Why Mortgages Don’t Get Renegotiated

As I have watched the second bubble of my adult life decimate the value of my home, one question has eluded me: why would lenders that want to maximize profit not bargain with their mortgage customers? After all, businesses renegotiate debt as a matter of course, and arguably lenders stand to profit more from cutting a deal and keeping a customer than from foreclosure, which drives down asset values. As an example close to home, a foreclosed house in my neighborhood is about to be auctioned. It’s a nice place. The person who was living there took pretty good care of it, and there was no vandalism or stripping as happens so often now in foreclosures here. The real estate agent who has the listing on the house draws attention to the fact that the house sold in 2006 for $416,000. The agent’s logic speaks to the persistent madness of the bubble–what bearing does the 2006 sale price have on the current or future value of the home? Absolutely none. But I digress. The reason I wanted to cite the 2006 sales price is because today, the lender that owns the house is willing to accept $99,000 as the minimum auction bid on the house. Sure, it will probably sell for more than that–the listing is currently at $275,000, down from $299,000–but assuming the lender’s ex-customer owed $300,000 on the property, the bank is now willing to accept 33 cents on the dollar. It makes no sense. If they had instead met the borrower halfway, might both parties be better off? Of course.

So why does this continue to happen? I’ve been asking myself and friends this question, but got no decent answer. Greed and evil would seem to be great explanations, but greed would seem to make a lender play a good game, then blink rather than foreclose and become the owner of a sharply less valuable property. I can’t think of any other business in which lenders deliberately and consistently devalue their assets. Finally, the good folks at Slate provided an answer:

If foreclosure is so costly, why don’t lenders avoid this cost through renegotiation? Renegotiations aren’t happening because so many mortgages are securitized. In the old days, if you wanted to renegotiate your loan, you just called your bank. Now you have to deal with the loan servicer, who acts on behalf of the thousands of mortgage-security holders who have a right to a share of your payment. The loan servicer gains little and loses a lot if it attempts to renegotiate a loan. Securities holders don’t trust servicers and threaten to sue them if they renegotiate loans; servicers usually don’t lose much money if the mortgage defaults.

Finally, an answer. Yes, the securitization of the housing market, the market perversion that wiped out billions of dollars of taxpayer wealth and that has cost billions more in taxpayer bailouts, is the gift that keeps on giving. The fact that nobody really owns our homes makes it impossible for the people who receive our mortgage check to cut a deal with us. They are free to foreclose, but face legal action if they try to renegotiate mortgages. This is exactly the opposite of what we need. What can we do? Fortunately, the authors of the Slate article propose an elegant, market-friendly, and fair solution:

The solution to this problem is for the government to force renegotiations to occur. A simple plan could do this. The plan would give all homeowners who live in a ZIP code where house prices have dropped more than 20 percent the option to have their mortgage reduced to the current market value of the house. In exchange, these homeowners would yield to their lenders 50 percent of the future appreciation of the house. To avoid any gaming and future moral hazard, both the current and the future value of the house will be determined by multiplying the purchase price and the variation in the housing price index. So if you bought your house for $300,000, and the average house in your ZIP code has lost 20 percent of its value, then your new house is assumed to have a value of $240,000. If your mortgage was $280,000, now it is $240,000 (the new value of the house). You are no longer underwater.

It’s beautiful, but you should read the rest of the article to see just how much sense it makes. We are going to have to do something like this, because otherwise the lenders are simply going to continue to run home values into the ground. They are on autopilot, which is scarier than just thinking they were stupid or evil.

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