Monday, February 02, 2009

WHO'S ON FIRST? AN EXPLORATORY CALCULATION

Sam Smith

Let's say a couple borrows $100,000 on their new house. Let's say one of the pair loses their job and has to take one at a lower wage and the family is no longer able to pay the $7200 annual mortgage cost. Thanks, however, to one homeowner still being employed, the couple can still pay about $5000, or 70% of the total.

What's to be done? If the bank lowers the interest rate from 6% to 5% and extends the mortgage from 30 to 40 years, this would lower the annual payments to about $5800, still too much but within the park. Besides, perhaps the owners have savings that allow them to handle it for a few years.

But what if the bank doesn't want to help and what if the bank is no longer in charge of the mortgage, but has bundled it off to somewhere else?

This is why giving bankruptcy courts strong powers to modify such loans is so important. Mediation can help, too, although a study in Connecticut found that about half of endangered homeowners didn't ask for any help, many apparently unaware that it was available. In the end, mediators could only resolve about 5% of the cases.

Michael Hiltzik, in the LA Times, explains how the proposed bankruptcy court changes would work:

"Under the leading proposal in Congress, a typical plan would work like this for a debtor owing, say, $225,000 on an adjustable-rate mortgage on a home now worth $200,000: The judge reduces the balance to $200,000. The excess $25,000 becomes an unsecured debt to the lender, to be paid off, probably for pennies, at the end of the case. . .

"The judge can modify the remaining loan by converting the adjustable rate to a fixed market rate, adding 1% to 3% as a risk premium. The judge can erase all the fancy gingerbread that makes so many mortgages toxic -- periodic rate adjustments, prepayment fees, balloon payments, etc. -- and extend it out as long as 40 years. If the judge determines that no combination of these alterations would produce a mortgage the debtor could handle, the house could be foreclosed."

Another solution - one the Progressive Review has argued for - would be for the government - federal, state or local - to become a part owner of the endangered house, pay its share of the mortgage and get its share of the proceeds when the house is finally sold, probably under better market conditions than at present.

But let's say the market doesn't recover and the house is sold ten years from now for 20% less than was paid for it, i.e. $80,000. The government would get $24,000 out of the sale. Interest payments plus principal balance minus sales price would leave the government in the hole about $23,000. If the house had increased in value by 10%, the government would end up down about $14,000.

But let's say you're part of the Washington power system. You know that more of your campaign contributions come from creditors than from those who owe them money. Besides you're used to dealing with issues from the top down. So instead of be interested in working out endangered homes at a local level based on the specific facts of each case, you decide it's a lot simpler just to bail out the banks, especially when Hank Paulsen says if you don't, we may have riots and need martial law.

So that $100,000 foreclosure-in-waiting disappears into a giant bailout. It's safe to guess that some of that bailout is going to be used to cover the bad $100,000 loan; it just won't be accounted for that way. Better yet, the bank can even get tax dollars for the failed mortgage and then sell the house at, say, a 50% discount. Then the bank would be ahead $150,000 from where it was before Congress acted.

There are other approaches being discussed, such as the government buying the $100,000 mortgage and then disposing of the house itself at a discount. In which case the bank would be ahead $100,000, the government down $50,000 and the homeowners still on the street.

Either way, what has happened - without a word being said about it - has been a substantial transfer of wealth. In one approach, the government has subsidized the homeowner by $14-24k and in the other case the winner is a bank that will end up $100-150k ahead. Which is cheaper? Which is wiser?

The troubled homeowners lose their house, their down payment and everything they have paid the bank to date. Further, everyone who does business with the family will likely suffer as well. The town in which they live will find their property tax revenues slipping. Social service costs may increase as the family needs assistance of one sort or another.

Meanwhile, if the bank is designated the official victim in this matter, it will either recover its losses (plus all the interest that was paid before the crisis) and may even make a profit out of the deal. Further, the gap between being a banker and being a homeowner has just widened again.

Note finally that if you primarily help the banks, the homeowners have gained nothing, but if you help the homeowners the banks are helped as well.

Multiply our aforementioned troubled homeowners by their several million colleagues in disaster and we're talking about real money and a real transfer of wealth and power.

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PLAY IT AGAIN, SAM

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Your editor has been a musician for many decades. He started the first band his Quaker school ever had and played drums with bands up until 1980 when he switched to stride piano. He had his own band until the mid-1990s and has played with the New Sunshine Jazz Band, Hill City Jazz Band, Not So Modern Jazz Band and the Phoenix Jazz Band.

NOTES ON THE MUSIC

Here are a few tracks:

SAM SMITH'S DECOLAND BAND

'SHINE' 

JELLY ROLL

PHOENIX JAZZ BAND

APEX BLUES   Sam playing with the Phoenix Jazz Band at the Central Ohio Jazz festival in 1990. Joining the band is George James on sax. James, then 84, had been a member of the Louis Armstrong and Fats Waller orchestras and hadappeared on some 60 records. More notes on James

WISER MAN  Sam piano & vocal

OH MAMA  Sam piano & vocal