size of the effect here, but I think nearly everyone would agree that a historic refinancing wave would sure as hell beat the Fed deciding to buy hundreds of billions of dollars’ worth of Treasury debt.
Get the incentives right
I should note that I’m not suggesting that we put delinquent borrowers out in the cold. I’m advocating that for these borrowers, focusing on reforming programs that can help reduce debt more holistically — bankruptcy, and perhaps even allowing cram-downs of mortgage debt in bankruptcy — would be policy dollars far better spent, in comparison. Allow those with too much debt the chance to address the root problem that ails them, instead of attempting to paper over it with a useless mortgage modification program; and give those who can perform the sort of incentives they need to continue to do so.
I’ve read for months among consumer advocates as well as analysts and academicians, all arguing for principal reductions for troubled borrowers. Why stop with just troubled borrowers? After all, the benefits of reducing principal for defaulted borrowers seem incremental at best, when you consider that most borrower defaults are ultimately due to an overall debt burden beyond a mortgage, and/or the loss of income due to unemployment. These borrowers will often need much more than simply a reduction of some portion of their mortgage principal in order to rehabilitate their household balance sheets.
I’d argue instead that what’s ultimately needed, for our economy’s sake and millions of unemployed workers everywhere, are broad principal reductions for performing
borrowers—the 85% or more of borrowers that are actually paying as agreed, even if they are underwater. These borrowers not only have the means and ability to meet their existing debt obligations, but also have the means and ability to contribute to the greater economic recovery, too. If only they were given the chance to do so.
This is the real middle class in America, the real consumer that would otherwise be driving a significant chunk of consumer spending in our country, if only they hadn’t committed to a $500,000 mortgage at 7.5% on a home now that’s now worth $375,000 while rates are at 4.5%.
This is the consumer that has been most noticeably absent from the recovery, yet it’s this consumer that is being told that only deadbeat borrowers can look to refinance into more favorable terms, or sell their home at a loss to the bank. It’s this consumer that still dutifully pays on their debt while everyone else wonders why the economic recovery we’ve seen isn’t proceeding at the pace we want.
Our current ‘avoid foreclosure at all costs’ political philosophy is providing incentives and benefits to the worst performers, not the best. Is that the sort of world we really ought to want to live in?
I see it this way. It’s sort of like giving a raise to the guy at the office that has failed their past two to four reviews and sometimes even refuses to follow company policy, while telling your workhorses — the ones that work late and work weekends, driving the company forward — that they have to absorb a salary freeze so that the company can try to get the poor performer to do better. It wouldn’t work in any one single business, so why is it that our policy makers seem content to believe that it will work when it comes to roughly one third of our nation’s economy?
Our government is already spending hundreds of billions of our dollars subsidizing housing in this country via payments to the GSEs and programs like HAMP, HARP and others. Isn’t the idea, at least among many economists, to focus stimulus dollars where the greatest multiplier sits? Where each dollar spent delivers hopefully more than a dollar of economic activity in return? If so, I’d argue that the multiplier effect of each dollar spent to reduce principal for performing borrowers would be far, far greater than just about anything else we can think of right now.
For those you surprised to hear me espousing this viewpoint, don’t be. The time has come to consider principal reductions — for the sake of our economy, and for the sake of a housing market that appears as if it might not really ever recover without it. And the truth is that principal reductions are coming; the only real question is who gets the benefit.
For just this once, we ought to consider what happens if we manage to align our economic incentives properly and reward those consumers who are able and/or willing to pay on their debts, rather than those who are not.
Paul Jackson is the publisher of HousingWire.com and HousingWire magazine. Follow him on Twitter: @pjackson