Opinion

A plan to unclog the housing market – where everyone wins

Millions of foreclosed and underwater homes are clogging the housing market, stalling economic growth. But there's a way to streamline the refinancing process. Banks and borrowers can work out new terms that keep owners in their homes and give lenders 50 percent of future appreciation.

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The housing market continues to be a drag on the economy. While many aspects of the Great Recession have been resolved, until the overhang of foreclosed homes and underwater mortgages gets flushed through the system, we are likely to have weak economic growth and high unemployment. Another million home foreclosures this year will also wreak havoc on families and communities. It is time to take bold action.

We can start by finally admitting that both lenders and borrowers share the blame. Homeowners borrowed more than they could afford, and banks made bad loans. When a bank lends $490,000 to a borrower so they can buy a $500,000 house, which then drops in value to $250,000, the bank has made a bad loan. Even worse, the lender may not have even required the borrowers to provide a pay stub to show that they could afford the payments.

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With most commercial, real estate loans, once the borrower and lender find that they have a problem, they sit down and try to work out a reasonable compromise. In the case of home loans, the number and size of the loans makes ad hoc solutions difficult. What we need are standardized processes and procedures that achieve a balanced outcome.

Start with new appraisal, new loan

This process would start with the borrower working with its servicer and obtaining a new, independent appraisal.

Based on that appraisal, the lender would then be obligated to write a new loan at the current interest rate and at 90 percent of the appraised value.

To make this system work, I would also include three other provisions.

Three key provisions

First, the borrowers would have to prove that the house is their principal residence.

Second, through pay stubs and similar paperwork, they would have to show that they can afford the payments and that the principle, interest, real estate taxes, and insurance would be no more than 30 percent of their gross income.

Third, the lender would receive a second mortgage entitling it to 50 percent of the profit when the house is sold. (The profit would be the sales price less closing costs and less the original amount of the new mortgage.)

This shared-appreciation second mortgage will keep most homeowners who can afford their current mortgage payment from refinancing and utilizing this program. On the other hand, homeowners who are in danger of losing their house should be willing to give up 50 percent of the future appreciation.

From the standpoint of the existing lenders, getting repaid 90 percent of the appraised value is probably more than they would receive in a foreclosure, and they get 50 percent of future appreciation as a bonus.

Working out the kinks

Once the kinks are worked out, the refinancing of underwater mortgages could become streamlined and efficient. In many states, it now takes well over a year from the time a lender starts the foreclosure process until it is completed. This process may get even longer now that homeowners are able to question the validity of the underlying paperwork.

Two major obstacles stand in the way of implementing this kind of program. The first is the role of the servicers. Mortgage servicers collect the monthly payments and deal with the borrowers. Currently, they are guided by some perverse incentives where they make more money if they charge penalties and foreclose on a home rather than writing down the mortgage, even if the owner of the mortgage note ends up with less money.

As part of implementing this new program, the government would have to work with the major servicers and convince them that their fiduciary responsibility to their investors outweighs their narrow self-interest in collecting fees. Since the largest servicers are affiliated with major banks, the government has considerable leverage in this negotiation.

The second major obstacle is the lenders. If lenders are forced to write down their loans in this way, it could force some of them into bankruptcy. Lenders have adopted an approach sometimes called “delay and pray,” where they hope that the housing market will recover and the loans on their balance sheet will then be worth more.

ANOTHER VIEW: Washington is making the housing crisis even worse

To overcome this second obstacle, bank regulators need to do their job. With all the assistance banks have received the past few years, if any bank is still insolvent, it should be closed. The choice comes down to unnecessarily kicking families out of their homes vs. allowing banks to overvalue their mortgages. The bank regulators need to stop siding with the banks.

If Fannie and Freddie get on board

A program like the one outlined here will not be simple to implement, of course. But there are two key players in the housing market who could jumpstart this process and make it happen.

Fannie Mae and Freddie Mac own or guarantee at least 50 percent of the outstanding mortgage loans. They are essentially owned by the government. If they agreed to implement this kind of program, we could quickly begin to unclog the housing finance system and the overhang of foreclosures and potential foreclosures.

While Fannie Mae and Freddie Mac would have to record substantial losses in the short term, that is preferable to spreading these losses over many years with all the negative consequences to the economy, taxpayers, homeowners, and communities.

John H. Vogel Jr. is an adjunct professor at the Tuck School of Business at Dartmouth College.

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