There is some interesting talk about how far the administration is willing to go to bring back the housing market. The original stimulus package included the purchasing of mortgage- 
backed-securities (to lower interest rates), home buyer tax credits (to spur demand) and a comprehensive foreclosure prevention program (to help keep families in their homes). Though these programs initially stopped the freefall in prices, it seems their impact is already waning.
Interest rates are still at historic lows but demand contracted as soon as the tax credit expired. The administration has helped over 300,000 families avoid foreclosure but that number is less than 10% of the families in jeopardy. The ‘shadow inventory’ of distressed properties is beginning to be introduced to the market. It seems the market might be headed for another dip down in prices.
What comes next? It seems the administration is headed toward a very dramatic conclusion: if we don’t lower the principle on people’s mortgages, the market will continue to falter. Let’s look at this issue:
The Challenge
As prices continue to fall, more and more families are falling into negative equity (where their mortgage is greater than the value of the house). There were 14 million people with negative equity at the beginning of 2010. Deutsche Bank just projected that number could jump to over 20 million by 2012.
The reason this is troubling is that when people fall into negative equity the chances of them not paying their mortgage increases dramatically. Housing Wire quotes the Deutsche report:
“Many existing academic studies model homeowners’ default decision based on the theoretical hypothesis that a borrower would exercise a default when it is in-the-money, i.e., when the borrower’s house has negative equity. Therefore, a homeowner with negative equity would default even though they can still afford to make their mortgage payments.”
If the people in negative equity started to ‘walk away’ in large numbers, the housing market might collapse.
The Talk
As reported by Calculated Risk, the Federal Reserve Bank of Cleveland provides new research that supports residential mortgage cram downs:
“[One proposal is] to revise Chapter 13 of the bankruptcy code to allow judges to modify mortgages on primary residences. The type of loan modification under consideration is known as a loan cramdown or loan stripdown because the judge would reduce the balance of the secured claim to the current market value of the house, turning the remaining balance of the mortgage into an unsecured claim (which would receive the same proportionate payout as other unsecured debts included in the bankruptcy petition).”
The Fed is actually saying that forgiving mortgage debt in certain situations makes sense. The theory is, if we forgive debt, we would avoid a negative equity situation.
The Rumor (remember, we said RUMOR)
Reuters, in a blog post yesterday, said:
“Main Street may be about to get its own gigantic bailout. Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth … The key date to watch is August 17 when the Treasury Department holds a much-hyped meeting on the future of Fannie and Freddie.”
Wow! It will be interesting to see if the administration actually pays-off some of the balance of people’s mortgages. We’ll keep you abreast of all developments.
We want to thank our friends at KCM Blog for this post.
