Some ideas

Housing Doesn’t Need a Crash. It Needs Bold Ideas, By GRETCHEN MORGENSON, September 11, 2010.

Interesting post, and focuses on headlines I’ve been thinking about. Should the market be allowed to crash? The reasoning goes: When house prices hit rock bottom, buyers will come out of the woodwork and snatch those great deals up.

But, notes Morgenson, where are all those buyers? According to CoreLogic, 46 percent of Florida homeowners are under water (and therefore stuck).

And sellers who have had to go through the short sale process can’t buy – They’ve been barred from receiving a mortgage for a certain period.

Then there’s the argument that helping those homeowners underwater, but who are still making their mortgage payments, would penalize responsible homeowners who didn’t take on a mortgages that they couldn’t afford.

STILL, there are real, broad economic gains to be had by helping people who are paying their mortgages to remain in their homes. Figuring out how to reduce their payments can reward responsible borrowers while slowing the vicious spiral of foreclosures, falling home prices and more foreclosures. And it just might help restore people’s confidence in the economy and get them buying again.

She asks readers to recall an idea suggested two years ago by Wall Street veterans, Thomas H. Patrick, a co-founder of New Vernon Capital, and Macauley Taylor, principal at Verum Capital. Their plan calls for refinancing all the nonprime, performing loans held in privately issued mortgage pools (except for Fannie’s and Freddie’s) at a lower rate.

The mass refinancing could have helped borrowers, while retiring mortgage securities at par and thus helping pension funds, banks and other investors in those pools recover paper losses created when prices plummeted. Fannie Mae and Freddie Mac could have financed the deal with debt.

At that time, $1.5 trillion in mortgages sat in these pools. Now, $1.065 trillion of nonprime loans is in private mortgage pools, and, according to CoreLogic of the 1.6 million loans in these pools, two-thirds are 60 days delinquent or more.

That means, she says, one-third are still making payments, and a good many of those homeowners are underwater and would benefit from an interest-rate cut.

So, the reasoning goes, let Fannie and Freddie buy these loans out of the pools at par and reduce their interest rates. That way,institutions holding these loans would be fully repaid, a lot of borrowers would be helped and additional foreclosures that are so damaging to neighborhoods might be averted.

“Every program that the government has announced was focused on bad credits, but they were trying to fix a hole that is too big,” Mr. Patrick said. “The idea is to try to preserve the decent risks and not let them go bad.”

Barry Ritholtz counters, Better Idea: Principal Reduction/Balloon Payment:

Let’s use round numbers to keep this simple: Someone paid $500k for house with a $400k mortgage. But the house is now worth $300k. This is a house that very well might be a walkaway, or go into foreclosure.

Solution: The bank refinances the home for its appraised value — $300k. It takes the $100k balance of the mortgage, and puts it into a zero interest, 10-year balloon loan. After year 10, if the mortgagee has stayed current on all of his payments, the $100k balloon payment gets reduced by 50%. The bank takes a hit on half of the “overlending.” The homeowner takes a hit on their downpayment. The $50k then gets added into the duration of the mortgage (20 years) at the same rates as the original $300k.

Prices come down the 10% they are overvalued, but not in a wrenching fashion. In theory, the homeowner will be earning more money by then, RE values will have stabilized (or even gone up). The bank doesn’t take a full hit — its a smaller write-down a decade later. And homeowners get to stay in a house at a price they can afford.

There is only a little congressional action required: The interest-free loan should be tax exempt (it would otherwise be taxable). The banks should be permitted to put these loans into a special “held to maturity” vehicle, so they don’t have to take the accounting write down today. The entire process is voluntary, but it is obviously in the banks’ interest to delay the writedown, and in a fashion that reduces foreclosures.

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