The Mortgage Deal – Brilliant
There are many reports on the mortgage deal. Here is a brief version: 'l'.
Dick Bove, a respectable bank analyst, was visibly angry about the moral issues when he appeared on CNBC shortly after the agreement was announced. Rick Santelli, the lone person on CNBC with a sense of reason, was also incensed.
What is the mortgage deal?
It is $26-40 billion that the banks will have to set aside for miscellaneous give-aways to borrowers who decided not to make their mortgage payments.
What is the rationale?
Banks supposedly defrauded borrowers because during the foreclosure process, they signed affidavits without proper documentation. In simpler terms, they did not cross the 't's and failed to dot the 'i's.
Why is this a big deal?
Because of the robo signing scandal, borrowers that may be years behind with their payments can at present not be foreclosed upon. This results not only in a non-performing asset for the banks, it is an asset that continues to deteriorate without them being able to put a stop to the process. Since the banks are indeed guilty of sloppy foreclosure procedures, they need to somehow put this issue behind them so they can foreclose and stop the bleeding.
What is the most important element of this settlement?
We will find out the details later, but I have to assume that it must include some safe harbor rule under which the banks can resume foreclosure proceedings. With this settlement, the banks found the safe harbor at no cost.
Why is this mortgage deal brilliant?
Attorney generals vs. big bad banks, that is not even a fair fight. The big bad banks have now put to rest a big mistake that has haunted them for years. Here is how it works:
Borrower A purchased a house for $500,000. Big Bad Bank (BBB) financed the purchase with no down payment from Borrower A. The house is now worth $350,000. Borrower A has not made a mortgage payment for two years. The BBB is sitting on a loss of $150,000 plus lost of interest plus foreclosure cost plus disposition expenses yet to come.
Prior to the settlement, this scenario was simply going to continue, with Borrower A not only staying at the house for free, but the bank's equity continuing to be eroded by having to pick up insurance and property taxes, plus 'owning' the physical deterioration of the underlying asset. At this point, the BBB should already have written down the loan, at least to the $350,000 level using a current appraisal.
With the settlement, the attorney generals made headlines that incensed Bove and Santelli and most taxpayers. The banks are the ones cheering and Borrower A should start looking for housing alternatives.
Step 1 – in this example, I am going to be generous. The BBB is going to reduce the principal of Borrower A's mortgage by $50,000, from $500,000 to $450,000. There is no cash given to Borrower A, but he now owes less. Furthermore, the monthly payment is now also reduced. I am going to be super generous and also throw in a new interest rate from whatever it was at thze time the loan was made to the current prevailing conforming loan rate of around 4%. Bottom line, the loan balance has been reduced by $50,000 and the monthly payment reduced by many hundreds of dollars for poor Borrower A.
Step 2 – while most would consider that a fantastic bargain for Borrower A, he is still faced with an over-encumbered property. Should he accept the deal and start making payments? Most would realize by now that Borrower A is still better off by not paying, by dragging the foreclosure process out for as long as is possible, while saving up to re-enter the market in three years (the penalty period for having a foreclosure on one's credit report).
Step 3 – the BBB is now placed in a no lose situation. Firstly, the $50,000 principal reduction has already been written down long ago. It is now just a paper entry with no effect to the bottom line. It is free money. Secondly, if Borrower A starts to make payments on the $450,000 loan, say at 4%, the BBB is in essense receiving interest on $450,000 with an asset that had previously been written down to $350,000 or less. Under this scenario, the BBB actually can book a gain. Finally, if Borrower A decides to continue defaulting, the BBB can now foreclose and put an end to the robo signing nightmare. A win-win scenario for the bank.
How is this going to impact the real estate market?
Foreclosures are finally going to become REOs. It will take years for the market to absorb this inventory.
How is this going to impact the economy?
There are over five million households with no housing cost, simply by dint of not paying their mortgage. This is going to come to an end. These subsidized households are either going to accept the settlement and start making payments, or will soon be foreclosed upon and evicted. They would have to start paying rent somewhere. One wonders what that is going to do to consumer spending.
Moral of the story: the big bad banks always win.
After writing this post, I was reminded by a friend that the mortgage debt relief act is due to expire this year.
I must therefore assume that any principal reduction is going to taxable unless they change the law. It is a mess.
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