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The problem with loan modifications


Thus far, the Obama administration has aimed most of its housing policies at helping people keep the homes they currently own. But some think that's a bad idea, and we need to encourage people to get out of homes they can't actually afford. Peter Goodman explains the thinking:



Foreclosure often feels worse, but for families trapped in a home they can't afford, it's probably quite a bit better. But it's hard to say whether any of this much matters. As the graphic atop the post shows, the programs are extremely small given the size of the foreclosure problem. Economist Mark Zandi, for one, wants the government to attack the root of the problem. Loan modifications typically knock down the interest on loan payments. But the bigger issue is folks who now owe more than their home is worth. Turns out that's an even stronger predictor of foreclosure than unemployment.

Zandi wants to see the government modify mortgages, not interest payments. He'd like "the Treasury Department [to] push banks to write down some loan balances by reimbursing the companies for their losses." In other words, the government would pay banks to write down the cost of the loans themselves. The word "some" is doing a lot of lifting in that sentence, so I'd like to see a fuller proposal -- how many mortgages would benefit, and how much would banks write down? -- but it's nevertheless the case that the Obama administration has done a whole lot more for the banks that own the mortgages than the people who are paying them. That said, I doubt the politics are very good for paying off banks that made bad loans, even if the ultimate beneficiaries are the people trapped in the mortgages.

Graphic credit: New York Times

By Ezra Klein  |  January 4, 2010; 2:15 PM ET
Categories:  Housing Crisis  
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In a rational world, this would be a sort of compromise to the bankruptcy "cram down" proposal. In a cram down, the portion of the loan balance in excess of the property's fair market value is treated as an unsecured claim and typically, paid very little. In Zandi's plan, banks would get to recoup the excess portion (or at least some of it).

But for some reason, neither the consumer friendly cram down or the bank friendly Zandi plan are politically feasible. Instead we will get nothing from the government, and the economy will have to take a ride until the free market works itself out.

Literally, everyone loses.

Posted by: mikehoffman82 | January 4, 2010 2:34 PM | Report abuse

A couple of points:

Because of a post-crisis change in accounting rules, bank are allowed to carry mortgages on their books at full value until they foreclose on the loan. This means that the banks have no incentive to bargain with you until you default. In fact, it's in their interest not to bargain with you. If the accounting rule were changed back and banks had to "mark to market", there would be much more incentive for them to bargain with mortgage holders.

As for subsidizing bank losses, the result of previous subsidy programs suggest that providing subsidies encourages banks to continue to act recklessly. The fact that a Harvard study out today shows that 92% of bank management from before the bank crisis are still in place suggests that subsidizing bank losses may not be the right way to go.

Posted by: lmnop2 | January 4, 2010 2:45 PM | Report abuse

*****That said, I doubt the politics are very good for paying off banks that made bad loans, even if the ultimate beneficiaries are the people trapped in the mortgages.*****

Gee, you think?

The big problem as I see it is it rewards people who who imprudently borrowed more than they could afford. I mean, just about everybody in America with a mortgage has seen the value of their home drop. Why should only those who are with negative equity get relief? Why not a taxpayer-provided $50,000 mortgage principal reduction for a person who owes, say, $150,000 on a home that's worth $400,000?

I know the argument is: well, we're giving lots of money to banks and rewarding THEM for lack of prudence. True. But we didn't really have a choice (really, we didn't) but to save the banking system because EVERYBODY would have suffered otherwise.

A more balanced approach in my view would be some sort of federal law preventing evictions (ie., foreclosed upon home owners would be guaranteed a right to lease the property). That way, the market clearing necessity of write downs could proceed quickly (and critics are correct, the administration's missteps on this front HAVE delayed the necessary rebalancing and impeded a housing market recovery) while preventing a sharp rise in homelessness, or in vacant properties.

Posted by: Jasper99 | January 4, 2010 2:47 PM | Report abuse


I suppose it would. But life isn't fair, now is it? In a war, a nation responds to a crisis by accepting the fact that some people who didn't deserve to die are going to get killed, and they do this to avert a greater national catastrophe. I'm more interested in averting an economic catastrophe and getting the housing market back on the right track than I am at ensuring that those who over-borrowed receive the appropriate punishment.

The rational response for someone who is way underwater on their mortgage -- whether or not they can afford the payments -- is to walk away. If we want to get our economy back on track and avert cascading foreclosures and get prices back to where they should be, we should accept cramdowns.

Posted by: constans | January 4, 2010 2:56 PM | Report abuse

In a war, the people who die are nearly always innocents. Here, the housing bubble was caused in large part by marginal buyers bidding up prices to levels they could not afford.

Seems misguided to reward them. Better to strengthen the safety net for those whom the resulting recession made jobless, and to encourage real cramdowns: bankruptcy is no reward, the cramdown punishes the lenders as well (they were also at fault) and once the cramdown is complete, something like Dean Baker's rent-in-place would keep folks in their homes.

Posted by: wcwhiner | January 4, 2010 3:41 PM | Report abuse

The flurry of headlines beginning "Sheriff Refuses" seem to be escaping attention, leading me to wonder what happens if an increasing number of elected sheriffs simply refuse to implement foreclosures. While it's not a solution I advocate, it is the sort of marginal revolution (or bloodless coup) that seems to be brewing.

Posted by: rmgregory | January 4, 2010 4:24 PM | Report abuse


Precisely my point. Sometimes bad things happen to good people. Likewise, good things sometimes happen to "bad" people. We waste so much time and energy telling the poor or the maimed that "life isn't fair" as a means of excusing the fact that we can't do anything to help them or make choices that harm them. Well, in this case, even if someone made a bunch of dumb decisions a few years ago, we have to accept that they might escape "punishment" which might not be "fair," but under the circumstances might be a good idea.

Posted by: constans | January 4, 2010 4:48 PM | Report abuse


Posted by: luko | January 4, 2010 5:39 PM | Report abuse

My position from the very beginning of this crisis has been that government should be focused on easing the consequences of the fallout on families rather than trying to patch up a bad situation.

Loan modifications, cram downs, etc. are all based on a false premise: that the underlying housing and banking policies were basically sound and everything will be all right once things "spring back" to normal.

Instead of trying to prop up inflated housing prices and keeping borrowers enslaved, we should be aggressively pushing "deed to lease". Too many of these people were never homeowners, they were renters with an interest tax deduction. Instead of talking about freezing foreclosures and schemes to let them somehow maintain the fiction that they are homeowners, the best way to stabilize housing would be for them to surrender their deeds and get a 3-5 year lease as a sitting tenant.

It is wrong to talk about using tax money to bail either the banks or individuals for their bad decisions. 30% of homeowners do not have a mortgage. Why should people who were careful with their money and withstood the temptation to borrow against equity, be expected to pay for the "ownership" of those who made bad decisions?

Posted by: Athena_news | January 4, 2010 6:31 PM | Report abuse

we are all sooooo concerned about what is fair to us! Me! Me!

Well, this isn't about us. This is about several million Americans who cynically or stupidly ended up in a home that is draining their savings and their hopes for the future.

We need them back in a stable place, working hard, saving and getting their kids ready for college. Because their kids are going to pay our Social Security and Medicare bills, and defend our country.

So let's do some cramdowns on the savable cases, and have a federal program that pays the banks 60% of their cramdown losses. For the hopeless cases, let's get them a rent-in-place deal for a few years.

We all are in this together, for the long run. Anybody who thinks they are too good to share in the burdens and the benefits of our country can complain, and wait, and vote for somebody like themselves, or they can leave.

But the rest of us, like responsible adults, will work hard, clean up our messes plus a few the children left behind, and get on with our lives.

Posted by: Dollared | January 4, 2010 8:04 PM | Report abuse

Anyone who put no money down is not a homeowner. I do like the lease back idea until the bank can unload the home.

That accounting rule change lmnop2 referred to is seriously insane. You still can't trust bank balance sheets. I don't understand why more people aren't shorting BAC ...yet. Don't pay the banks- they financed risky bets and I don't want to pay them for that.

Minimum down payment in China is 40%. Average LTV ratios in Korea are 50-60%. We basically let anyone with a steady job and okay credit place a 3.5% FHA backed (taxpayer guaranteed) loan on a property. This is fundamentally unsound. If they were getting a 30-1 leveraged bet to play in the stock market, you'd call them Lehman Brothers. You want to make big bets on the margin, you pay the price. This is not risky loving bankers making these huge margin bets, this is the FHA backed by your future tax dollars making huge bets. Look at the 20 yr curve on residential real estate prices in Japan. It's not a place to bet on big appreciation given our current status.

Posted by: staticvars | January 4, 2010 11:17 PM | Report abuse

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