The Great Government Bailout April 29, 2009

We all are hearing great things from Obama and his advisors about how the so-called Stimulus Package will be helping the economy pull out of its doldrums, but it is silent on the mortgage foreclosure mess.  After the failure of the Bush TARP plan many commentators advocate letting the market play out its normal course with thousands of foreclosures and the failure of the banks which hold the bad loans.  While this approach probably would allow the system to correct itself, the cost of banks closings and homes lost to foreclosure makes it a politically untenable option for the new administration. A nationwide system of reappraising and revaluing delinquent loans coupled with a streamlined process of modifying loans could do a long way to bringing closure to the burgeoning sub prime mortgage crisis.
  
My fondest wish is for a package which would give lenders and homeowners some direction on how it plans to handle the sub prime mortgage crisis.  Lenders need some idea about how the government proposed to handle the toxic mortgage foreclosure mess which has threatened our banking system.  Delinquent homeowners need to know whether to continue to try to hold off foreclosure or leave their properties and get on with their lives.  Unfortunately, several plans have been mentioned but none has garnered the needed level of political support.  Three interesting options are

1) Toxic Mortgage Bank -a government takeover of the bad loans
2) Mortgage Reformation in Bankruptcy Court- permitting bankruptcy judges to reduce the interest rates and principal balance of mortgage loans
3) National Reappraisal and loan write down program- issue guidelines on valuing delinquent mortgages

From a real estate attorney’s point of view option 3 makes some good sense as it would free up the lending markets and allow assets to be valued and losses to be reported.  While the losses will be massive at least the banking system will be able to quantify them and go forward.  The worst thing that can happen is to continue to do nothing (although option 2 would vest unprecedented power in judges not envisioned by the credit markets and could be a disaster) and have the market continue to drift aimlessly. 

For mortgage lenders having delinquent mortgages on their balance sheet stops them from making new loans as the value of delinquent loans cannot be accurately calculated.  Homeowners have no guidance as to what proposals can be made to their lender to work out problem mortgages which would benefit both borrower and lender.  A new proposal is for a reappraisal program to allow lender’s to fairly value delinquent mortgages.  Once a valuation model could be agreed upon this would set the stage for the bank’s non performing assets to be valued and /or liquidated in an orderly way.  Once values are agreed to lenders will be much more willing to listen to current market value based proposals to help homeowners make payments and keep their homes.  This proposal would have licensed local area appraisers come up with current fair market values of distressed properties so the lenders could give them real value in their portfolios.  The lending markets could now get a true reading on the value of the assets held by the banks and banks would be encouraged to make arrangements with homeowners to modify mortgages based on realistic numbers. 

The Bush TARP plan offered government money to struggling mortgage lenders to allow them to remain afloat.  The lenders promised to try to help struggling homeowners modify their mortgages to try to keep them in their homes.  While the banks did receive the funds new mortgage guidelines caused the vast majority of loan modification requests to be rejected so the TARP bill did little to help homeowners.  While this reappraisal plan could be used to allow homeowners to stay in their homes at current values it needs to be coupled with real enforcement mechanisms to insure that lenders and homeowners do not game the system by over or under valuating properties.  There should be a streamlined process to determine the value and guidelines to try to allow homeowners to keep their homes.  This needs to be coupled with a much quicker foreclosure process for those homeowners who cannot be rescued by this program or who get its protections and again become delinquent.  This would serve both lenders and homeowners as the lenders liquidity would be increased as non performing mortgages could be made performing and homeowners would be released from the strictures of bad sub-prime mortgage programs and given a fresh start.  This fresh start must come with a price as those homeowners unable to make it despite the new start would end up without their homes but in most cases these people should not have been homeowners in the first place.
Allowing Bankruptcy judges to reform mortgages including reducing principal balances is a radical change that can only serve to further distort an already distorted market.  Lenders were encouraged by FANNIE MAE rules to relax lending standards to increase which led to poorly thought out mortgage programs offering which required down payments, credit scores and income levels to qualify for home loans.  These programs set the stage for the mortgage crisis as the is  participation which encouraged reckless lending would The goal of any mortgage bailout program should be to facilitate new lending while attempting to help delinquent homeowners stay in their homes.  The problem is that these goals do not necessarily work together.  To facilitate lending the old bad loans need to be dealt with quickly and efficiently but the pain of homeowners faced with the loss of their residences makes this option.  The first two options would radically change the lending landscape for good.  Both would interject government into the lending equation in a way that would increase lending costs for borrowers and give the government unprecedented influence over homeowners.  A toxic mortgage bank option would allow the banks to be rid of the bad loans but could saddle the taxpayer with trillions in losses.  Coupled with the likely provision that the government as the owner of these bad loans would be much less likely to start foreclosure proceedings against borrowers would mean these bad loans stay around for a lot longer than if banks followed normal lending practices and brought timely foreclosures.  The increased time that the bad loans remain in the system will only increase the government’s losses and continue to weigh down the sales markets.

Lender’s have assets which cannot be valued so they clog up balance sheets stopping them from lending to new qualified borrowers. 

Supposedly the $900 Billion will kick start everything and in a couple months everyone will be fully employed at great wages, the housing market will rebound, state and local government deficits will disappear and a new era of general happiness will ensue.  While I didn’t vote for Obama, I am someone who had great hopes that a really smart person with a mandate could come in and make some meaningful changes in desperate times.  I see first hand the trouble that Washington business as usual politics has wrought as the local housing market continues to flounder under the weight of foreclosures. Maybe the Obama message can lead to meaningful changes that benefit all Americans.

Steven Decker is a New York Personal Injury attorney specializing in New York real estate law , New York business law, and New York franchise law. You can visit his Law Firm Decker, Decker, Dito and Internicola website by clicking here, download his FREE New York Car Insurance book, or call him at 718-979-4300 or 1-800-310-5520 for a free case analysis.

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