In an opinion column in the Wall Street Journal (Why be a Nation of Mortgage Slaves) Ramsey Su poses some provocative questions on foreclosures.
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.
But can a free market solution help homeowners? Su thinks so...
If the intent is to help homeowners, then foreclosure is undoubtedly the best solution.
In fact Su sees the efforts to keep people in their underwater homes as an attempt to make them slaves of a sort.
The intent of modification programs to date is to create a generation of mortgage slaves.
Let's first look at Su'a argument, then we'll get into some discussion on its validity.
In short Su's conclusion is that foreclosures are actually better for the homeowner and for the debt market.
Why?
Homeowners who are foreclosed upon no longer need to make "oversized" payments on their underwater properties. Foreclosure lets them start to repair their family balance sheet by wiping out the debt and mortgage payments and replacing them with more manageable rental payments. Yes, their credit takes a hit, but it can be rebuilt over time.
The debt market also benefits because as many of the mortgages were securitized, trying to find a "workout" acceptable to all holders of the securitized debt is nigh on impossible. A foreclosure wipes the slate clean, eliminating with one stroke the multiple layers of securitization.
While a key component of Congressional action has been to try and mitigate foreclosures Su notes that
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.
This of course agrees with some other private sector studies that show that mortgage loan modifications to date have merely put of the day of reckoning for a few more months, and not avoided it altogether.
But what about the human side?
Su rightly notes that most media coverage is on the people being foreclosed upon, while they are being foreclosed upon, undoubtedly a traumatic time. He suggests that we should also look at how people feel about foreclosure a year or so later:
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?
Discussion:
It is obviously a bit counter intuitive to think as foreclosures as "good", as obviously for anyone being foreclosed upon it is a traumatic and heartbreaking time.
However, staying in a house that is worth far less than you paid for it and having to make crippling mortgage payments to mortgage lenders in far away places for years on end is also not a pleasant alternative.
Foreclosures also force the "loss" back onto the books of the mortgage lenders. They can no longer pretend to have a property that has full value. They have to take the hit... and they should be the ones to take the hit!
Of course there are some other alternatives to foreclosure and to the failing attempts at mitigation so far. The new "cram down" legislation is definitely one step in the right direction. Allowing bankruptcy judges to force mortgage holders to take less on their holdings cuts through the red tape bureaucracy of securitization and is a welcome step, and one that used "wisely" may prove to be the most effective for all concerned.
Finally, many people who bought houses with no money down, or with low teaser rates, were effectively buying not a house, but a call option on the house. If the house price went up, they won. If it went down they did not lose that much (no equity). The sooner the holders of these mortgages (banks, hedgefunds, etc.) are forced to take their losses the sooner this financial mess can be put behind us.
So, is Su right? He is right that attempts so far to modify loans have been a failure and very often the same families are back a few months later needing more help (after having made a few more oversized payments). The modifications are often pushing the extreme of what a family can afford (that is, not helping that much), so to that end he is right that they are effectively being made mortgage slaves.
Also, unfortunately, the availability of "loan modifications" can convince some people to stop paying their mortgage so that they too can get a "modification". This exacerbates the over financial mess by creating new "non-performing" loans.
Obviously there need to be other, more effective ways, of resolving who ends up with the housing losses without the not inconsequential collateral damage to families and neighborhoods. The "cram down" is one idea, but unfortunately there have not been too many others. Foreclosure probably does need to remain a viable way to handle the problem in that it at least forces the lender to shoulder the majority of the loss.