Housing Solution - The Bank of Negative Equity

[Phoebe Loosinhouse]

(long - I expect only the wonkiest with interest in housing solutions to read)

The US has already come up with a plan called Hope for Homeowners that so far doesn't seem to be having a very large effect because the participation of the banks is voluntary and step one of this plan involves negotiating a short sale with the primary lien holder to 90% of current value before a house could be refinanced into the FHA program. Most lenders weren't/aren't happy with this and say that an internal workout would be more to their benefit, or they are so short staffed that nothing happens and the home ends up being foreclosed on anyway.

The question for the real estate situation has always been "what do we do with the fake equity which vaporized when the boom busted and who gets left holding the bag?"

The banks who made the bad loans should be left holding the bag, BUT, since the problem is so pervasive, the banks bad behavior has put the entire system at risk, so we have to do something less draconian than just let the banks fail and take the entire country and global financial system with it.

One suggestion has been to have the US just buy up all the "toxic" mortgages into a Bad Bank. I have a bit of a problem with this as it leaves the US on the hook for the bad decisions of the banks and also removes "moral hazard" for banks that just threw all the rules of common sense and fiduciary responsibilities out the window because they thought they could stick investors and bond holders with all the garbage notes.

So, here I think is a viable alternative solution:

1. Stick with the basics as already defined and set up in the Hope for Homeowners Act which basically says if someone is paying more than 31% of gross income to mortgage debt, the mortgage is by definition "unaffordable". That, by the way, is a return to the underwriting standards that were commonplace before all the banks went collectively insane. Also keep the 90% Loan to Value for a new loan that is part of Hope for Homeowners.

2. Establish a Bank of Bad Equity which is where the negative equity portion plus an additional 10% of Current Value of the previous mortgage loan goes. (The 10% additional is what provided the 90% L to Value for the new mortgage in step one) The usual suspects, oops! I mean the banks will do the new first mortgage as a special FHA program (or, as part of Hope for Homeowners).

3. The new mortgage for the distressed homeowner will be 90% of current value at 30 years at 5%(example) PLUS a silent second on the negative equity( NOT including the 10% of current value that was essentially the down payment - the banks will eat this as a punishment for their bad behavior)that will be at 0% for 30 years.(Since the silent second is a principle only loan, every single payment goes to reduce principle and in theory, a homeowner could pay this off a lot quicker, particularly if they want to sell the house. Or, possibly payment on the silent second is optional, but the lien does NOT disappear unless paid and no title will be transferred with an outstanding balance)

Example - someone buys a 300,000 home 2 or 3 or 4 years ago that has a current market value of 200,000. The current bank writes off 10% of current value (20K) leaving 180 to be financed as a new first mortgage. 100K remains to be financed by a silent 2nd at 0%)

300K loan at 7% over 30 years is 1995.91 P&I.(for example. Some of the adjustables and subprime went a lot higher)
180K new 1st mortgage at 5% over 30 years is 966.28 plus 277.78 for silent second = 1244 P&I

The bank gets 280 on their toxic loan of 300 and they should get down on their knees and say, thank you. They should be able to write off 10% without going down the tubes.

The homeowner gets a new affordable mortgage, but they are still responsible for most of their original commitment. (No one made them buy the 300K house and this solution preserves their credit and keeps them out of foreclosure and bankruptcy.)

I think this could REALLY work and stabilize housing somewhat and protect us from a flood of foreclosures. No housing program or stimulus will work, however, if people have no jobs.

[Phoebe Loosinhouse]

1. Since Obama is talking about housing solutions I will kick this

He suggests that home loans be able to be modified in bankruptcy. Maybe this could be way to restructure in a way that doesn't torpedo the value of the banks assets.