Tuesday, April 21, 2009

Foreclosures, Bankruptcy and Cramdowns.

Since about 1995, real estate prices have soared. That is mostly because the federal government held down interest rates to artificially low levels, which allowed real estate prices to zoom. This was part of Alan Greenspan's effort to create a new bubble (in home real estate) to cover up the major screw-up in the Tech Bubble that he had created by early 2000, and which had tarnished his claim to be a brilliant monetary manager.

Let's say a $300,000 loan at 6%, 30 years, and let's say the borrower would pay around $600 per $100,000, or $1800 total. But if we reduce the interest rate to 3%, then they pay $300 per $100,000, and could borrow twice as much, pay twice as much for the same home -- pay $600,000 instead of $300,000 -- yet their monthly mortgage payments would be the exact same amount: $1800/month. By holding down interest rates, this allowed the developers and the lenders to radically inflate the price of homes and convince people that they could "afford" to buy it because they could "afford" the monthly payment.

Loans for homes have for decades been subject to two general rules: (1) you cannot borrow more than 3 times your gross income; and (2) you cannot borrow more than 80% of the fair market value of the home you are buying.

At the end of the Clinton era, Bob Rubin (later to go on to collect $100 million leading Citicorp into insolvency) working with Bill Clinton (himself later the recipient of hundreds of thousands of dollars in contributions from the major financial institutions in this country who benefited from this policy change) decided that the best way to "regulate" the financial system in the U.S. was to just fire all the cops and let the inmates run wild. Which they then did.

So without restrictions or regulations, and with the artificially low interest rates promoted by Greenspan, we ended up with a housing bubble. Let's say interest had been held to 6%, a fairly normal level over many decades of our country's existence. And let's say the regulations had remained in place. Your average family makes $55,000. They could borrow 3 times gross, or $165,000. That is about 80% of $200,000, which means the average family could have purchased a home for the total price of $200,000, which would require them to have a down payment of $35,000.00. Their monthly payment at around 6% wound have been around $1,000/month on the mortgage. Which most people can afford.

By Greenspan holding down interest rates to ridiculously low levels, like 2% (now it's less than 1%), by Clinton and Rubin eliminating the restriction that people could only borrow 80% of the value of the home they were buying, by eliminating the restriction that people could only borrow three times their yearly gross income, all hell broke loose. All of a sudden the same family found that the nice little home that was for sale for $200,000 in 1992 had zoomed up to $400,000, or $500,000. But the banks loaned them that amount of money -- just on funny terms, such as an adjustable mortgage starting at 2%, then after 3 years going way up. Instead of paying $200,000 for a house they could afford, people had to pay $500,000 for the same home. And they could not, in the long run, afford a loan of $500,000, which is why there have been so many defaults and foreclosures.

Here's the good news: when Greenspan's most recent balloon burst, the value of real estate plummeted. Those same houses now have a "real" fair market value of $200,000 again, which a normal family could afford. (Or maybe less -- remains to be seen). But the banks and the government are engaged in a massive consumer fraud to try to "pretend" -- let's "pretend" that this was not a balloon, let's pretend these houses really are worth $500,000.

One thing the banks are doing to try to prop up the temporary value of the homes is foreclosing on homes, then hiding them away, not re-selling them, not putting them on the market. If they listed all the foreclosed properties for sale, prices would drop even further. Or some of the lenders have been holding off altogether on the foreclosures, waiting for another government hand-out to rescue their corrupt asses. See Mike Whitney, "Housing Bust Comes Roaring Back - Worse Than Ever."

Most people in foreclosure would be better off walking away, deeding the property back to the lender. This is not legal advice, no one should rely on this statement, and people should hire an attorney to assist them before deciding how to proceed. But this will often be their best bet. Walk away from the $500,000 property. Get the lender to release them from any further claims, such as a deficiency if available in their state. Go rent. Save your money. In a few years when things hopefully settle down, they can go back and buy the same or a similar home for $200,000. It does not make sense to "fight" for people to stay in a home, using every penny they earn to pay a $500,000 mortgage on a house that, in truth, is only worth $200,000.

One of the issues being debated in Congress is called a "cramdown" provision. The people who are supporting this provision in Congress want the law to say that a bankruptcy judge has the authority to change the terms of a mortgage if the homeowner files for bankruptcy because they can't pay their mortgage. So, let's say a $500,000 loan at 6 % for 30 years, the judge could decide to make that a $400,000 loan at 5% for 40 years. For example.

I don't think that's a good idea. I think it is just another way to try to prop up the real estate market temporarily and save the banks from further losses. If the house in question is only worth $300,000, or $200,000, then it's not really doing the homeowners a favor to "help" them by sticking them with a $400,000 loan to be paid for the next 40 years, on a house that's only worth $200,000.

In general, if a loan is secured by an interest in real estate (such as a note and deed of trust, or a mortgage) the bankruptcy court cannot give the homeowner any relief. The lender can get almost an automatic relief from the general stay of bankruptcy, and proceed to take back the home. Let them.

The reason the banks have stopped foreclosing is because they were hoping President Obama would give all our taxmoney to the lenders to help them prop up and salvage all their fraudulent loans. I say let them foreclose and take the losses.

If you want to help the people who are in foreclosure, then pass a law saying that they are not liable for the difference between the loan and the value of the home after foreclosure (other than in the case of waste), they will not be taxed on the forgiveness of debt, and force the public-trough-feeding banks to loan money to these people on conservative terms (80%, 3x gross) to buy new homes at $200,000, or the actual new value. If they perform without substantial default, in 5 years their flawed credit record should be ordered erased. Now that would be real help for the homeowners.

The real estate developers have overbuilt the mcmansion type of homes, and local communities' planning commissions routinely turn down applications to build apartments or rental units because they don't want the poor folks moving into their town. We really need a nationwide commitment to building rental units. Not everyone needs to own a home, and a lot of people cannot afford to. There would be no shame in renting if we had decent rental units available. And eliminate the tax write-off for mortgage interest. Why should home buyers get a break when they, presumably, have more money than renters do? It's just another disguised give-away to real estate developers and lenders who can charge more money because the homebuyers know they can "write off" a portion of their monthly payment. The mortgage interest write-off should be phased out. It's the renters who need the tax break.

We also have serious questions about whether the single family residence model is ecologically so destructive that we need a national commitment to a return to multi-unit housing. Which could start with decent rentals and rent control. Certainly single people, young people, single parents, and seniors could all live comfortably in decent rental housing if it was affordable and available. Many would prefer it to the expense of home maintenance.

Maybe this is the right time to begin making radical changes in our national housing arrangements. It does not make any sense to claim that every 4-person family has some need or "right" to own 2500 grossly overpriced square feet of stucco and tile, within which to store their 4 TVs and 3 computers, and a 3-car garage to house their gas guzzlers. There may be bigger issues involved than propping up a housing system developed around cars, freeways, isolation, and 50% of take-home going to pay for shelter. It doesn't make sense, and this is the time to change it.

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