“The Value Of Mutual Can-Kicking”

Dolors & Sense

by Sanford Rose

KISSIMMEE, FL—(Weekly Hubris)—3/1/10—The key to Obama is his oft-quoted belief that “things are never so bad or so good as we think.”

He’s wrong. The great implosion was worse than virtually anyone thought, and our underestimation of this continuing cataclysm has immeasurably aggravated it.

Is it finally over? Not when over 300,000 foreclosure notices are mailed out each month, a number slated to rise throughout the year. Not when one in four owes more on a mortgage than her or his house is worth. Not when one in seven is either out of work or underemployed.

Can we pull out more quickly and with much less suffering than now seems likely? Yes, and not in a way that would allegedly drive the dollar, which is recovering in the wake of Eurozone angst, back down again.

The linchpin is, of course, housing, over-discussed and yet still undertreated. Despite its much-publicized loan modification program, the Administration, quailing at the supposed complexity of a basic housing solution, has taken the approach that general demand reflation will gradually resuscitate the residential and commercial real estate sectors—”a rising tide lifts all ships.” The approach isn’t working.

It could get worse. It is becoming chic not to pay your mortgage, even if you can. In this area, as in so many others, the bankers are our beacon, our guiding light. Recently the Mortgage Bankers Association of America announced that it had “short sold” its Washington DC headquarters building and would be paying the lender, or mortgagee, some $26 million less than the amount of its loan. The MBA had of course tirelessly intoned the need for all to respect contracts. But the fact that its behavior belies its words should not blind us to the wisdom of that behavior. The bankers will pay the difference between the loan amount and the sales proceeds later. They are kicking the can down the road. That’s supposed to be bad. But is it? Quite the contrary: it’s very good.

There are two reasons why the Administration has not moved more aggressively to solve the housing problem. Solving the problem requires the writing down of loan principal, and that’s supposed to be unwise because: 1. It will give everyone with a mortgage the incentive to default; and 2. If the principal on the first mortgage gets written down, the entire amount of the second mortgage, which is junior to the first, must also be written down. But, while the banks have securitized the bulk of their firsts, they have offloaded comparatively few of their seconds. There are some $950 billion of seconds still on their balance sheets. Write these down and the industry’s capital vanishes. We are right back where we were in September of 2008.

Both objections can be addressed by applying the lesson implied in the mortgage bankers’ delaying action. But it has to be done by law. Voluntarism doesn’t work.

Pass a law that mandates the writing down of the principal value of home mortgage assets (never mind the commercial part for the moment) to an amount at least equal to the property depreciation in any given local area, if and only if home owners request this and are willing to abide by the following condition: To wit, they will repay half the difference between the reduced mortgage value and whichever is the greatest of (a) the realized value of the home if it is sold, (b) its appraised value if not sold, or (c) the appraised value of a newly purchased home within (and this is key) the next seven years. If you think about it, this type of can-kicking tends to limit the number of people who will immediately come forward to claim the principal reduction because it says: we will restore your positive home-equity position but any increments to that equity must henceforth be shared with the lender 50-50. But it does restore positive equity for many and thus cuts the potential for “strategic” defaults by perhaps a couple of million.

Now can-kicking has to be mutual, so the lenders get the option of amortizing the writedowns over a comparable seven-year period, cushioning the impact of the writedowns on their capital positions. Of course, this would require some muscling of accountants, but Congress is practiced at this job.

This is a bet that the “re-equification” of the homeowner will increase his confidence and thus help unzip his wallet. The resulting rise in consumption and spending will prevent further depreciation in house property values (indeed, initiate appreciation) and help repopulate those empty stores in the nation’s malls, levitating commercial real estate values. It is a bet worth making. But we must do this quickly, formalizing the process of shared payment of future increases in home values and delayed recognition of the loan losses that help make possible a revival of those values. We must, in effect, rush to delay.