Why Be a Nation of Mortgage Slaves?
By RAMSEY SU
Preventing foreclosures has become a top priority of politicians, economists and regulators. In fact, allowing foreclosures to happen has merit as a free-market solution to the crisis.
If the intent is to help homeowners, then foreclosure is undoubtedly the best solution. Household balance sheets have been destroyed by taking on too much debt via the purchase of inflated assets. With so little savings, a household with negative equity almost implies negative net worth. Walking away from the mortgage immediately repairs the balance sheet.
Credit may be damaged, but homeowners can rebuild it. And by renting something they can afford, instead of the McMansion they cannot, homeowners are most likely to have some money left over each month that they can save toward a down payment on a house they can eventually afford.
If the intent is to help the credit markets, then foreclosure is undoubtedly the best solution. The securitization model has proven to be flawed. Slicing loans horizontally into tranches created asset classes that have conflicting interests in a dissolution strategy of the same underlying asset. The holder of a senior tranche would be agreeable to modification, since his position is secured; the holder of a junior tranche would essentially be wiped out. The lower tranches are worthless but are still legally an encumbrance, hindering any type of sale or work-out effort.
Consider a property that sold for $500,000 at the peak, financed with a $400,000 first lien and an $80,000 second lien, which is now worth $300,000. The second lien is worthless, but the lien will remain as a cloud which complicates any modification effort by the senior lien holder. There is no incentive for the junior lien holder to voluntarily agree to a modification. Foreclosure would be the best and finite action. It wipes the slate clean.
What is the market telling us? Dataquick recently released December sales data for Southern California, once the hotbed of speculative excesses supported by nontraditional financing. Foreclosures now dominate sales. Prices are down. Sales volume is up. New home construction is down. These are beautiful textbook illustrations of supply and demand driving price and market equilibrium.
Toxic financing abruptly stopped during the spring of 2007. By that summer, there were no more 100% financing, negative amortization option ARMs, piggyback seconds, or the now-infamous NINJA (no income no job no assets) loans. Even though real-estate prices have continued to decline, post summer 2007 purchases are by a different class of buyers financed by loans with much tighter underwriting guidelines. We are at a crossroads. The time line of the default and foreclosure cycle is about to hit 2007 vintage loans. If the default rate on them is lower than for loans made from 2004 to early 2007, it would be the confirmation of a turning point.
Foreclosures provide the foundation of recovery, both for Main Street and Wall Street. As properties are foreclosed, they can move from weak hands to strong hands. Households that have been foreclosed upon today are the buyers of tomorrow, when given a chance to recover.
The replacement of credit flow is not all about money. It is about a new system of delivery that will provide clean guidelines, so there will be a reliable source for borrowers based on sound underwriting standards and a product that fixed-income investors have confidence in buying.
With the government in total control of the Federal Housing Administration, Fannie Mae and Freddie Mac, this is the perfect opportunity to reform the secondary market.
Finally, loan modification is not only ineffective, it is evil. Coercing borrowers to continue paying a mortgage on a home that is hopelessly overvalued and not informing them of alternatives is predatory lending.
The media should interview those who had been foreclosed upon. Do they feel sorry or relieved? Are they rebuilding their credit, not to mention their lives? Do they miss the pressure of having to make payments they cannot afford on a McMansion that belongs to the lender?
The intent of modification programs to date is to create a generation of mortgage slaves. Fortunately, mortgage slaves can free themselves via foreclosure, and the masses are choosing to do so.
Mr. Su is a real-estate consultant and a former REO broker. |
