Friday, February 13, 2009

There is No Substitute for Mortgage Debt

Dr. John Hussman, a mutual fund manager and former lecturer at the U of M School of Business, argues that mortgages should be restructured - i.e. the principal should be reduced in a systematic, rather than just voluntary, fashion. There are proposals on the table to allow bankruptcy judges to modify mortgages, for example.

Banks are generally against this. They say that a) this would cause some banks to fail and b) this disrupts lending, because now banks have no assurance that they would receive the profits they are entitled to.

On Tuesday, the Treasury will announce how it plans to use the remaining $350 billion in TARP funds. Last week's market advance was largely based on Wall Street's hope that current mark-to-market rules will be abandoned or modified. This is like someone taking huge losses in their investment portfolio, and believing that not looking at the brokerage statement will improve their financial situation. Look, if the underlying assets are likely to regain value over a reasonable amount of time, then it might be appropriate to modify the capital accounting rules so temporary fluctuations don't drive banks into failure. But if you've got securities that are marked down to 20 or 30 cents on the dollar, and the underlying borrowers are likely to default because you haven't changed their payment obligations, failing to mark the portfolio to market simply allows banks to go quietly insolvent without the knowledge of the public. Providing federal insurance for those securities would amount to an open-ended, unlegislated, future bailout. Let's hope that isn't part of the plan.

The heart of this problem continues to be the need to restructure the payment obligations of borrowers. For the better part of a year now, I have repeatedly (and increasingly urgently) advocated the restructuring of mortgage obligations by a variety of methods (collecting the pieces of securitized mortgages through all or nothing auctions, writing down principal in return for property appreciation rights, etc). Frankly, I had expected more progress on this from both Congress and the Treasury, considering the obvious urgency. But evidently, only perhaps $50 billion of TARP funds will be directed toward foreclosure abatement. On Tuesday, we'll find out to what extent they've got it right.

Christians value fidelity in contracts on both ends, buyer and seller. However, we cut people a break in bankruptcy.

Additionally, voluntary efforts by lenders to restructure individual mortgages have failed so far. In most situations, past interest, fees and penalties were tacked on, leaving people with higher payments than before. No surprise that this doesn't work. Since the industry isn't able or willing to work things out voluntarily, they should not complain too loudly if government has to step in.

Property appreciation rights mean that if a borrower returns to solvency, keeps up with their payments and later sells the home at a profit, they have to share some of the profit with the bank. That's fair. I believe all the mortgage modification proposals include property appreciation rights to protect the banks.

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