One of my greatest reservations when I voted for President Barack Obama was his plan for addressing foreclosures specifically, that bankruptcy courts could determine new home values for those in danger of foreclosure. From my October 7, 2008 column:
Case in point, a statement made by Sen. Biden in last Thursday night’s vice-presidential debate:
BIDEN: "We should be allowing bankruptcy courts to be able to readjust, not just the interest rate you are paying on your mortgage to be able to stay in your home, but in — be able to adjust the principal that you owe, the principal that, that you owe. That would keep people in their homes; actually help banks by keeping them from going under…"
Still unclear as to why this strategy has not only the potential for major economic fallout, but would establish flawed judicial precedents? Refer to that column; I broke it down in plain and simple terms.
When I read Matthew Pavlevky’s piece on The Huffington Post lamenting the lack of mortgage modifications even in light of continued foreclosures, I was glad. Not because I side with the banks, nor because I’m insensitive to others’ financial struggles. I’m glad because while it sounds like a viable short-term solution, the long-term impact is decidedly negative.
Pavlevsky cited a New York Times piece by Gretchen Morgenson on the analysis of Wells Fargo mortgage data by Valparaiso law professor Alan M. White. Morgenson writes:
"Loan modifications occur when a lender agrees to change terms of a troubled borrower’s mortgage; the most common approach is to reduce the loan’s interest rate. Cutting the amount of principal owed — an option that could be of more help to a borrower — is rare because it means homeowners pay less money back to the bank over time."
Cutting the amount of principal owed is exactly the modification I argued against in my previous column. But Pavlevsky, Morgenson, and White are all still in favor of reducing the principal as a means of avoiding foreclosure, and the data and reasoning given by White seems compelling:
"There is 100 times as much money lost in foreclosure sales as there was in writing down balances in modifications,” Mr. White said. “That is not rational economic behavior."
Yes, foreclosures cost banks money — a lot of money. Much more money than they’d lose if they cut principal balances. The bailout(s) aren’t even going to make up for the foreclosure losses.
But reducing the principal means altering the mortgage contract. As I wrote before:
"If mortgage contracts are fluid — that is, their value: the principal owed, plus the interest, can be adjusted by a bankruptcy judge — then they will be an even riskier investment in the future than the sub-prime mortgages of the past… That means the investor loses money, so they won’t buy more mortgages from that bank. In turn, because the bank is unable to sell their mortgages, they run out of cash and can’t approve more mortgages."
The banks are taking a major short-term loss by allowing foreclosures to proceed, but they’re avoiding far more significant long-term losses — both for themselves and for homeowners seeking loans — in the future.
Pavlevsky looks at it from the perspective of families facing foreclosure, as seen in the HuffPo series, "Dispatches from the Displaced":
"These families’ primary complaint has been the dearth of information regarding how likely they are to receive a modification. They want to know if they should sell their house now and possibly go into bankruptcy, or hold out for a modification."
This attitude frustrates me greatly. It’s downright childish. The responsibility of home ownership belongs to the homeowner, not the government. It sounds almost as if these families are looking for someone else to blame in the event that they end up in foreclosure, instead of taking steps on their own — that is, without government assistance — to avoid that end.
But another HuffPo writer, Jim Randel, offers some much-needed tough love in his piece, "The #1 Lesson of the Housing Crisis":
"Do not rely on the government to protect you. Do not rely on the good faith of your friendly real estate agent or mortgage broker. Do not depend upon your attorney or title carrier to help you avoid pitfalls. EDUCATE YOURSELF."
I couldn’t agree more. And that’s why, in spite of my sympathy for those who face losing their homes, I refuse to support absolving them of their personal responsibilities.