This was the dilemma in 2008-2009; should the government slash mortgage rates and mortgage amounts if 50% of home owners are in trouble or underwater? Or is this actually rewarding the less careful at the expense of the 50% who were careful and cautious with their money? What if you own your home outright and have no morgage? Why should the guy next door who bought something he could never afford get a break if you don’t get anything?
What does a personal loan between two individuals have to do with loans made by the banking sector? This is a micro analysis parading around as a macro one (and in doing so, creates a sunk cost fallacy). It’s not a relevant example in the least.
Sure it’s unfair. Why should AIG executives get to keep their bonuses, when if my company goes bankrupt, I’ll only see pennies on the dollar from my contract? Why should investment houses get an infusion of cash when my personal investments didn’t? Why should some people have gotten a tax break if they purchased houses during a very specific period–I didn’t get that tax break!
There’s already been a tremendous amount of unfairness in pushing through the financial crisis. But the fact is, our housing market is in a slump, we have a debt overhang that needs to be worked through, and banks are sitting on a bunch of shaky assets. Who does it benefit if the bank forecloses on a house and then lets it sit empty and deteriorate? The bank loses, the neighbors lose (foreclosed properties depress neighboring values), the homeowner loses, the government loses (in potential tax revenue). Or, you could try to figure out a way to keep the homeowner in their house while at the same time getting property values back to a more realistic valuation. And I don’t see how you do that without homeowner’s getting some benefit, even the ones who people think may have been foolsih.
The value of the loan is based on the property value, the expected future payments and the risk of default. If the property value has dropped, then the value of the loan has to drop as well, unless the risk of default decreases or the expected future payments increase. Do you really think enough people have a lower risk of default or an increase in future payments to balance out loan portfolios? Remember, it has to be enough of a difference to balance out all the decreased valuations. I find this very hard to think is true.
To quote a great legal scholar, “Ur doin it rong.”
:smack:
No, it’s a devaluing consumer product, which in rare cases may, if you happen to be very lucky, wind up appreciating. Housing stock does not naturally appreciate in value. We may actually get stable or declining land values for a generation.
Yes, it is.
Here. I’ll give better advice than everything in your entire post: “Never buy any investment you can’t afford to lose.” Ta-da!
The S&P does not, and to my knowledge, never has, told anyone to get buy a house they can’t afford on the principle of, “It’s a good investment.”
I do not know as much as I would like about finance, and sio I restrict myself to being conservative about my advice. You, on the other hand, seem to know just everything and feel free to claim anything. I suspect you are trotting over a precipice here. For example:
Alright, BrightNShiny… I will give you a huge hint here. Can you guess what is the one huge and blatantly obvious thing you have wrong in this paragraph? The thing which is so wrong that it causes the entire thing to be wrong as a result? Can you?
Because if you can’t, then you don’t understand what a loan is.
Well, I could have made some clarifications about underwater vs. non-underwater property valuations or tax implications or things such as that, but I simplified based on the example provided. Why don’t you tell me, because I suspect you don’t understand what a loan is.
I’ll just deal with these other things:
You can keep smacking yourself all you want, and you can keep restating the same thing over and over, that doesn’t make it true. If you want to analyze it as a consumer product, that’s useful in some circumstances. But it’s completely valid to treat it as a capital investment. I can go into detail as to why this is, but I suspect you’ll just ignore it.
The experts said it wasn’t an investment that would cause a loss. Ta-da!
The S&P told people they could afford it, because land values were not inflated and they would appreciate. That is essentially the model they were using in order to rate these mortgages. If they weren’t using this type of model, then they couldn’t have made those ratings.
This is the only thing you’ve said that I agree with.
OK, but how about we imagine this. You gave someone a $300,000 mortgage to buy a house, and they’re paying it off, just like you said. Five years down the road the house, once valued at $350,000, is now valued at $225,000.
If the guy paying the mortgage can keep up with the payments, and doesn’t ever need to sell the house, then you don’t have a problem.
Except, those conditions don’t always hold. The guy you lent the money to might have lost his job, and now has a new job across the country that doesn’t pay as much. He has to sell the house and move. Except he can’t because he’s never going to come up with the $100,000 difference between the price he paid for the house, and the price he could sell it for now. And so, is he going to keep making payments? Why should he? He should default on the mortgage, and you foreclose on the property. Thank God it was a secured loan, eh? Except, you just took a $100,000 haircut on your loan. The asset you thought was securing the loan doesn’t exist anymore.
So which would you rather do? Foreclose, and then try to sell the house at the new market value, or renegotiate the mortgage? Because the guy who bought the house has options. He can declare bankruptcy, mail you the keys to the house, and live with his brother in law. And even if a bankruptcy court wouldn’t allow him to discharge the $100,000 difference, the fact it, you’re never going to see that money, at least not for years and years.
So what next? Why is it that the guy who borrowed the money is an idiot who should be punished for his financial illiteracy, buy you, the guy who lent the money, should protected from your financial illiteracy. He took out a bad loan, you made a bad loan, both of you are idiots, not just him. When you loan $300,000 to a guy, first find out if he’s nicknamed “Ratzo” and likes to play the horses, and if he does, don’t loan him the money. And if you do lend him the money, and Ratzo blows it all at the track, does that mean the taxpayers are responsible for getting you your $300,000 back?
Lemur866, that’s a very clear example, and it’s what I’ve been trying to get across in this thread. With a mortgage, it’s very difficult to collect more than the property value if the borrower defaults. And so, once the property value goes underwater, the market value of the loan will also drop. If the loan wasn’t underwater, the bank could just foreclose and make all their money back.
I’ll also add, that there are many instances where it makes financial sense for the borrower to simply default the loan. Right now, a lot of borrowers who should default aren’t, because they like where they live or the feel a stigma about a default (or maybe for other reasons). But the worry is that as the economy keeps stagnating, that more and more borrowers will default, either because it makes financial sense or because they are forced to. And if too many people do that, then our banking system is in another round of crisis again.
So… you want to revalue the prices of real estate downwards, reduce mortgages proportionately and reduce mortgage payments proportional to that. That would involve a fair amount of complicated interaction between the government and the banks.
How about raising all wages by 10%? That would make mortgage payments more affordable. Simultaneously you could raise prices by 10%. That would make real estate prices fall, relative to the higher product prices. They might do that anyway eventually, but housing markets often take time to clear.
Suitably tweaked, the OP has a perfectly sound policy prescription. Unanticipated inflation benefits debtors. We have a huge debt overhang, but 7% inflation per year for 3 years would cut it down nicely. Don’t laugh: it’s worked before. The US did something like this after WWII – eyeballing the chart it seems that the US had double digit inflation.
Worried that the bond market won’t like it? The Fed can buy long term securities. Real rates would fall, just as they did during the 1970s. But there would be a hangover to consider: bringing inflation down from 7% to say 4% would involve some austerity, though not as bad as the US is experiencing now. This is the worst downturn since WWII after all.
Well that’s curious. smiling bandit was sure I had no idea what a loan is, but he’s been posting on this board for 2 days now, and he hasn’t deigned to return to this thread. Why not return and show me how I’m wrong? This is GQ. I’m sure there are many people reading who would like to know.
Ok, I’ve been busy with work, so I haven’t had time to be on these boards, but seriously? Where’s my answer?
For some reason this whole thread reminds me of this exchange from ‘Seinfeld’:
Jerry: So, we’re going to make the post office pay for my new stereo, now?
Kramer: It’s a write-off for them.
Jerry: How is it a write-off?
Kramer: They just write it off.
Jerry: Write it off what?
Kramer: Jerry, all these big companies, they write off everything.
Jerry: You don’t even know what a write-off is.
Kramer: Do you?
Jerry: No, I don’t.
Kramer: But they do - and they are the ones writing it off.
Sorry, other than that, I got nothin’.
It’s called the intervention of equity, to protect the borrower’s “equity of redemption”. Courts can intervene to change any of the terms and conditions of any mortgage if it deems them unfair: it doesn’t allow lenders to prevent borrower’s from redeeming the mortgage (Toomes v Conset), to tack on options to purchase to a mortgage (Samuel v Jarrah Timber), to tack on a collateral advantage like requiring a company only to stock the lender’s goods (Esso v Harpers Garage) or attaching an interest rate that the court deems unreasonable (19% was deemed unreasonable in Cityland v Dabrah), among any number of other reasons for the court to intervene. The court can either leave the contract in place but change the term to a more reasonable one, or rescind the contract altogether.
Now obviously the court would never unilaterally take a step as a radical as wiping out the debts of every mortgage in the UK overnight, and it probably doesn’t have the power to at the moment anyway. It would require Parliament to legislate to that extent. But the concept of a court stepping in and changing the terms of private contracts, including mortgages, is a very well-established one and it already occurs constantly.
Historically, housing prices keep up with inflation. The idea of buying a house and having it increase in *real *value is a relatively new, and erroneous, concept.
Cite: Real vs Nominal Housing Prices: United States 1890-2010 — Visualizing Economics
So? Why are you quoting me? Nothing you’ve posted here contradicts anything I’ve said. Furthermore, it wasn’t me claiming that real values would increase significantly. It was Alan Greenspan, the ratings agencies and the banks that were claiming it.
EDIT: I’ll also add that in highly zoned areas or areas where growth is restricted by geography, you do tend to see a slow increase in real values. But that’s very localized.
Perhaps you can clarify this for me. My post was meant to address the OP’s suggestion that the government revalue all mortgages. This would be a situation that no one, not the individual in my example nor the banking sector would take into consideration when the loan was made. Loans made after this would likely be much harder to get and more expensive. I agree that my scenario was a simple one (perhaps verging on simplistic), but I thought it made a valid point.
I generally agree with the posters who are saying that the idea presented in the OP is hogwash. However, these banks are able to present a false picture of their financial stability by holding “assets” that aren’t there.
Case in point. A friend of mine owns a house in Florida. He purchased it in 2006 for $340,000. He currently owes $280k on his mortgage. The last assessed value of the home is $106,000. Does the bank have a $280k asset? Yes, if my friend was paying but he hasn’t paid for over two years. Many people are not paying, but the banks are simply not foreclosing. Better to keep that $280k asset than to foreclose, and then auction the property for about $85k. Just on that ONE PIECE OF PROPERTY, the bank would show a $200k loss if it foreclosed.
Debtors laws are so forgiving in Florida that it makes eminent financial sense for him to bankrupt this debt and start over.
But that’s another topic, but my point was that we are in sort of a stalemate here. Yes, the homeowner is on the hook for that debt, but it is to the point where they are simply not going to pay, even if that means losing their home. They could move into a similar home down the road for a third of their current payments. So, who is really on the hook? The banks. It’s like that old saying if I owe you $50 and I don’t pay, that’s my problem. If I owe you a million and I don’t pay, that’s your problem.
But the banks pretend that all is well with their outstanding loans. It doesn’t matter whether we blame the banks for making the loans or the homeowners for taking them. I would say that they are both at fault with the banks bearing more of the responsibility because they are in a better position of knowledge and should have known better.
But no matter, until the government takes some steps to break this stalemate, the housing market and the economy as a whole won’t recover.
I don’t think that a forced cramming down is the answer, but I would support a comprehensive program of mutual negotiations with homeowners and banks. Obviously the homeowner would pay more than someone at a foreclosure auction. I think that the accounting rules should be changed so that the banks have to report the value of their loans at the current value of the security that backs it. Then they can’t hide.
Next, a voluntary system could happen where the homeowner gets a reduction of their mortgage to current value +10% with the stipulation that the bank gets a split of the profits when the home gets sold. There is no reason that the banks wouldn’t voluntarily do this because it’s a damn sight better than foreclosing and getting a home that’s destroyed. It’s not perfect, but it’s a start.
I don’t think a bank can simply neglect to classify a delinquent loan as nonperforming. If done wholesale, that would imply the bank is defrauding the central bank and regulatory agencies and its shareholders, is in violation of Sarbanes-Oxley for publishing financial statements the company officers personally assert are correct but are known to be lies. “Everyone else is doing it, and everyone knew it” won’t fly as a defence when the authorities begin to investigate, and the bank officers can be individually prosecuted too.
It may be OK to set a timeline - we give them 6 months before we declare them non-performing; but by now, I would assume almost all nonperforming debts are evident. Don’t confuse “decline to evict” or declining to sell properties that have very little value with what they may be doing about those accounting-wise.
The problem, though, is that the simplicity makes the analysis not valid on a macro scale. Yes, if I personally loaned someone money and got burned, then I’m going to be very hesitant to loan money in the future. But I’m not a bank. I’m not in the business of making loans.
And the reason that banks are in the business of making loans is that, as a whole, there’s money to be made making loans. But when a bank is deciding whether to make a loan to Joe, it doesn’t matter that Phil defaulted on his loan. Phil’s default is a sunk cost. All that matters is what profit it can make from Joe’s loan. The bank, of course, will look at the economy as a whole in order to determine whether Joe’s loan will be profitable, but Phil’s default is a very small part of that equation. The banks may adjust their lending criteria as a whole, and it may make it difficult for less credit worthy people to get loans now then they would have in the past (which given your post in this thread, I would assume you would think is a good thing), but if there’s money to be made on a new loan, the bank is going to lend. So, there’s very little possibility that the banks are going to stop lending completely just because we force a realistic valuation of their loan portfolio.
And I haven’t even gotten into the role of other things such as loan insurance, Freddie/Fannie, and the mortgage tax deduction, which further reduce risk to the banks and incentivize them to lend.