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The Math of Foreclosure Bailouts

Home ForeclosureForeclosure rates have been skyrocketing and are expected to continue to rise through the end of the year. This is a tragedy.

While I have never lost a home myself, some close relatives have. Just a few weeks ago the folks who lived across the street from our lot were forced to move due to a foreclosure. If the “bank owned” signs I see everywhere are any indication, we all probably have friends or neighbors who have been through this awful situation.

It should go without saying that losing a home is a seriously crappy thing. It’s devastating, it’s discouraging, it’s incredibly difficult. And it should go without saying that, when possible, we hope to help anyone in this terrible situation.

But just how we help those about to lose their homes — or in any awful financial difficulty — is an issue that should be handled with reason, not emotion and name-calling. And far too often the latter is employed, rather than the former.

This afternoon I read an article in Parade titled, “Help for Struggling Homeowners.” It begins with a tragic story about an unemployed, divorced mother — yes, with cancer. It’s an awful story. There is no question that her situation is truly horrendous. There is no question that it would be devastating to any of us. There is no question that she needs assistance. What can we do?

Unfortunately, this sad story was the entry into an article with a bad solution. It expressed the view that banks should just be nice and renegotiate mortgages —or be forced to by the courts.

This is a country based on the rule of law. That is our protection. And yet we are willing to throw that principle out the window the minute it makes it easier for us to (1) keep something we can’t pay for or (2) assuage the guilt of seeing people suffer by forcing someone else to step to help those in need (3) blame someone else for bad stuff.

Here is a rundown of the general scenario in question:

  1. Jack wants to buy a house, but doesn’t have the money to buy it.
  2. Jack goes to USA Bank and asks to borrow money for the house he wants.
  3. USA Bank offers to lend Jack house money at x% interest with the house serving as collateral on the loan.
  4. Jack promised to pay bank back $x per month for x months at the rate requested.
  5. Jack and USA Bank — of their own free will and in what both consider an arm’s-length transaction — sign legal documents recording the deal.
  6. USA Bank takes money from others to loan to Jack for his house.
  7. Jack uses money to pay for the house, with bank as owner until payoff.
  8. Jack moves in the house.
  9. Jack sends monthly mortgage payment to the bank.
  10. USA Bank uses Jack’s payment to:
    • Pay interest to those who have interest-earning deposits at the bank.
    • Pay for salaries of those who run the bank and administer the loans.
    • Pay for building, facilities, ATMs, statements, mailings, advertising, postage, utilities, and all other overhead.
    • Etc.
  11. Something bad happens to Jack and he can’t pay his mortgage.
  12. USA Bank sends him a letter, telling him he needs to pay his mortgage so they can use his payment to pay for those things listed in item #10
  13. Jack says he can’t pay, but won’t give back the house that was kept as collateral.
  14. Jack gets a lawyer to “negotiate” his mortgage.
  15. Politicians trying to buy votes tell everyone the bank is evil and mean and hateful.

Stop! I thought we had an agreement? I thought Jack said, “I will pay this amount every month for x months and, in exchange, you own the house until I actually pay for it.”

The bank fulfilled their obligation to him as promised. But now that he can’t fulfill his obligation to the bank, he wants the courts to keep the bank from having the house the bank paid for (with other people’s money). He wants to keep the house and keep the payments. And if the “mean” bank doesn’t comply, he’s going to get a lawyer to impose, as the article said, “a tiny bit of arm-twisting” to the bank.

How does the bank come out as the bad guy in this story?

To the mathematical point, when Jack doesn’t pay his mortgage and the courts and arm-twisters force the bank to reduce Jack’s mortgage, who pays for the difference? Answer: Other real, living, breathing people.

Someone pays. Someone always pays. And when we use tragedies to make policy, we always forget the real victim: the person who actually ends up paying.

What is my solution? First, let me warn you, you won’t like it. It won’t fix the problem, it will only help, sometimes. And I have no big, evil, faceless entity who will pay the price for all the world’s ills. Because there isn’t one. It’s always people who pay. Other human beings who are forgotten in the equation. And forgetting them is fundamentally wrong and unfair.

Having trouble paying your mortgage? Here’s my amazing plan.

  • Increase income to pay your debts.
  • Slash spending to pay debts.
  • Request longer payout period from bank or other term modifications that allow you to pay your entire debt within your means.
  • Request assistance from family.
  • Request assistance from church.
  • Sell house and move to one you can afford.

Other options:

  • Consider sharing space with other family members and pooling resources to pay debts.
  • Temporarily move to a more affordable place while renting your place to someone else.
  • Create an apartment to rent to others.
  • Other?

That’s it. Nothing complicated or fancy.

It seems common sense to me that the person who signed the contract is responsible for the payments. And unless the bank engaged in fraud (and I don’t call “not reading the contract you signed” fraud), the bank isn’t the problem.

As far as other “assistance,” I’m all for it — as long as it’s voluntary. The woman in the story was helped out by her family. Bravo! And what could be better than if the people in her community got together to do something to help? Hooray!

But forcefully taking the resources of others — without acknowledging those harmed or weighing the opportunity cost of those redirected resources — is extremely bad fiscal management. And it’s patently unfair and un-American.

{ 17 comments… add one }
  • StanD May 2, 2010, 11:22 pm

    It’s such a hard thing when someone loses a home. I never really thought through to the end because it sounds so great to get out of mortgage payments.

    This is good information.

  • Teresa May 3, 2010, 2:05 pm

    I really liked this article. Yes there are hard cases out there, but there are also people who have just walked away because it was easier. The neighbor behind us did just that. It has been devastating to our neighborhood. Because of the Short sale on his house, market prices in our neighborhood have dropped $100,000 in 2 years. This is the big reason housing market has crashed. Selfish!

  • Alison Moore Smith May 3, 2010, 3:40 pm

    Agreed, Teresa. It’s easier for the person walking, but other people end up paying and the “walker” seldom considers those harmed.

    As for your property values, you aren’t kidding. I know this too well. It was a nightmare getting our construction loan. This was mainly due to the fact that every single comp in Lindon and north Orem — back to March 2009 — was a short sale! There was one lone exception, but because it was a actually a builder selling to himself or a family member or another builder or something odd like that, it didn’t count.

    We put our last custom home in Eagle Mountain on the market in May of 2006. After years of appreciation, this was a few months into the housing slump. The house was listed at $1,000,000, and finally sold in January of 2007, for $900,000. We lost a clean 100K because of our timing.

    We leased the home back from the new owner for over a year. In May of 2008, he put it on the market for 1,300,000. (I thought it was overpriced but, boy, I was going to be ticked if he could make a $400,000 profit in just over a year!)

    Last time I heard, a couple of months ago, the home was still unsold and listed at $650,000. It was down $250,000 from his purchase price and he still couldn’t move it. And that’s for a home with over 12,000 square feet. Wow, that’s a huge hit. And if it ends up in a short sale, that’s bad news for the neighbors.

  • jack May 4, 2010, 12:42 am

    I think there are lots of people who disagree with you, but they’re too afraid to say so. They can’t really argue with your position.

  • PGP May 6, 2010, 12:41 am

    Terrific work! This is the type of information that should be shared around the web.

  • Alison Moore Smith May 6, 2010, 1:09 pm

    Like Teresa, I’m always interested in hearing input. But I agree, jack, because I’ve heard them before. Generally the “arguments” are that it’s mean and greedy not to want to help people.

  • Teresa May 6, 2010, 12:14 pm

    I’d be interested in hearing their disagreement.

  • anon May 6, 2010, 3:58 pm

    teresa’s comment 2 and your comment 3 actually show why it IS in your best intesest for these loans to be renegotiated. in addition, you sweep an awful lot of “and unless the bank engaged in fraud…” under the rug. there has been extensive writing that there was SUBSTANTIAL amounts of fraud.

    these 2 links may interest you. they are a bit old, but the argument remains. the second link has many of the objections you list and his answers to them. i think he successfully straddles the line between doing something and not making it a “bailout” in a traditional sense.

    Workouts, Not Bailouts

    and

    Consequences for Lenders, Aid for Borrowers

  • Alison Moore Smith May 6, 2010, 8:47 pm

    Hello anon.

    I’m not sure what you mean about Teresa’s second comment and my third showing the reason for negotiation. Perhaps you can clarify. Also, as I said, when there is fraud, those committing it should be held responsible.

    The articles were interesting. I have a couple of thoughts about them.

    In the first, Roopak Shah:

    please explain why the people who bought bonds that they couldn’t value properly are bad actors but the people who contracted to pay mortgages that they could not afford pay are only victims?

    Krugman’s response is:

    Because borrowers aren’t billing themselves as financial experts, and they aren’t steering lucrative business to credit-rating agencies that say don’t worry, be happy. A lot of the subprime victims, in particular, are less-educated, lower-income people who are especially vulnerable to dishonest marketing.

    This response is extremely problematic to me for a number of reasons. To argue that people are “victims” because they are uneducated or because they are willing to enter into contracts that they (a) don’t read, (b) don’t understand, (c) won’t be good for them in the long run but give them great goodies in the short run — in other words they are victims if they are free to be stupid — puts the freedom of all of us at risk.

    Think of the great things that have been accomplished by those willing to take risks that most label foolish! By removing all those choices, we take away the positive and the negative aspects of freedom to determine our destinies. And who will be hurt the worst? Likely it will be the “less-educated, lower-income people” who have been deemed by the nanny state too stupid to make any risky decisions.

    If mortgage brokers and/or lending institutions are dishonest, then by all means deal with the fraud! I absolutely agree with Nancy who discussed the depth of corruption. And trust me when I say I really do understand the price whistleblowers pay when facing those with huge financial incentives to defraud. We have a great deal of housecleaning to do in this country (another post entirely). But putting the government in charge of purging corruption is probably the most idiotic thing we could ever do.

    Later Jonathan Doolittle and Krugman get cranky about changes in bankruptcy law. But they provide little basis.

    Doolittle:

    Under the prior provisions of Chapter 13, you could cram the value of the house down to its fair market value

    According to the two of them, this is “fair and workable”:

    • Jack buys $500,000 home.
    • Jack borrows $450,000 from bank, with house as collateral.
    • Something wicked happens and Jack can’t pay mortgage.
    • Housing market drops. House is now worth $400,000.
    • Jack and/or his lawyer and/or the government “crams” the loan down to $400,000.
    • Jack now owes $400,00.
    • Big evil bank loses $50,000.

    Again, we are ignoring the real victim. It’s not Jack. Jack just got $50,000 of someone else’s money for free. Who is the real victim? And how is this fair?

    But do notice that I’m fine with banks renegotiating, voluntarily, as long as the correct parties are held responsible to the extent possible.

    In the first article you link to, Krugman isn’t very clear about what he’s proposing. He says it’s not a bailout, yet it involves “federal agencies buying mortgages…at a steep discount, then renegotiating the terms.” I’m not sure how he’s differentiating, but as far as I can tell his “victim” is, again, someone who enters into a contract and then defaults. He calls them “…borrowers who were victims of the bubble.” Victims? Is there some guarantee that property will appreciate every year with no downturn?

    Investments have upside potential and downside risk. That’s life. I’m not willing to forgo all of life’s possible upsides to make sure I never have a downside. But I let my kids swim and ride bikes, too. 🙂

  • Mike February 22, 2012, 4:02 am

    So do you think fractional reserve banking is ok, loaning money that does not exist. and earning interest on that money that does not exist and then the bank taking an insurance policy out on your loan being paid out of your monthly mortgage payment to pay for the insurance, collect all interest you paid. then collecting insurance on the loan when after forecloser and then selling house all over again to start the process over.

  • Alison Moore Smith February 22, 2012, 11:48 am

    MIke, I’m not completely against leveraging assets, but whether or not the current levels are fiscally wise is another issue. Might be good fodder for another post someday. 🙂

  • Mike February 24, 2012, 2:29 am

    About my last post, is fractional reserve banking right, the big evil bank is losing nothing, how can you lose something that never existed

  • Mike February 24, 2012, 3:07 am

    Why are banks the only ones that can leverage assets as you called it, why not everyone. Let’s say I bring my paycheck home multiply it by ten and only spend the 90% of the money that does’nt really exist. That’s what banks are doing isn’t it.

  • Alison Moore Smith February 24, 2012, 8:39 am

    Actually, Mike, regular people CAN leverage assets — and do it all the time.

  • Alison Moore Smith February 25, 2012, 12:35 pm

    Mike, I have a mortgage. That’s leveraging my assets. Anytime you get a secured loan, you leverage your assets. I kind of like the idea.

  • Mike February 25, 2012, 12:14 pm

    Who came up with the leveraging assests idea, I think we all know. Those who control the money control the peaple.

  • Mike February 27, 2012, 3:11 am

    That is were I do not see were fractional reserve banking and asset leveraging are the same thing You can not borrow 9 times what your house is worth and your mortgage is totally secured by the value of you home plus usually 20%.

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