I came, I saw, I conquered.
Julius Caesar's rather boastful rumored comment must be something similar to what the CEOs of Bank of America, Wells Fargo, JP Morgan Chase and Citigroup will be saying this weekend. Negotiations with the government to help distressed homeowners avoid foreclosure will be coming to an end — and a solution is in sight.
The critical question is not what should be done with foreclosed homes, but rather: Where does the money to pay foreclosed and distressed mortgages come from?
This is a subtle difference.
In a recent document released by the Federal Reserve Board, chairman Ben Bernanke argues foreclosed homes reduce surrounding property values twice as much as home vacancies. Bernanke said a continuing decline in home values makes people materially poorer because the largest asset for most Americans is a home. This, in turn, causes people to feel poorer and spend less. Bernanke hypothesizes keeping people in their homes instead of reselling them, or having the bank take losses, Mr. Bernanke hypothesizes, should give the economy a kick.
Bernanke gives suggestions, ranging from somewhat farfetched, such as a type of rent to own scheme, to more sensible measures such as providing an incentive for homeowners who are facing foreclosure to keep their mortgages.
However, banks are reluctant to take any advice because of pending litigation, including a potential $25 billion settlement with the Obama administration for alleged improper mortgage servicing. Banks have no incentive to cooperate.
Enter the nice parent.
As reported in the Financial Times, banks and the U.S. government are developing a scheme that equates aid received by distressed homeowners to amnesty and varying levels of penalty reduction. Banks have two distinct classes of mortgages: mortgages on their balance sheets and mortgages sold to investors.
The current plan is to incentivize banks to reduce the value of mortgages on their balance sheets rather than reducing the value of mortgages sold to investors. Reducing the value of mortgages on bank balance sheets would reduce the mortgage debt of homeowners, but mortgages investors own would retain their value. So, investors get the full amount of interest over the life of the loan.
This plan has a problem, though. A $25 billion cumulative reduction in penalties is mere pennies compared to the $7 trillion in household wealth estimated by Bernanke to be lost after 2006. Bank of America alone gave out $2 trillion in mortgages between 2004 and 2008, according to data complied by Morningstar, a fund-research firm.
If banks can repossess homes and find new owners, they stand to make back the principle loans plus mortgage interest, which turns into far more than $25 billion.
Alas, what is a government to do? Incentivize cooperation more, apparently.
The president of the New York branch of the Federal Reserve recently gave a speech arguing $15 billion of taxpayer money should be spent per year reducing home mortgage principle until the housing problems are solved.
He makes a compelling argument, though it is likely to anger many. An alternative is for investors of home mortgages to use investment equity to reduce mortgages on bank balance sheets, equally angering to others.
Both plans come to the same end: mortgage principles get reduced because banks receive equitable payment to do so. Banks, then, will get the principle and interest over the years plus amnesty from punishment. Quite the conquest, indeed.
Reach the columnist at whamilt@asu.edu
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