The Case for Principal Reduction

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SEE LAURIE GOODMAN: THE CASE FOR PRINCIPAL REDUCTION The Journal of Structured Finance Fall 2011, Vol. 17, No. 3: pp. 29-41  DOI: 10.3905/jsf.2011.17.3.029 The Case for Principal Reductions Laurie S. Goodman, Roger Ashworth, Brian Landy, and Lidan Yang

Posted By susanne In Real Estate,Today’s Marketplace

RISMEDIA, February 16, 2010—“Defaults, foreclosures plummet in January. Analysts discern signs of stability.”

So read the headline of my local paper.

Signs of Stability? Really? Now what might those be? I saw the Virgin Mary on a piece of toast once so I know we tend to see what we want to see but my tea leaves aren’t spelling relief.

In fact, things appear to be getting worse. See “White Washed Windows and Vacant Stores.”

Last year, I correctly argued against the common wisdom that there was this shadow inventory of foreclosed property that banks were holding back that would soon swamp the market. They weren’t showing up anywhere. So far, so good.

But, as continuing price declines push more and more homeowners deeper and deeper underwater, we are going to see a second wave of defaults. And, this one is not only going to swamp the market, it’s going to take the future with it when it recedes.

The employment numbers don’t mean anything. They don’t count failed business owners and other self-employed, and there are a lot of them, who are not entitled to unemployment insurance. There are those who have simply given up looking for work or those who have “graduated” and have maxed out their benefits.

Without substantial job creation, more homeowners will lose their grasp on their finances as unemployment insurance, savings, and retirement accounts are depleted.

Then there is the thorny issue of deferred interest loans made between 2005 and 2007, the peak of the market, that will adjust upwards in the months to come. Property values in some cases have fallen by as much as half, making the possibility of a refinance remote and increasing the likelihood that the borrower will exercise a strategic default.

I’m not sure where the good news is being found, but according to RealtyTrac:

One in every 409 homes in America was sent a default notice, scheduled for auction or bank owned in January, while 87,000 homes were seized and that is 31% more than January 2009.

Last year there were a record 2.8 million households facing foreclosure and that number is supposed to increase 40% to 3.5 million this year, according to RealtyTrac.

Consequently, that good news about stability is just the first wave receding.

There are two parts to a Tsunami. The first big wave is usually more of a curiosity, and then the water pulls way back from the coastline. It’s time to run for higher ground. When that tide comes back in, it comes with a vengeance and a wall of water several stories high.

Those who have referred to the economic collapse as a Tsunami may be faulted for being overly dramatic, but not for being inaccurate. Prepare for the next wave.

The bad news is we cannot stop it. We could lesson its impact on our communities. Cities like mine are already stuck with a bunch of vacant commercial buildings, and others like Buffalo, Detroit, and Baltimore are being squeezed by the burden of vacant houses that the banks don’t want to be bothered with. In Flint, MI, there are about 10,000 vacant homes.

According to the Brookings Institution, vacant and abandoned properties make up about 15% of the area of the typical large city. We don’t need to be rebuilding other countries; we need to rebuild our own.

There will be more strategic defaults in the commercial sector. There comes a point when the idea of continuing to struggle to make payments on something worth half the loan amount stops making sense. At that point, you no longer own the home; it owns you—for life. Because, we are not going to see these prices double in our lifetime.

And, they know when that point is. Researchers at the University of Chicago’s Booth School of Business and Northwestern University determined that owners with negative equity of 10% or less rarely default. But, when negative equity reaches 50%, close to one in five owners would default.

My bet is that will increase as the story of crooked banksters unfolds and as the numbers of people defaulting increase; the stigma will lessen and many people will be kicking themselves for not defaulting sooner.

Now, banks are pretty smart. They know that as values continue to fall, the number of defaults will continue to increase. And, in order to collect on the lucrative default swaps, they will continue to act in ways that cause values to fall, pushing more homeowners below the Mendoza line.

According to Time magazine, by June, as many 5 million homeowners will be underwater. Most will be concentrated in a few states.

The only way to avoid more and deeper pain across all sectors of the economy is principal reduction to market value. What is a short sale but a principal reduction for the new owner? How does that solve anything while getting us to the same place?

Obviously, the banks will resist and not just so they can collect on the default swaps. Principal reduction would require bringing the borrower and the true holder of the note, the investor, to the same table. The last thing the banks want is for borrowers and investors to come face to face.

The investors would realize that half of their money was skimmed off the top and that the value of the security is only a fraction of what they were led to believe.

As investors, they understand the difference between a 75% loss of value and a 100% wipe-out. Sooner or later, these assets have to be corrected on someone’s balance sheet. Not only would they more readily agree to mark to market rather than lose everything, but in most cases, these are the only people who could legally agree to a permanent loan modification or a short sale.

The upside for them is that the revenue stream is restored. Once the pools are in default, they get nothing, even though there may be performing loans within the pool.

Foreclosing and reselling in most markets is done at a price that represents the true market…what a willing buyer will pay tempered by what a willing lender will appraise the collateral for, often, some tentacle of the foreclosing lender. In this scenario, the financial intermediary also gets any proceeds from the foreclosure, not the investor.

These are extraordinary times and they call for extraordinary approaches. Here are 10 reasons why reducing loan balances and restoring lost equity is the best approach now.

1. What we are doing to address the problem isn’t working.

It isn’t going to work and, in fact, the longer we pretend that there will be significant loan modifications, the worse things are going to get.

2. Everyone who is upside down should get relief.

By “re-equifying” those households, we free up consumer spending, stimulate lending, and start putting people back to work—everyone wins.

3. It will cost less.

By keeping people in their homes, we reduce the costs of social services that are breaking the budgets in every community.

4. We were all gamed by the system.

Some worse than others. Here is just one little trick that even the smartest know-it-all usually wouldn’t catch in their loan documents. It is in the disclosure of Yield Spread Premiums. Most of us are used to seeing four percent written as either 4% or .4. But financial intermediaries express it this way, .04. The way we might express four tenths of a percent. On a $500,000 loan, it’s the difference between $2,000 and $20,000.

5. It will happen anyway.

The equity is gone; the loss is real. Foreclosure is the most expensive, least desirable way to bring the property back to its true market value

6. We all win if we do and we all lose if we don’t.

I’m sure that a handful of people who haven’t felt some real pain may be taking some perverse pleasure in watching their neighbors pack up and leave, but when you hear the stories of some of the homeowners who have stayed in vacant neighborhoods, the actual cost to those who remain is probably greater.

7. Borrowers and investors both gain.

Securitized loans put the investor and the borrower in same boat. Both were defrauded by the financial intermediaries and neither has received any remedy for their losses.

Trillions for financial intermediaries and nothing for the parties that were scammed. Instead of giving the money to the financial intermediaries that perpetrated this Ponzi scheme, it should have gone to the investors who were willing to accept the reduction in value of the pool. Instead, we give the money to the financial intermediaries who conceal the values of the assets. It’s a game.

8. We can afford to do it; we cannot afford not to.

Since the start of the meltdown, the Fed has amassed a whopping $9 trillion in loans to foreigners, but they will not say and, apparently there is no record of, where the money went. That’s $30,000 for every man, woman and child in America. That’s our money and right now, we need it.

At the moment, Congress is pushing for an audit of the fed, something that hasn’t been done in over ninety years. You would think everyone who is working for the taxpayer would want the taxpayer to know where their money is going, but this is shaping up to be one heck of a fight.

9. Some players in the mortgage arena are starting to get it.

Wilbur Ross owns American Home Mortgage Servicing, Inc. the third largest mortgage servicer in the country and he recently became one of the leading advocates for principal reduction. His reason, loans with significant principle reduction that give the owner equity in the property stay current.

In an interview with HousingWire he said, “The price of housing needs to be cleaned out. The Obama administration could right-size every underwater home and reduce principal to fit the current market value of the home. If they are going to deal with it they have to deal with it in a severe way.”

This was demonstrated in a study by investment firm Ellington Management which showed that every month, 8% of homeowners whose mortgages were 160% of the value of the home became delinquent while only one percent of those with loans that were 60% of value become delinquent.

10. It would jump start the economy.

Uncertainty isn’t good for the economy. Not knowing how far values will fall, not knowing when job losses will abate, and seeing no light at the end of the tunnel are paralyzing. Not just to consumers, but also to small business owners who are the hiring engines we need to pull us out of this recession. They need to know that consumers can and will spend before they start rehiring.

By restoring the lost equity in homes, we immediately stabilize real estate prices by establishing a “floor” and the true market value of property.

By stopping foreclosures, communities start to see their tax basis improve. They can start to rehire laid off workers such as teachers and emergency responders.

As distasteful as this may be to some people, it’s time to admit that there are no other solutions. The value is gone, never was really there, a few people got rich, a lot of people got poor, and now we have to fix it.

Top 9 Reverse Mortgage Myths – Separating Fact from Fiction [1]
Murphy’s Law and the Real Estate Agent [2]

22 Responses

  1. RIGHT ON, JOANN.

  2. Principal reduction of how much the Banksters owe the American People

  3. Principal reductions so that everyone can now pay (back) people who never loaned them a dime? So that now they won’t take the house anymore? If the people who “loaned” the money have already been made whole many times over – time for pay back.

  4. @Etolle—————-

    fantastic video and my message as well—————–right at 3,322 views.

  5. This principal reduction is just hypocritical BS. How can you agree with the thieves to give you principal reduction on something they don’t own?? i.e stole from you. Are we bloody idiots?.The next time a robber comes to your house , rapes , burns and murders family members, ask him not to come back if you will pay him $2500 per month for the rest of your life. See where that gets you. Are we jackasses??

  6. This says it very well:

    [youtube http://www.youtube.com/watch?v=R4dujufNj_Q&w=560&h=315%5D

  7. Does anyone know how long it generally takes for a Federal judge to rule regarding the defendant motion to dismiss 12 (b)

  8. E.Toile, I completely agree with your analysis. There are times when my brain is so stressed from pondering over and over this enormous “virtual” manmade catastrophe, with very real human consequences, that all I want to do is crawl up into a ball and sleep through it. We have a government that keeps on ignoring the problem as though it will go away by itself, while keeping on with the same failed politics of the past 30 years. It will not go away and until someone decides to tackle it, things will keep on unraveling.

    I’ve decided that possession is 9/10 of the law. I won’t voluntarily move out of a house I am not paying for, for want of knowing where my money has been going and to whom I should have been paying, until a sheriff physically carries me out. So far, it doesn’t seem that it is heading that way but no one knows what the next six months will be made of. All the information needed for action has already been uncovered and broadcast. We know the extent of the fraud, we know who benefited from it and who still does and we know that most of the current players are too timid to stump their foot and scream “Enough!”. Ideas are being tossed around but nothing is being implemented. Obama keeps on coming up with programs which can only help a breed on the brink of extinction: those of us who have never missed a payment, without removing the cancer in the system: the middlemen still bound to enrich themselves since nothing is required from them other than a “voluntary” participation. It doesn’t take a genius to realize that if it didn’t work with HAMP, it won’t work with anything remotely similar to it. Actually, that is stupidity at its best: doing over and over the same thing while hoping for a different result.

    My concern is that until extreme violence is used by the victims of this monumental fraud to make themselves heard and to regain what was stolen from them, nothing will be done by anyone. The chances of it happening are remote as hell: disinformation has become the norm in this country and fear is endemic.

    Sad commentary about America…

  9. Thanks, E. Tolle.

  10. @ Linda, puzzle no more:

    http://metanoia-films.org/compilations.php

  11. This is a classic case of Stockholm syndrome and one that I’m not at all willing to accept to suggest principal reductions with the very same criminal infrastructure that smashed our entire world’s financial system against the reefs. One would have to be insane to even court the idea of holding discussions with the likes of Dimon, Moynihan, Summers, Blankfein et al on how to fix any of society’s ills, financial or otherwise.

    These people should be considered greater threats to society than pedophiles, rapists, arms dealers, Al Qaeda, meth cookers, and similar psychopaths. But unfortunate for all of us, our world leaders; brainwashed by their own propaganda look to these criminals for the answers. Obama and his European counterparts attempt to convince us that if only these benevolent saviors, the financial titans of the world, would loan us even more of our own money; through this additional debt we might finally shore up this listing ship before we hit the exact same reef again, even more destitute as a result. The predictability of this lethal shipwreck is 100%. It doesn’t take a degree in actuarial sciences to see the mortal dangers inherent here. They’re everywhere.

    The underlying truth here, the understanding of which becomes not only inevitable but paramount, is that the entire financial system is 100% fraudulent, built upon lies that once the mirror is seen through the smokescreen, the reality can no longer be hidden. But just like the carnival tarps that were painted to make it look like there was a huge enterprise just inside, one worthy of expending your last dollar to see what’s in fact behind there, the truth is that all the carnie barking is nothing but false promises to get yet another dollar from the gullible bystander before the carnival packs up and hits the road.

    Give up any thoughts of reconciling with the very criminal elements that held/ still hold the gun, the sack, and the keys to the get-away car. Discover the truth behind the need to do whatever it is within your power to support the OWS movement in whatever fashion is best suited to you. Don’t ask yourself why OWS isn’t doing this about that. Just do it. Others will follow.

    Understand first and foremost that there is no alternative within the present system, other than begging the looters for respite. We don’t need a temporary stay here. We need these assholes imprisoned until they can show that they can act along with other adults who see fit to operate as a society, not as the gifted class, the 1%. History is replete with leaders who have held this same deceit over gullible masses since the beginning of time. Fuck them all. No Peace. Death to Wall Street.

  12. Some of Neil’s articles are good and informative—and some are hogwash.

    I take everything here with a grain of salt and look for the truth myself.

    Always examine MOTIVES.

    Pure motives will lead you to the truth.

  13. This is always puzzling….Why, when everyone seemingly knows what’s going on…the fraud still continues!! Can you imagine you or I getting away with this? We would not get to first base! The media would make a huge spectacle out of us and we’d be locked up for life.

    The denial and continuance of these heinous acts perpetrated on our citizenry and the harm caused by them, I think, is what shows the deliberate and willful misconduct/fraud/misrepresentation… by all those involved. They show no remorse outside of a slight pretense of it.

  14. ANONYMOUS…Fair enough. I agree, with the exceptions of an economic recovery from principal reductions. I don’t see it!

    The Fraud…in your face. This is definitely a problem. This needs to punished and people need to get their mortgage problems clarified/solved and be made whole….NOW. The banks are not broke, nor have they ever been and have been stealing for some time now. I say, go and get them, make this right and put them in jail. ASAP!

  15. Wilbur Ross — a hero??? Got to be kidding. Before anyone can even considers principal reductions — have to ask principal reduction on what??? what type of “loan”‘? — and who owns the “loan”??? It is not the security investors.

    But, yes — Chris — there must be principal reductions — and not just for those who are current — but for victims of foreclosures too — and restitution to those who have already lost their homes. But, no principal reductions until the fraud is addressed first — and answering all questions. No one should sign anything without identification of the current creditor — and IT IS NOT security investors — not servicer — and not trustee.

    Will this help the economy?? Maybe — maybe not. But, the fraud CANNOT continue — one way or another.

  16. And for the record; reductions in principal will not jump start the economy, only my opinion. Private industry growth has to happen and real estate values need to stabilize first.

    Inflation is over the top, which everyone in DC is claiming does not exist, which is baloney. Goods are up over 40% and people are what they call “elastic” right now. Measuring contents, checking brands, looking at sales and using coupons. Most are changing many of the behaviors they used to have, given this economy. I am formerly, middle-class and no one I know is doing well and cutting back on everything from gas/transportation to groceries.

  17. The banks made this mess, they should be required, by law, to fix it.

    Servicers do not own the note and have no rights under the law to do anything, except accept payments and send them to the pool.

    This situation was crafted and carried out “intentionally”. It does not matter whether or not someone could afford a house, as that was the grand plan, to put them in default and collect, collect, collect. The scam has been on the homeowners, the insurers, title companies, investors and the courts. The information is available at various sites. Do your homework and the truth is there. My question is: why has no one else been able to unravel it and do the right thing. As for the comments about getting something on someones back; speak to the Obama administration about that, as it was totally unnecessary for the taxpayers to aid them, the banks. Bailouts need not be given, the banks were never in peril or broke!

  18. If they wanted to fix these things, they would. Because when they want something done…like a health care bill…they steamroll ahead to get it done, even without reading it. (Sounds a little like a foreclosure, huh?)

    Conclusion: “They” don’t want to fix it. (At least not until it works to their advantage in some way)

    Principal reductions would help the economy lot, but not as much as giving us our homes back that they stole…and restoring the integrity of our recording system and the laws of the land.

    I mean, REALLY, what is needed here is a complete confession of wrongdoing and the monetary compensation that goes with it.

    We are a nation of forgiving and compassionate people. Sometimes that does not work in our favor, but it could.

  19. What the heck? Principal reduction? On what mostly all mortgages in this country were non qfc’s. People please seek the truth in this matter shift through all legal docs about what qfc/non qfc is.

    The banks are trying to get you to admit they are a creditor, instead of the truth. They are not even a creditor not even unsecured. For servicers as they call them-self only get a “piece” of the payment. When we all know in truth they get all of it and pass it to no one, all the “servicers” part is really another pass through entity that acts like they have nothing to do with anyone.

    Don’t let them do it say no to this reduction crap. The only way to fix this problem is to leave the home owner alone period. Everyone made money in this game including the home owner. The house is already paid for and banks already got paid for this loses in full.

    If you do not think this is the truth read mbia vs fdic in Washington dc federal court. MBIA says this in there own document. The funny part is that they also say “because of the split homeowners now do not have to legally pay on there mortgage”. Thats not me saying that but an insurance agency saying it. Why would they say something like this? We all know why.

    Again people on here will type after me and try to muddle the waters saying this and that. People challenge anyone to show you the truth including me, don’t take anyone’s word for fact. Unless you can seek the truth yourself.

  20. This is such propaganda

    Time to fix it you say?

    Give me a break.  The writer piously affirms  Wilbur Ross (Ahmsi) has gotten religion?  Well, he just stole my property and i was paying every month but ole wilbur wasnt satisfied   His bloodthirsty minions literally shoved me into the foreclosure ditch. Now he is satisfied?  Ha!  Not likely.

    This business about principal reduction will be done on the backs of people like me whose “principal” asset was deliberately forced into foreclosure and stolen. Now they’re choking on their ill-gotten gains and are ready to deal

    If I read one more article on this site about principal reduction after all the bull I ve read ad nauseum about how the banks don’t own the loans, I’ll stop checking this site   Too much speaking with forked tongue for my taste

     I ve noticed that this site pays little to no attention to those who’ve already been sacrificed

  21. […] See original article: The Case for Principal Reduction […]

  22. Regarding #9 Wilbur Ross ,, he’s advocating a haircut to keep people current because he’s not a servicer , he’s a debt collector who bought defaulted (paid off by insurance) portfolios at a huge discount and as in “re VEAL” he is about to lose his properties ,,, he is already changing strategies and is using the TRUSTEE name to foreclose in and is not having AHMSI listed as plaintiff on his actions… WILBUR needs to spend at least 20 years in an orange jumpsuit for attempting to collect on paid off notes.

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