Fed Chairman’s principal reduction idea is crazy-talk.
From Virginia’s Jim Duncan:
Honor and personal responsibility should have a place in our society. Sadly, that seems not to be the case.
Oh, this morning is not the time to get me started on that one, but I am moving on.
Alert reader and inquisitive mind Jakob asked me in an email yesterday what I thought about Ben Bernanke’s gentle nudging to lenders to forgive a portion of principal balances on troubled home loans. I had to let the question stew overnight for two reasons: I was really busy yesterday, and I needed to avoid an emotional response. It is what my father-in-law called the “24-hour rule,” and for a girl prone to spontaneity, I have found it an essential one.
Hat tip to Jim Duncan for saying what I wanted to say and for saving me a few brain cells in the process.
In fact, the more I think about it, the idea of rewarding those who fail to take responsibility and to live up to their commitments is just crazy-talk, a concept that should be snuffed out by those of us who play by the rules and live by our decisions. Sure, you can make the argument that the banks would be making a sound business decision, and the result would be reduced losses and a healthier bottom line. But if we were to allow this kind of corporate thinking to prevail, where would we be?
Imagine a world where someone could buy a dress from Nordstrom and return it after the event, no questions asked, resulting in higher overall prices for those who chose not to return a worn item. Consider a society where people would shoplift sundry items from the drug store, resulting in a mark-up on similar goods sold to the honest shoppers. Soon, hospitals would start charging more for their treatment of patients to compensate for non-payment from the patients who can’t or don’t pay. Reckless drivers and uninsured motorists could start causing insurance companies to raise their premium rates.
Heck, real estate agents might even argue that costs associated with marketing homes for clients who change their minds and with showing buyers homes every weekend for three months to have them walk into an open house and sign with the listing agent are necessarily factored into the fees they charge their most loyal customers.
It’s crazy-talk, I tell you. And it’s business as usual, like it or not.
March 5th, 2008 at 3:09 pm
I love it when someone so clearly states, with eloquence and irony, exactly what I’m thinking. If I didn’t so agree with you, I’d probably right click, cut and paste.
March 5th, 2008 at 4:13 pm
Mark - You clearly do not know what happens to right-clickers around these parts.
Now, I have to return the cell phone that I dropped in the bathtub to Verizon and tell them it has never worked right. No biggie, right? It’s insured.
March 5th, 2008 at 4:20 pm
I thought you’d appreciate that I’d read your previous post, and hey, insurance is just business as usual, right?
March 5th, 2008 at 5:15 pm
[…] Fed Chairman’s principal reduction idea is crazy-talk., by Kris Berg. […]
March 5th, 2008 at 5:44 pm
What’s wrong with this thinking:
A homeowner should actually prefer his underwater neighbors get a principal reduction, rather than have their homes foreclosed which would flood the market with more inventory.
I would rather have my neighbors get a $100k gift. It doesn’t hurt me. In fact, it helps me if it holds up property values.
March 5th, 2008 at 6:04 pm
Jakob
It’s think Kris is making the point that Bernake is trying to solve a problem that was created by lack of personal responsibility, with more irresponsibilty. I think you are making the point that two wrongs might make a right. I have to agree with Kris.
Mark
March 5th, 2008 at 6:04 pm
Kris,
I’m also reminded of Ann Lander’s sage advice to “set aside” a harsh letter (blog post?) overnight, and read it again in the morning before sending it. Your overnight pause has resulted in a succinct, yet powerful, indictment of much of society today.
My first broker taught me that we Realtors have to have broad shoulders, to carry a (sometimes) heavy load, when irresponsible customers and clients accidentally (and, sometimes purposely) leave us by the side of the road after all of our effort to serve them in their best interests. Clearly you got that same message somewhere along the path of “experience”.
The greatest thing we can teach our children, and all young people in general, is the concept of personal responsibility. The era of irresponsibility, whose latest banner-carrier must be Ben Bernanke, will surely pass. I only hope that those of us who have demonstrated personal responsibility in our lives won’t have our backs broken carrying the load which Mr. Bernanke would slough off onto us. The sooner the irresponsible elders pass into oblivion, the better.
Am I being unneccessarily harsh?
March 5th, 2008 at 6:09 pm
Vance
No, just wordly.
Mark
March 5th, 2008 at 6:11 pm
Jakob - Funny that Steve and I were just this very minute having this debate. (Yes, I know. We have no life.)
My post was intended to be sort of Geneva-like (neutral). You have an excellent point, and we have personally been witness to too many cases this month of distress sales causing undue injury to their local real estate market. Lenders don’t negotiate; they dump properties. We are all being affected. As a homeowner, I am being affected. It is human nature to scream “not fair,” however. If anything, my subtle intent was to remind that life is not fair.
March 5th, 2008 at 6:22 pm
Jakob: It won’t. Right after the principal reduction comes the sale, your neighbors move on and you have exactly what you had before: a depressed comparable next door, which you would have had with the foreclosure, anyway. Look at it this way: you can pay less property tax due to the lower valuations. You did buy your home as a place to nurture your family, right?
If mortgage contracts are modifiable after closing, there will be no lenders (your retirement fund, bank and insurance company reserves, etc) willing to invest in an uncertain payout. If there are no lenders there will be no home sales and no home construction. Delete 25%of the US GDP.
This solution would do exactly what you would like to avoid. With no loan money available, property values would fall to the value where cash transactions could take place. In the absence of cash buyers, the house would have a value of the land plus the house as scrap material.
As Kris said: Crazy-talk.
What Bernanke is signaling, is that he has no clue how to salvage the mortgage banking system.
March 5th, 2008 at 6:24 pm
Okay, Mark and Vance, I am getting “behinder” by the minute. Didn’t mean to skip over your comments.
Much of what Steve and I were discussing was the unfortunate absence of alternatives. When he returns (I dispatched him to carpool land), I am sure he will chime in. As he was pointing out to me (throttling me over the head with the concept, actually), absent an “unfair” bailout, our economy and the world economy, in fact, could be in deep doo-doo. It stinks that, in large part through the irresponsibility of the banking community, banks are in big trouble, but absent intervention, we could all be in a lot bigger trouble yet. No one wants government meddling in the affairs of business until business solvency and, on a larger scale, the health of our nation’s economy (meaning you and me) depends on it.
We are in a fairly big pickle, to put it mildly, and it is going to take a lot more than singing happy songs around the campfire to get us out of it. In my Utopian world, walking away from dept and commitment would cease being the new pink for Spring. Where this would have been a source of shame years ago, it is now perversely a badge of honor in a sense. However, we do not live in Utopia, and we need to get past it and move on while hopefully learning from our mistakes.
March 5th, 2008 at 6:24 pm
I tend to think Rich Toscano has it right in his Voice of San Diego article yesterday, in that prices have much farther to fall before they hit a sustainable equilibrium. So, it’s just a question of how the market gets there. The current loan balances over the long-term sustainable amounts are “gone” (sooner or later), and it’s just a question of who “eats” the loss.
Kris and Steve - which is better for realtors (R)? Foreclosures or magic reseting of loan balances? Which process gets the market back to one with sustainable values? Which process will result in future buyers being able to get loans at decent interest rate without puting 50% or more down in the future (which, of course, effects the sustainable prices)?
You guys are on the front lines, so to speak. What say you?
(you will at least be pleased that the foregoing post was made without reference to any fast food establishment)
March 5th, 2008 at 6:27 pm
Thomas and Smithers - Crying “uncle” for a minute. My head is starting to hurt. One comment forward and three behind. I am tagging Steve while I take five. Stand by.
(Smithers - Thank you.
)
March 5th, 2008 at 6:30 pm
Hehe. I’m coming to realize your post sums up beautifully the prevailing opinion of people.
Interesting that you’ve seen the dramatic comp hit in practice. Even in the high priced areas you seem to deal with….
March 5th, 2008 at 6:34 pm
TJ, the principal reduction will put off the sale for years. People can stay put. No foreclosure. No fire sale prices.
March 5th, 2008 at 6:48 pm
Smithers, Couldn’t stay away (kind of like a train wreck). Interesting Voice of San Diego article. Thanks for the mention, and (for everyone else) here is the link: http://tinyurl.com/3dwouh
March 5th, 2008 at 6:55 pm
Too much to handle here. I’ll try to limit my comment/response to this - I tend to favor no government interference in the free markets. What Big Ben did today was push the lenders to back the borrowers. My fear is that will not be enough. Who is backing the lenders? We already know that many have ceased to exist as the markets have shaken out. More will follow. But at some point, the magnitude of the problem gets to a tipping point beyond which things start to spiral out of control. We definitely do not want to approach those boundaries, even if it means that the FED needs to get involved. How? They will need to back the lenders, obviously. However unfair all of this may seem, it pales by comparison if we start to lose control of the U.S. banking system. I don’t have a lot of confidence that my free market preference will do enough, quickly enough, without significant collateral damage. The FED may need to move on this situation in the very near future. Being too late is not an option.
March 5th, 2008 at 7:02 pm
It has been said by many people who are much smarter than I am that “you do not solve money problems with money”. Most of the people that I respresent in short sales did not deliberately cause the situation that they are in now, but they DID make some poor decisions about their money. They bought homes that they could barely afford or used their house to purchase other items or they tried to dabble in real estate without learning about the ups and downs of the market. I am truly sorry for the situation that they are in and am working hard to help them get out of it. BUT I am not sure that bailing them out will be a long term solution to their money decision problems which is what we (as a nation) would be gambling on by paying off a portion of all the outstanding delinquent debt.
March 5th, 2008 at 7:13 pm
@ Jakob Jakob: What makes yo think that the person of such character to not be able fulfil their obligations would not move on? The workout principal reduction scheme (scam?) would have all kinds of complications one of which is: rewriting 50 sets of real estate laws. Every state has its own statutes. Not gonna happen in time to save the banks. Texas legislature doesn’t even go in session again until 2009.
Keep in mind Bernanke is not trying to save homeowners here. He wants to make sure that he will still have a Federal Reserve System of which to be Chairman. The major banks are so capital impaired that they cannot even properly report their balance sheets for fear of creating an even more severe run on the dollar than we are seeing now. For a more scholarly look at the situation, read Mish http://globaleconomicanalysis.blogspot.com/
Guaranteed to give you indigestion.
March 5th, 2008 at 8:01 pm
TJ, maybe i’m being naive but presumably not everyone would sell right away, and we’d have a softer landing for house prices. Who knows tho. I’m actually a renter so if I’m being selfish I’d say bring on the foreclosures and the massive inventory.
BTW, every time I read Mish I have an urge to sell everything and short the market and stock up on canned goods. It’s dangerous stuff.
March 6th, 2008 at 9:05 am
Jakob: Be selfish. Your order is being filled as we speak. It is the invisible hand that is the foundation of Capitalism at work here. What we are seeing with all these trial balloons is an attempt at handcuffing of the invisible hand to protect certain interests. The sooner we work off the glut in housing, the better. I realize that it will be very painful in SoCal, Phoenix, Las Vegas, Washington DC and the other bubble markets.
In my little cow town, Houston, it took almost 20 years for some neighborhoods to recover 1980’s pricing as a result of the Oil/S&L bust, and that was about half the size of the bust we are looking at today: 200 billion vs 400 billion. I am not counting the 15x leveraged margin calls in the hedge funds where not even Bernanke knows what the numbers are.
That is why our clients buy very carefully to this day-they purchase as if they might be in the home quite a while. Of course, here in Texas, we tend not to day trade our homes, we live in them.
If you don’t believe Mish, buy a house this year. The FHA lending limits were just raised as eye candy for the election year and FHA loans are easier to qualify for. A 6% rate is low by historical standards, and if the sky really is falling, you will be able to rapid refi (an FHA feature) at 4% and 2% as we deflate. If we inflate banana republic style, and rates go to 18% 1980’s style, you will have an assumable 6% loan. (I think I just stumbled on my next blog post.)
March 6th, 2008 at 12:41 pm
Bernanke was actually talking from the bank’s point of view. It’s a way to minimize losses for the banks. I agree that it’s completely bogus that people who purchased for more than they could afford in a glutenous are suddenly rewarded with $30,000 in reduced principal, but it really beat the alternative for the bank.
You’ve heard of those services like “Just walk away” right? That leveraged equity that people were cheering on about when prices were going up is working in the opposite direction now. I read an anecdotal story recently of a gentleman who purchased a house across the street (track homes) that was identical to his for over $100,000 less. Then he rented it out for the 8 months while his current home went into foreclosure intending to just go across the street.
In other words, for 8-10 months he gets an effective 30-50% reduction in his mortgage payments (collecting rent on one place while not paying on the other) followed up by a permanent reduction in debt and a payment structure lower than what he was originally paying. What’s sad about what he did is that it’s not even illegal. To prove fraud, you’d have to prove that he didn’t intend to pay off his loan when he signed the documents. Which he probably did.
What Bernanke is suggesting is morally wrong and unfair, but it may be the lesser of two evils and the best choice for the bank. Foreclosure expenses, sales commissions, and carrying time for an nonperforming asset are way worse.
March 6th, 2008 at 10:39 pm
Sven: My point exactly- Bernanke has absolutely no clue how to salvage the Federal Reserve System so that he has a system of which he can be chairman. All this election year pap that is spewing out of Washington, is an attempt to keep a lid on the mess through the election. Call it incumbent job protection. With Bernanke spouting principal reduction as an answer, is it any wonder that the mortgage market is locked up? You need to remember who owns the mortgages. It’s not just some glass and steel tower downtown: the bank: It’s pensioners, it’s you in your retirement plan, it’s your town in it’s pothole fund, it’s Norwegian villagers(no joke), its the guys in turbans we buy our oil from(any guess why oil is over $100/bbl?).
Most lenders/investors would like to have an assurance that the money they lend is coming back in accordance with the agreement. If you put $10,000 in a CD, you expect to get your 10 grand back plus interest. The CHAIRMAN of the FED is suggesting that the banks, pension plans, your 401k, and all other lenders might just want to take a big hair cut on their investors’ money for the Gipper.
I can see it now: Ben Bernanke announces that all the retired policemen, firefighters and teachers in the country will have to take a 20% monthly pension reduction so that Citibank can pay its dividend and keep “Wall St.” happy.
As Kris said: Crazy talk, but “It’s the Fed Chairman.” he said in disbelief.
Also note: Bernanke wrote the book on the Great Depression: He knows what he is facing, he just needs to stop babbling when the microphones are on.
March 7th, 2008 at 4:15 pm
Thomas, I agree with you, but would go a bit farther. The “big hair cut” has already happened to the investors, they’re just afraid to look in the mirror and deal with it. (And Bernanke is trying to sweep the hair up off the floor and glue some of it back on their heads).
March 8th, 2008 at 1:47 pm
Thomas: I really don’t see how Bernanke could solve this problem. What we needed was Greenspan back in 2003 to say that the surge in the housing market was unsustainable and immediately call for a drastic and strong increase on lending standards. Instead, he says the housing market is a little “Frothy”, but no bubble here right? I saw it back then, and it’s not my job to watch it. I can’t see how he was blind to it.
When people have to resort to “Affordability Products” like Neg-Am loans and Interest only loans to make the payments on their houses, then things are way out of hand. There’s a reason they increase interest rates when the economy is booming. Because excessive unchecked growth leads to crashes.
Bernanke came in too late to do anything. I honestly feel bad for him. I do wish he would talk less though.
March 8th, 2008 at 1:48 pm
“Bernake is trying to solve a problem that was created by lack of personal responsibility, with more irresponsibilty.”
IMO, Bernanke is cutting losses quickly. I also take issue with agent and lenders who want to throw around the responsibility blame card. Let a neutral 3rd party vet all your transactions, and if yo can show that you walked from all transactions that shouldn’t have gone down, then feel free to cast the first stone.
I have literally several dozen people who are simply victims of a falling market and a few bumps, or pot holes or real tragedies derail their responsible lives.
In situations where the borrorer would like to hold on to the property but only if debt reduction occurs, the banks have choices -
1. foreclose and lose, while dragging down the market comps and adding to the distressed inventory,
2. approve a short sale that has roughly the same effect,
3. see a savvy BK attorney get what is now an under-secured, therefor unsecured 2nd discharged and the borrower stays in the home paying the 1st
or
4. Forgive that same debt that they’ll write off anyway. Agents don’t like this option because it takes them out of the picture.
There is no perfect blanket answer to the situation, but there are options that don’t have to be worst case.
March 8th, 2008 at 1:51 pm
Btw, don’t worry about having another great depression. We’ll definitely have a recession here, but the thing that triggered the depression was a complete collapse in the banking system. The government will do whatever it has to in order to keep the FDIC solvent, and as long as that is maintained, banks will still have money to lend. It’ll just be tight for a few years.
March 15th, 2008 at 3:45 pm
Did you fail simple math? Do you have the ability to discern which of two numbers is greater?
In many markets that have seen drastic declines homeowners have seen the value of their property drop by 50-60%. Many of them are not going to keep paying $4K a month in housing expenses for a home that is worth $160K and that they could rent for $800 per month. If you are in that situation, its a pretty easy calculation to make.
Now, the reality for the loan servicers and their investors is that in a foreclosure the best can expect to net is about 50 to 60% of the current market value. (not the original value). What is a better deal for the investors in that situation? What would you want on your balance sheet - $80K after a 1 to 2 year legal battle or a performing asset valued at $160K that is generating about $1K per month income?
This is an economic issue, not a moral issue. That a realtor or mortgage broker would try to infuse ethics into this argument is laughable and their conflict of interest is palpable.
May 28th, 2008 at 10:44 am
Apparently you haven’t read your history books. Thumbing your nose at people to “teach them a lesson” at the expense of the country’s economy is exactly what Herbert Hoover did during the Great Depression and led to economic disaster. But hey, he sure showed them, huh! Yippee! To place the “shaking of the finger” ABOVE the well-being of the country (which, “crazy-talk”as it may seem), affects the decent, hardworking, responsible people of the country as well. That’s not exactly rocket science. In fact, it is competely idiotic to dig your heels in to punish people, when the economy of the entire nation is at stake. I surely hope you are kidding. This isn’t Nordstrom, genius. It’s the most powerful nation in the world.