Bernanke’s brilliant idea is to have mortgage lenders write down some of the principal owed by borrowers who are struggling to pay their mortgage payments. His reasoning is that if people have negative equity in their homes, then they have no incentive to keep paying the mortgage. If mortgage lenders were to write down some of the principal owed to make it more in line with the actual home value, then less people would default on their loans.
Previous talk of principal write-downs has gone nowhere, and for good reason. The thing is, Bernanke and those politicians who support his approach aren’t the ones who stand to lose money here. They are asking the mortgage lenders and the investors in mortgage securities, who have already taken a beating, to suck it up some more. Naturally, this idea isn’t going to sound all that appealing to them, but Bernanke and friends sure look good to the people. I know that if I owned a house with negative equity, then I would love a nice, easy fix to that problem at no cost to myself. Who wouldn’t? But if I were the one with money to lose, this type of deal would make me uneasy, and the fact that the government would be making me out to be the bad guy wouldn’t sit too well with me.
Who’s to say that these people are actually going to continue paying? Are they just guessing that the reason people aren’t paying is because of the negative equity? Bernanke was quoted by Bloomberg as saying, the “recent surge” in delinquencies has been “closely linked” to the slide of home equity. My thought is that they are using past information that suggests that people with equity in their home pay their mortgages at a better rate. Here is a potential problem: in the past, people with equity have been able to refinance and pull money out if they got into trouble, but that opportunity no longer exists unconditionally. Sure, if you have 20 percent equity, then you can probably refinance, but I don’t think that lenders would even contemplate a write down of that extent.
Writing off the principal to even it with the home’s value (100% LTV) still probably wouldn’t allow homeowners with negative equity to refinance. How far do they want the lenders to go with this write-off? If people don’t have the ability to refinance, will having the negative equity removed really make that much difference? I’m sure that it will have some effect on the amount of people paying their mortgage and avoiding foreclosure, but will those savings be enough to offset the additional costs to the lenders? That is the question that they will have to analyze for themselves.
Even if this plan could work the way Bernanke suggests, I don’t think that the lenders and investors will be able to come together to enact something like this. I just don’t see it happening, but if it does somehow come together, it will certainly be interesting to see how things turn out. Will it keep more people in their homes, helping the overall housing market? Or will it lead a mass fire sale of homes by people who now think that they can get out from under their house?
A proposal like this even being mentioned is an ominous sign for the real estate market. Investors who regularly read my blog know that I am very into cash flow real estate, especially right now. If I can’t see the income before I buy it, then I’m not interested; it’s that simple. I’m sure that there is money to be made in other non-cash flow properties, but with the way things are going right now, that is just more risk than I’m willing to take.
Labels: Bernanke, cash flow, housing bubble, real estate
