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Bernanke: Reduce The Amount Of The Loan
by Robert Franco
 | 2008/03/04 |
Feberal Reserve Chairman, Ben Bernanke calls for a vigorous response from lenders to aid distressed homeowners. In what he calls a "longer-term permanent solution," Bernanke believes that lenders should write down principal on mortgages. That is certainly a tough sell to lenders, but the idea has some merit.
"Reducing the rate of preventable foreclosures would promote economic stability for households, neighborhoods and the nation as a whole," Bernanke said. "Although lenders and servicers have scaled up their efforts and adopted a wider variety of loss-mitigation techniques, more can, and should, be done," the Fed chief said.
One of the suggestions Bernanke made was for mortgage and other financial companies to reduce the amount of the loan to provide relief to a struggling owner. "Principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure," Bernanke said.
With low or negative equity in their home, a stressed borrower has less ability — because there is no home equity to tap — and less financial incentive to try to remain in the home, he said.
(See Fed Chief: Mortgage Crisis to Continue)
There is a problem here, however, that would make his suggestion very difficult to pull off. How do you determine who gets the reduction in principal? Lenders do not want to reduce principal for everyone - and definitely not those who have the ability to repay their mortgages in full. To the extent that borrowers can repay their obligations, they should. So who would determine who can and who cannot afford to payback their mortgages?
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This is why I think that the bankruptcy system should have the power to make that decision for them. Those who have filed for bankruptcy protection go through an extensive debt and income analysis. In chapter 13, they are required submit a plan that would get them back on track and repay what they can afford. Who is in a better position to determine when writing down principal is appropriate?
Those who are in bankruptcy due to an overburdening mortgage debt, especially those who have subprime adjustable rate mortgages, are most certainly headed for foreclosure when they leave the protection of the bankruptcy court. In a foreclosure, the bank would most certainly get less than full value for the home. Around here the auction starts at two-thirds of the appraised value and most of them go back to the bank as REO properties. Then, the bank must wait for a willing buyer and go through the expense of selling the property. These often sell for below market value and further depress home prices in the neighborhood. So, if the bank is going to take a loss anyway - why not reduce the principal, and interest rate, for the existing homeowner?
It seems to me that would be a win/win situation. The homeowner would get to keep their home and the bank would most likely get more than they would in a foreclosure auction or a short sale. And, it's not really a windfall for the homeowner - he has already filed bankruptcy and will have that stigma for the next ten years. Only those who feel it necessary to file for bankruptcy protection would be able to benefit from the reduced principal, which would alleviate the burden on the lenders to figure out how to determine who they should help.
Bernanke is on the right track, but asking lenders to voluntarily write down principal may be asking too much of them. The bankruptcy system is better equipped to make that call and it wouldn't rely on the generosity of lenders to provide relief to those who need it. It would also work as a filter to ensure that those who can repay their loans would not receive reductions of the amount they owe. Those who are unwilling to file bankruptcy and risk losing other assets would not qualify for the protections afforded by the bankruptcy court.
The basic premise is simple - those who can repay should, and, those who cannot should receive some relief from their debts. Of course, there would need to be some protections for the lenders to prevent a homeowner from receiving a reduction in principal and then realizing a profit on the sale of the home when the market rebounds.
I would propose a new type of in rem lien on the home that would require a realized gain on a future sale to be returned to the lender if the value of the home has increased between the date of the write down and the sale. Perhaps the lien should attach to after-acquired property to prevent the homeowner from selling the home and buying a new property to escape the lien and realize appreciation on another property. Basically, the lien would ensure that any appreciation that the bankrupt debtor might realize over an arbitrary period, of maybe ten years, would go to satisfy the loss incurred by the lender who was forced to write down principal.
There are no perfect solutions to this complex problem that is dragging down the U.S. economy. It is time to start thinking outside the box and come up with something new. We need to stop the rising foreclosure rates to protect neighborhoods from further deterioration that is affecting many more homeowners than those who are currently suffering from overburdening mortgage debt. At the same time, we need to provide protection to the lenders to ensure that affordable home loans are available to all Americans.
If I can some up with one solution in the hour it took to write this blog, I'm sure that there are others out there, smarter than I, who could come up with 100 more ideas. We can't fix this problem within the constraints of "how things have always been," we need to create new solutions to deal with new problems.
Robert A. Franco
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rfranco@sourceoftitle.com
Categories: Foreclosures, Innovation, Legislation, Mortgage Industry, Subprime Lending
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