Here’s a unique proposal for the Obama administration, which has been casting around for ways to revive the housing sector: Let the market do its job.
Housing ranks among the biggest drags on the U.S. recovery. Almost 11 million households still owe more on their mortgages than their houses are worth. Foreclosures are piling up as banks take years to repossess and sell homes. Those who don’t want to walk away find themselves in a sort of debtor’s jail. They can’t sell, they can’t move for a new job and they can’t borrow money to start a business. As a result, houses don’t change hands, prices keep falling and the vitality of the entire economy suffers.
If the market were working properly, millions of homeowners would have received debt relief a long time ago. That’s because it’s in the interest of creditors, who can gain by averting foreclosure. Consider a delinquent $100,000 loan on a house that is now worth $60,000. After taking possession of the house and selling it, a lender typically might recover less than $35,000, according to recovery rates calculated by Amherst Securities Group LP, an investment firm based in Austin, Texas.
By contrast, a 50 percent writedown of the principal balance could make the loan affordable and give the borrower some equity in the home. In that case, the lender has a performing asset worth $50,000 -- a $15,000 difference.
10 Million Loans
Analysts at Amherst estimate that roughly 10 million loans with a combined outstanding balance of about $2 trillion are delinquent or likely to become so in the next several years. If just half of those loans got a 50 percent writedown, investors and lenders could gain about $15,000 for every $100,000 in outstanding loans, or about $150 billion in total.
What’s more, the deals would go a long way toward reducing the giant debt burden weighing on consumers and the economy. People who struggle to stay current on their loans might see the writedowns as unfair, but they’ll be better off with fewer foreclosures in their neighborhoods.
So why isn’t this happening? The main reason is that the mortgage market suffers from a structural problem. Most loans are packaged into securities and sold to a constantly changing group of investors strewn around the globe. Because the investors are far too diffuse to agree on anything, they entrust the job of handling modifications to specialized companies called servicers. But the servicers aren’t set up to do writedowns. They lack the staff and expertise; they don’t want to risk getting sued by investors who might feel shortchanged; and they make their money by charging fees, which would shrink if they reduced the value of the debts they handled.
Thankfully, the market has a solution. So-called distressed-asset investors, otherwise known as vulture funds, are ready to swoop in and buy delinquent loans for, say, 40 cents on the dollar. They would then put in the effort needed to boost the value by either negotiating principal reductions with the borrowers or fixing up and selling empty homes. Major investment companies, such as Invesco and its subsidiary WL Ross & Co., are committing their own and their clients’ money to the business.
The challenge, then, is getting the servicers -- as well as mortgage-finance companies Fannie Mae and Freddie Mac, which hold roughly $180 billion in seriously delinquent loans -- to sell their inventory to the vultures, who are better equipped to do principal reductions. This may be possible with no new legislation, and at minimal cost to taxpayers. Here are some things the Obama administration could do to clear a path:
1. Encourage Fannie Mae and Freddie Mac, operating under a federal conservatorship, to build on a pilot program under which the Federal Housing Administration has auctioned almost $500 million in delinquent mortgages. Remind their overseer, the Federal Housing Finance Agency, that more money now is a better deal for taxpayers than less money later.
2. Give legal cover to servicers who sell loans, provided the sale price exceeds the expected recovery value. Minor changes in existing rules for servicers under the government’s Home Affordable Modification Program could do the trick, according to a paper co-written by James B. Lockhart, the former head of the FHFA and currently vice-chairman at WL Ross (which, of course, could stand to benefit from the changes).
3. Allow servicers to sell loans that have been packaged into securities. Many of the trusts that hold the loans prohibit this. The government can offer to pay the legal costs of trustees and servicers -- which include big institutions such as Wells Fargo & Co. and Bank of New York Mellon Corp. -- that agree to change the rules. In their paper, Lockhart and co-authors estimate the cost of such a program to be in the tens of millions of dollars -- a negligible amount given the potential benefit.
4. Encourage the mortgage trusts to let servicers charge a small sales commission. This incentive could help offset whatever conflicts the servicers might face, such as loss of fees.
Vultures play a vital role in the natural world. They make the best possible use of what others won’t touch. With some small changes, the government and the private sector could allow them to do the same for the housing market and the economy.
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