Tuesday, December 01, 2009

Post Reprisal: A Modest Proposal

I originally published this post almost a year ago. Given the news about loan modifications--particularly the paucity of mods, I'm lazily reprising my Modest Proposal in original form that can be found here:

I have an idea, likely hairbrained, but that will not stop me from stating it.

Here are some simple facts to consider:

* Anyone who bought a home in the last 3-5 years paid too much.
* Some of those people who bought a home did so under false pretenses--I'd not extend these benefits to them.
* Many of the those people are hard working Americans, who did not lie, who did not fully understand the egregiousness of loan resets etc, or simply believed that continually increasing home values would mitigate any concerns that they had.
* Home prices are falling and LTV ratios are very unfavorable for lenders.
* Payment/interest resets are putting borrowers (the good ones and the bad ones) under stress.
* The recession will put more mortgage/home owners at risk.

My proposal is not to help with the last bullet or help scammers or speculative borrowers. Here's my proposal.

Objective: To find a manageable way to help both borrowers and lenders to rework loan terms; keep borrowers in their home to the extent practicable; not deal an egregious blow to lender balance sheets for principal modifications.

Example: Borrower (qualified, and no falsification) bought a home for $400K and the loan value was $400K (LTV=100%). At the time of purchase the home's fair value was not impaired. Interest rate is 6.%; term is 30 years; payment is $2,400.

The home can now has a fair value of $320K. That is an asset impairment of $80K affecting both the borrower and the bank. The bank and the borrower agree to modify the loan provisions. We bring in another party. The Fed. (Why not?). The bank records a temporary loan impairment of $80K. This impairment is guaranteed by the Fed (or through some other arrangement) so the bank creates a deferred loss that is carried on the balance sheet and shown as a contra receivable.

The loan is modified so that the principal is now $320K, the payment term is 35 (420 months) years and the interest rate is 3%. The payment is now $1,232 per month, for a reduction of 49%. Each time the borrower makes a payment, the amount of the temporary impairment is reduced by 1/420 or $190 ($80K/420). The bank will record a loss in the amount of $190 for each payment made. (One could fashion some tax consequence to the borrower in the amount of reduced tax benefit of interest payments).

Periodically, the amount of the impairment unamortized balance will be reviewed. To the extent that the impairment can be recouped (there is a recovery in home prices that would make the $80K temporary impairment now $60K, the bank will reduce the impairment prospectively. The decrease in the impairment (net of expense already recognized) would be added to the principal amount of the mortgage and the future amortized expense reduced. (Loan receivable would be increased and the deferred liability would be decreased).

I realize that is pretty complicated way of monitoring values, and perhaps there is some regional house price index that can be used--like CPI--a housing price index: HPI.

I'm sure that there are lots of problems with the above, but I see a few benefits:

* Induces borrowers and lenders to work together;
* Allows the lender to not recognize an immediate loan impairment (as the Fed guarantees the temporary impairment); keeps the loan from becoming a non performing asset (so the bank stabilizes their asset ratios, but interest expense is reduced); reduces foreclosures; supports housing values;
* Allows the borrower to reduce their liability on the temporary impairment so long as they are making payments--so that is an inducement for them to make payments;
* Pings the borrower by reduced tax benefits of mortgage interest to the extent that they have received a benefit. (Rather than having to pay income taxes on debt forgiveness).
* Reduces the "freebee" perception by those who did not get themselves into the pickle.

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