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<a href="http://mortgage.freedomblogging.com/2009/06/09/foreclosure-is-the-cure/11685/">Foreclosure is the ?cure?</a>
<strong>Should tax dollars be spent helping people avoid losing their home to a bank?</strong>
A study I blogged on last week found borrowers who lost their home to foreclosure in November 2006, 2007 and 2008 often had cashed-out all their equity. The data for the study wasn?t perfect ? public records don?t show how much a borrower actually pulled from a home equity line of credit.
But even so, some borrowers have taken hundreds of thousands of dollars out of their homes. Such cases can test one?s sympathy.
I recently interviewed two people on the topic. On the less sympathetic side is Larry Roberts, who has chronicled what he dubs HELOC abuse on the Irvine Housing Blog, is co-author of the book ?The Great Housing Bubble,? and is director of planning for Mayers & Associates Civil Engineering Inc.
More empathy comes from Kevin Stein, associate director of San Francisco-based consumer group the California Reinvestment Coalition.
Roberts had a slight advantage ? he answered questions via email, thus having more time to think and craft his answers. I caught Stein on the phone without warning.
<em>Q. A new study suggests many people facing foreclosure ?cashed out? all their equity, often totaling hundreds of thousands of dollars. Considering that such owner behavior may be a big factor causing foreclosures, should the government be trying to help people avoid foreclosure?</em>
<strong>Larry Roberts:</strong> ?There are two issues that need to be explored to answer this question: (1) should government be trying to help anyone avoid foreclosure? (2) Should government encourage or discourage ?cash-out? equity borrowing?
?A premise buried in your question is that the government should be doing something to prevent foreclosures. In my opinion, nothing should be done to prevent foreclosures. We do not have a foreclosure crisis in America; we have a debt crisis. Foreclosure is the cure. Simply stated, people have more debt than they can handle. Debt levels must be reduced.?
?Some people will be able to sell their properties and pass the debt to someone else, but since both house prices and debt levels far exceed people?s ability to pay from wage income, aggregate debt levels must fall. There are only two methods for reducing debt; foreclosure and bankruptcy. Everyone who has too much debt and cannot sell their house for enough to pay it off will go down one of those two roads ? some will go down both. We should have never let lenders put people into this position, but now that we are there, the only viable solution is foreclosure. Principal reduction is not an answer.?
?Many people cling to the fantasy that lenders will simply forgive the debt or that the government will bail them out with direct assistance. Neither event will occur. Forgiveness of debt is antithetic to the cornerstone of lending. Lenders are so afraid of the moral hazard brought about by debt forgiveness that they would rather lose more through foreclosure than start modifying loans with lower principal amounts.?
?Another manifestation of this moral hazard would become apparent as the behavior of buyers would change if principal reductions were to happen. Consider this scenario: In 2004, two would-be buyers are considering a $400,000 property. One buyer makes $100,000 a year and can afford the property with a conventional 30-year mortgage, and the other buyer makes $70,000 a year and can finance the property with an Option ARM with a 1% teaser rate. The borrower making less money but employing more leverage actually outbids the more responsible buyer and obtains the property. Fast forward to 2009, and the conservative borrower has been renting for five years while the reckless borrower has been living in a house they ?own.? The Option ARM borrower now owes $440,000 on his mortgage, he cannot afford the payment, and now he is pleading with the government for assistance. The government takes the tax money from the renter and uses his tax dollars to pay down the debt (either directly or indirectly) of the irresponsible borrower. The responsible renter is actually paying a subsidy to the irresponsible ?owner? who crowded him out of the house to begin with. Is that fair??
?How will debt forgiveness change behavior? Well, next time around everyone will extend themselves to the absolute maximum because they know if everyone does it, they will all get rewarded with debt forgiveness. If you thought the last bubble was bad, the next one will be even worse if that behavior is encouraged.?
?One thing government could and should do is to discourage cash-out refinancing. One thing the state of California could do is to trigger a Proposition 13 revaluation whenever cash-out refinancing occurs. If borrowers have to give up their low tax basis in order to get the money, the cost of the borrowing goes up dramatically, and the desire to do so should drop significantly. The justification is simple; the borrower is acknowledging an increase in property values with the refinance. Why shouldn?t the state acknowledge it as well??
<strong>Kevin Stein:</strong> ?I don?t know if there is an easy answer. Of course there are people who made unwise decisions. Should they be bailed out? That is the question, but I would take it further and ask, should people who made bad decisions at financial institutions be bailed out??
?We talked about this issue with (an executive) at Washington Mutual two weeks before it went under. We told him, ?You have all these people with negative equity, and the thing they really need is principal reduction. You are not doing it.? He went into an argument about moral hazard. Two weeks later they went under and got spoon fed to J.P. Morgan Chase. Chase got bailout money.?
?There is a calculus by this Administration: Are people generally better off or worse off, if institutions fail? In many cases, it argues for trying to work with people. People cashed out and some used the money in unwise ways. We don?t know how people used the money, whether they paid off credit card debt, had medical expenses etc. Maybe they refinanced because they were preyed upon by the aggressive sales culture of that era. We could be looking at the same data set and one is more sympathetic than the other. People we are in touch with are having a tough time; they have some very compelling stories.?
?And I think even the President is saying it is unfortunate people can?t refinance. It?s not people?s fault if they have a tough time refinancing. You know everybody was told you can refinance in six months. A lot of people are not financially sophisticated and reasonably rely on the expertise of the person helping them.?
?Even if we put all that aside, is it better for Orange County if we let people go into foreclosure? Preventing foreclosures helps maintain community stability, keeps blight at bay, supports local tax revenue and the local economy. Also, we have a big concern for tenants being displaced by foreclosure through no fault of their own. We believe that everyone is generally better off if communities stay stable and that includes housing prices.?
<em>Q. County records, which are the basis for the study, don?t show how much of a HELOC is actually outstanding at the time of foreclosure. Does this and similar efforts to track HELOC usage exaggerate it by relying on the total face value of the HELOC?</em>
<strong>Roberts:</strong> ?There is not a good automated method for determining the amount of HELOC abuse for the reason you describe; there is no way to know the outstanding balance of the HELOC from public records. Whenever I write about HELOC abuse, I look for confirming indications that the HELOC has been used. Many properties show a pattern of increased debt that signals a pattern of refinance abuse. In these circumstances, it is very likely that the HELOC funds have been used.?
<strong>Stein:</strong> ?Data is often limited. But I think (HELOC usage) probably is overstated. If people are in trouble, they might give up. They might be advised not to borrow more in hope they can restart later. It?s hard to know how specifically people dealt with HELOCs.?
<em>Q. Whether or not you support government efforts to prevent foreclosures, do you think they are effective? Do they adequately address junior liens?</em>
<strong>Roberts:</strong> ?Government efforts have been completely ineffective at actually preventing foreclosures. The statistics bear this out. Only a small percentage of loans that go into default are modified, and 70% of loan modifications end with the borrower defaulting again. If the measure of success is putting homeowners who are distressed back into a state where they can permanently maintain homeownership, then the government efforts were a dismal failure.?
?Government efforts to prevent foreclosures have accomplished two things: (1) These efforts have given politicians a platform to look compassionate and look like they are doing something, and (2) these efforts have also provided additional time for banks to recapitalize before being forced to write down the value of the bad assets on their balance sheets. Of course, neither of these results was the stated intention of the foreclosure moratoria, but that is what they accomplished. As a side effect, we now have a massive inventory of homes the lenders are going to need to dispose of over the next several years.?
<strong>Stein: </strong>?It?s taking a long time for the President?s plan to get up and running. The portion of the plan dealing with second mortgages is newer and taking even longer. In the meantime people are falling through the cracks. Also, the Obama plan does not in any way emphasize principal reduction, which is what would keep people in their homes in Orange County and California.?
<strong>Should tax dollars be spent helping people avoid losing their home to a bank?</strong>
A study I blogged on last week found borrowers who lost their home to foreclosure in November 2006, 2007 and 2008 often had cashed-out all their equity. The data for the study wasn?t perfect ? public records don?t show how much a borrower actually pulled from a home equity line of credit.
But even so, some borrowers have taken hundreds of thousands of dollars out of their homes. Such cases can test one?s sympathy.
I recently interviewed two people on the topic. On the less sympathetic side is Larry Roberts, who has chronicled what he dubs HELOC abuse on the Irvine Housing Blog, is co-author of the book ?The Great Housing Bubble,? and is director of planning for Mayers & Associates Civil Engineering Inc.
More empathy comes from Kevin Stein, associate director of San Francisco-based consumer group the California Reinvestment Coalition.
Roberts had a slight advantage ? he answered questions via email, thus having more time to think and craft his answers. I caught Stein on the phone without warning.
<em>Q. A new study suggests many people facing foreclosure ?cashed out? all their equity, often totaling hundreds of thousands of dollars. Considering that such owner behavior may be a big factor causing foreclosures, should the government be trying to help people avoid foreclosure?</em>
<strong>Larry Roberts:</strong> ?There are two issues that need to be explored to answer this question: (1) should government be trying to help anyone avoid foreclosure? (2) Should government encourage or discourage ?cash-out? equity borrowing?
?A premise buried in your question is that the government should be doing something to prevent foreclosures. In my opinion, nothing should be done to prevent foreclosures. We do not have a foreclosure crisis in America; we have a debt crisis. Foreclosure is the cure. Simply stated, people have more debt than they can handle. Debt levels must be reduced.?
?Some people will be able to sell their properties and pass the debt to someone else, but since both house prices and debt levels far exceed people?s ability to pay from wage income, aggregate debt levels must fall. There are only two methods for reducing debt; foreclosure and bankruptcy. Everyone who has too much debt and cannot sell their house for enough to pay it off will go down one of those two roads ? some will go down both. We should have never let lenders put people into this position, but now that we are there, the only viable solution is foreclosure. Principal reduction is not an answer.?
?Many people cling to the fantasy that lenders will simply forgive the debt or that the government will bail them out with direct assistance. Neither event will occur. Forgiveness of debt is antithetic to the cornerstone of lending. Lenders are so afraid of the moral hazard brought about by debt forgiveness that they would rather lose more through foreclosure than start modifying loans with lower principal amounts.?
?Another manifestation of this moral hazard would become apparent as the behavior of buyers would change if principal reductions were to happen. Consider this scenario: In 2004, two would-be buyers are considering a $400,000 property. One buyer makes $100,000 a year and can afford the property with a conventional 30-year mortgage, and the other buyer makes $70,000 a year and can finance the property with an Option ARM with a 1% teaser rate. The borrower making less money but employing more leverage actually outbids the more responsible buyer and obtains the property. Fast forward to 2009, and the conservative borrower has been renting for five years while the reckless borrower has been living in a house they ?own.? The Option ARM borrower now owes $440,000 on his mortgage, he cannot afford the payment, and now he is pleading with the government for assistance. The government takes the tax money from the renter and uses his tax dollars to pay down the debt (either directly or indirectly) of the irresponsible borrower. The responsible renter is actually paying a subsidy to the irresponsible ?owner? who crowded him out of the house to begin with. Is that fair??
?How will debt forgiveness change behavior? Well, next time around everyone will extend themselves to the absolute maximum because they know if everyone does it, they will all get rewarded with debt forgiveness. If you thought the last bubble was bad, the next one will be even worse if that behavior is encouraged.?
?One thing government could and should do is to discourage cash-out refinancing. One thing the state of California could do is to trigger a Proposition 13 revaluation whenever cash-out refinancing occurs. If borrowers have to give up their low tax basis in order to get the money, the cost of the borrowing goes up dramatically, and the desire to do so should drop significantly. The justification is simple; the borrower is acknowledging an increase in property values with the refinance. Why shouldn?t the state acknowledge it as well??
<strong>Kevin Stein:</strong> ?I don?t know if there is an easy answer. Of course there are people who made unwise decisions. Should they be bailed out? That is the question, but I would take it further and ask, should people who made bad decisions at financial institutions be bailed out??
?We talked about this issue with (an executive) at Washington Mutual two weeks before it went under. We told him, ?You have all these people with negative equity, and the thing they really need is principal reduction. You are not doing it.? He went into an argument about moral hazard. Two weeks later they went under and got spoon fed to J.P. Morgan Chase. Chase got bailout money.?
?There is a calculus by this Administration: Are people generally better off or worse off, if institutions fail? In many cases, it argues for trying to work with people. People cashed out and some used the money in unwise ways. We don?t know how people used the money, whether they paid off credit card debt, had medical expenses etc. Maybe they refinanced because they were preyed upon by the aggressive sales culture of that era. We could be looking at the same data set and one is more sympathetic than the other. People we are in touch with are having a tough time; they have some very compelling stories.?
?And I think even the President is saying it is unfortunate people can?t refinance. It?s not people?s fault if they have a tough time refinancing. You know everybody was told you can refinance in six months. A lot of people are not financially sophisticated and reasonably rely on the expertise of the person helping them.?
?Even if we put all that aside, is it better for Orange County if we let people go into foreclosure? Preventing foreclosures helps maintain community stability, keeps blight at bay, supports local tax revenue and the local economy. Also, we have a big concern for tenants being displaced by foreclosure through no fault of their own. We believe that everyone is generally better off if communities stay stable and that includes housing prices.?
<em>Q. County records, which are the basis for the study, don?t show how much of a HELOC is actually outstanding at the time of foreclosure. Does this and similar efforts to track HELOC usage exaggerate it by relying on the total face value of the HELOC?</em>
<strong>Roberts:</strong> ?There is not a good automated method for determining the amount of HELOC abuse for the reason you describe; there is no way to know the outstanding balance of the HELOC from public records. Whenever I write about HELOC abuse, I look for confirming indications that the HELOC has been used. Many properties show a pattern of increased debt that signals a pattern of refinance abuse. In these circumstances, it is very likely that the HELOC funds have been used.?
<strong>Stein:</strong> ?Data is often limited. But I think (HELOC usage) probably is overstated. If people are in trouble, they might give up. They might be advised not to borrow more in hope they can restart later. It?s hard to know how specifically people dealt with HELOCs.?
<em>Q. Whether or not you support government efforts to prevent foreclosures, do you think they are effective? Do they adequately address junior liens?</em>
<strong>Roberts:</strong> ?Government efforts have been completely ineffective at actually preventing foreclosures. The statistics bear this out. Only a small percentage of loans that go into default are modified, and 70% of loan modifications end with the borrower defaulting again. If the measure of success is putting homeowners who are distressed back into a state where they can permanently maintain homeownership, then the government efforts were a dismal failure.?
?Government efforts to prevent foreclosures have accomplished two things: (1) These efforts have given politicians a platform to look compassionate and look like they are doing something, and (2) these efforts have also provided additional time for banks to recapitalize before being forced to write down the value of the bad assets on their balance sheets. Of course, neither of these results was the stated intention of the foreclosure moratoria, but that is what they accomplished. As a side effect, we now have a massive inventory of homes the lenders are going to need to dispose of over the next several years.?
<strong>Stein: </strong>?It?s taking a long time for the President?s plan to get up and running. The portion of the plan dealing with second mortgages is newer and taking even longer. In the meantime people are falling through the cracks. Also, the Obama plan does not in any way emphasize principal reduction, which is what would keep people in their homes in Orange County and California.?
