The mortgage crisis—then and now

“The lending criteria that make mortgages saleable in the open market need to be amended.”

By JEFFREY McKIE

article created on: 2010-03-20T00:00:00

The mortgage crisis has now continued for over a year. The Treasury Department provided huge amounts of TARP funds for the major banks to negotiate modifications to existing mortgages or facilitating refinancing and new purchases to prevent foreclosures.

Modifications have not happened, cram-downs have unthinkable consequences, and refinancing has rarely been approved. FHA, Fannie Mae, and Freddie Mac, to avoid financing additional subprime loans, overreacted by tightening their lending criteria so drastically that mortgage lending has ground to a halt.

Money provided to the banks has been used to bail out other, more risky operations, improving their profitability and balance sheets and justifying more executive bonuses.

After more than a year, we are still in a severe recession with high unemployment, depressed real estate values, inability to obtain mortgages, and lack of funds for small business loans.

Now, a major impediment to economic recovery is this very lack of mortgage funds.

In spite of the other negative economic factors, there is pent up demand for purchasing homes. There are first time buyers who would like to take advantage of low prices and low interest rates.

For a variety of reasons, they cannot get mortgage applications approved. Homeowners who want to trade up can’t sell their existing homes and, consequently, can’t buy other homes.

Homeowners who want to downsize are unable to do so, again, because they can’t sell their homes.

Purchasers able to pay cash for a home are rare, but they seem to be almost the only ones who are able to purchase.

This further depresses home prices so that more and more owners are simply walking away from their homes because their debt exceeds their value. This aggravates the problem by driving prices even lower.

The money is out there, but it needs to be designated as “mortgage money”. It needs to be available through all mortgage lenders, not just a handful of large banks.

The lending criteria that make mortgages saleable in the open market need to be amended so that FHA, Fannie, and Freddie can facilitate the legitimate securitization of mortgages for sale on the open market to investors looking for safe and secure income investments.

There is a lot of room for adjusting requirements while ensuring that loans are properly secured by the property value and that borrowers have the income needed to make their payments.

In addition to lubricating the mortgage industry, the Treasury Department, through FHA, Fannie, or Freddie, needs to approach distressed homeowners, who otherwise might be facing foreclosure, and renegotiate the terms of their mortgages by establishing a reasonable, market-based fixed 30-year rate, keeping the present balance intact and adjusting the payments to one-third of household gross income.

Most likely, the payments will not cover all of the interest that accrues, and the balance will increase. However, economic recovery and future appreciation will eventually put homeowners’ equity into the black.

Household income needs to be monitored and the payments adjusted when and if the homeowner’s income increases. Because the principal balance would not be compromised, this would not constitute a giveaway program.

Adjusting the payments and forestalling foreclosure against a homeowner would avoid leaving the lender or the Treasury Department stuck with an empty house and would prevent the homeowner from becoming a resident of a station wagon. Any financial damage would fall on the institution that owned it. This approach would be beneficial to taxpayers over the long run.

This is not a partisan issue. It is not about Republicans and Democrats. It is about stabilizing the mortgage and real estate markets. This should have been done when the problem first became apparent. Over a year has passed and all of the government’s maneuvering has failed to remedy the situation. Had these steps been taken at that time, there would have been substantial improvement by now.

If our representatives in Washington would put our country’s interests ahead of their own, stop playing partisan chicken, and work together to get it right, the markets would be stabilized and confidence in our economy would improve. The benefits would reach far beyond solving these specific problems.

Our free-enterprise economy can function as a well oiled machine if given the chance. This isn’t the only monkey wrench in the works, but removing this one will bring about a big improvement.

Better late than never.

Jeffrey McKie is a recently retired Registered Investment Advisor in Portland.