Sunday, March 2, 2008

A new plan from the Office of Thrift Supervision would have lenders reduce mortgage balances, but let them collect the difference later.

Mortgage crisis: Don't forgive debt, just postpone repayment

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A plan that would help troubled mortgage borrowers today - and might make lenders whole later on - was unveiled Wednesday in Washington. The Office of Thrift Supervision (OTS) is urging the federal savings and loans lenders under its authority to refinance loans by reducing mortgage balances to the current market values of the homes. Thanks to falling home prices, many homeowners are now stuck with mortgages that are actually worth more than the houses themselves.

Posted by lvmreader @ 12:06 AM (651 views)
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6 thoughts on “A new plan from the Office of Thrift Supervision would have lenders reduce mortgage balances, but let them collect the difference later.

  • Fascinating post lvmreader.

    At first glance, I can see three problems:

    1. Establishing the “fair market value” is awfully difficult. The only really meaningful fair value is the price paid when it is sold. Who exactly is going to make these valuations? Let’s face it, the valuers haven’t done a good job in the past so why should we trust them now?

    2. If I did have a negative equity mortgage and was awarded a “negative amortization certificate” or whatever they want to call it, I would try to sell immediately; just get out and cut my losses. Obviously, if lots of others do that, then the effect is to flood the market – perhaps not so good at the moment.

    3. Property prices are still falling in the US. Unless the person with the mortgage thinks their house price has bottomed out, there is little point in hanging on – even with a “warrant”. Hand in the keys and get it over with.

    The more I think about this, the stranger it sounds. Essentially, the idea is that banks allow their customers to borrow using long term value of their home as collateral. Try saying it this way: “Yes Mr Bank Manager, I can’t afford it today but if you issue a warrant against future profits in the distant future, then eventually you will get your money back.”

    And all of this will work within a Fiat currency system. What a mess!

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  • @Quiet Guy,

    I am no advocate of this necessarily, although I think there is mileage in discussing the merits openly. Mark-to-market is a dubious concept which can attribute zero value to something just because a buyer was not found in a certain time window. A pertinent question is just how wide to make that window.

    I would think that this basically would be achieved by allowing longterm investors bonds which pay the difference between the loan and the asset for the down-period but any appreciation later goes towards repaying the bondholder. A clause would have to prevent sale in the meantime.

    This would have the effect of damping the see-saw effect and there are several exotic option strategies which already allow this – range resettable forwards are one.

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  • “Mark-to-market is a dubious concept which can attribute zero value to something just because a buyer was not found in a certain time window.”

    I see your point. Normally, it would be nuts to declare a property worthless apart from a few exceptional cases e.g. perched on the edge of a rapidly crumbling cliff or a houseboat at the bottom of a lake.

    How about an 80% drop instead? Too extreme? Have a quick peek at this:

    http://www.doctorhousingbubble.com/real-homes-of-genius-lifetime-achievement-award-nearly-80-percent-loss-in-oakland-california/

    Hee hee hee!!

    Charles Hugh Smith’s blog has more to say about this:

    http://www.oftwominds.com/blogjan08/housing-predictions.html

    Smith has a background in construction and has discussed the problems with some recently build US housing. I find his case quite strong – a house really can become practically worthless in some situations. There may not be a “window” in the worst cases.

    What a pity LVM isn’t available for comment!

    Now back to the topic. Let’s forget about percieved “market value” and look at the agendas of the parties.
    – The bank wants to minimse its’ loss if foreclosure goes ahead.
    – The borrower wants to avoid losing their home.
    To make this work, let’s look at it as a negotiated negative amortization certificate value between the two parties. The bank won’t get all their money back but they should get something from the lower negotiated mortgage and maybe future asset appreciation. The borrower will not have to find somewhere else to live but must give up any future profits on the asset.

    In retrospect, this doesn’t look like a house price issue at all, rather it is a negotiated way to minimise the pain for both parties.

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  • stillthinking says:

    Amazing that the Americans have a system where they can just walk away from secured debt. A really really great idea.

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  • @quiet guy, is that not what I said?

    “I would think that this basically would be achieved by allowing longterm investors bonds which pay the difference between the loan and the asset for the down-period but any appreciation later goes towards repaying the bondholder. A clause would have to prevent sale in the meantime.

    This would have the effect of damping the see-saw effect and there are several exotic option strategies which already allow this – range resettable forwards are one.”

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  • @lvmreader

    Apologies. Perhaps I am missing the point. To me, there is a huge difference between offering bonds in this area in comparison with negotiations between the borower and lender.

    I’m the first to admit that finance is not my strong point but I thought that generally speaking, bonds are sold to investors.

    The situation I was thinking of was one in which a borrower and lender renegotiate to make the best of a bad job by focussing upon mutual interests. The motivation for doing so is that both parties have serious problems to dealt with *NOW*. There is no choice; the lender must repossess or compromise. To sell bonds in this situation looks to be hellishly difficult and complex in the current financial environment because a potential bond buyer surely has other options that are less risky.

    Upon reflection, the problem with my earlier post is that I was addressing an “old style” mortgage in which a bank holds a mortgage debt. The layers of abstraction caused by the modern approach of selling on debt to other institutions just makes the whole conecpt seem less feasible.

    Again, I find myself thinking that selling financial instruments (debt) is a deeply flawed concept.

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