"What To Do With 'Under Water' Mortgages?"

Reuters – A real estate broker checks a foreclosed California home for damage and missing appliances in a May 2008 …

Long before she filed for bankruptcy, Ann Neukomm was "under water" -- she owed more on her mortgage than her house was worth -- a situation more and more Americans are finding themselves in.

As the financial crisis hits Main Street America, nearly one in six U.S. homeowners are finding themselves in the same position, threatening the U.S. economy with a new wave of foreclosures and bankruptcies.

About 12 million U.S. homeowners owe more than their homes are worth, compared with 6.6 million at the end of last year and slightly more than 3 million at the close of 2006, said Mark Zandi, chief economist at Moody's Economy.com.

"At the root it's 'the' problem," said Zandi. "If you're going to put your finger on the one thing that's gotten us into this fiasco, it's the fact that millions of homeowners are under water on their homes."

If, like Neukomm, these homeowners go into foreclosure, it would add to the oversupply of homes, delay a recovery in the housing market, and add to pressure on banks.

Already, U.S. consumer spending is slumping as homeowners find they can no longer take equity out of their homes to fund their lifestyles.

In a slowing economy, it doesn't take much to push an underwater mortgage into default.

"When you're under water and you have some kind of hit to your income or some kind of unintended expense, that's when you default. And so now we've got this noxious mix of millions of people under water and quickly rising unemployment," Zandi said.

Like Neukomm, 57, many people got into trouble by refinancing mortgages to pull out cash when rising property values made it seem like an almost risk-free deal.

She ended up filing for bankruptcy in May after failing to keep up with mortgage payments on her home in Cape Coral, a once-booming town in southwest Florida.

"It's a dirty word," said Neukomm of her bankruptcy and personal feelings of failure. "Nobody wants to say it."

Nationwide, for those who purchased U.S. homes since the beginning of 2003, nearly one in three now have negative equity. Nearly half of buyers who purchased in 2006 are under water.

Despite tighter credit and underwriting for home loans this year, Steve Berg, a managing director at research firm LPS Applied Analytics, said mortgages originated in 2008 were on par or trending worse than those originated last year or in 2006.

"Presumably the equity position of the borrowers in the loans originated this year should be better," Berg said in an interview. "That doesn't appear to be the case, and certainly not to the magnitude you'd expect."

Foreclosed homes already account for 50 percent of all home sales in some markets, according to Zillow.com, an online real estate research service.

Economists like Zandi worry that the underlying housing crisis could eventually prove much more costly to the U.S. taxpayer than the $700 billion the U.S. government has pledged to recapitalize banks and buy up distressed debt from financial institutions.

"The government is going to have to start filling this negative equity hole and that's just going to be a direct cost to taxpayers," Zandi said. "This is going to be the really costly part, I think, for taxpayers."

While the U.S. government has focused its rescue on banks, it has done little to help individuals who are struggling to pay their mortgages, apart from the HOPE NOW program, which has facilitated a few hundred thousand mortgage restructurings.

The government may have no option but to step in, especially if a rising tide of foreclosures and falloff in property and other tax revenues endanger municipalities and local governments and force some into bankruptcy.

Both presidential candidates have outlined plans for relief for distressed homeowners but critics say they have been short on details and there appears to be little consensus about how best to help homeowners who are under water.

When John McCain announced his "new" plan to address the financial crisis by having the government directly buy up troubled mortgages, our first response was "wait a minute...that's already in the bailout bill." And, in fact, the bill does give the Treasury the authority to buy up precisely this type of debt." The TARP authorizes the Secretary of Treasury through Section 3 (9b) to buy "any other financial instrument" that the Secretary of Treasury "determines promotes financial market stability," including "residential or commercial mortgages." The legislation also directs the Treasury to use its new authority to help keep struggling families in their homes. Indeed, word is that Treasury is already exploring how to implement such authority.

As outside economic advisors to the Obama-Biden campaign, we were also aware that his type of effort to restructure mortgages to help keep families in their homes had been something Senator Obama had been calling for since March. Thus our initial conclusion was that this proposal was a rather non-consequential ploy by McCain to provide cover for the fact that he has tended to be either late, on the wrong side, or frenetic and all over the map on policy responses to our current financial crisis.

But today we learned of a detail that makes his plan significantly different -- and much worse. The McCain plan uses taxpayer dollars to buy distressed mortgages at their full, face value from the banks and lending institutions that are currently stuck with them. Only then, after we the taxpayers have fully absorbed the cost to the lender of these troubled loans, does the homeowner get the benefit of the lower principal.

That's right folks...it's private profits and social losses. Instead of an effort to safeguard taxpayers as Senator Obama has called for and the Frank-Dodd bill goes to great lengths to do, this plan takes from taxpayers to provide unjustifiable subsidies to financial institutions - even those who engaged in deceptive or outright fraudulent practices to induce people into homes they could not afford.

What responsible plans like Dodd-Frank do, by contrast, is to include the following critical provisions: First, if lenders want into the plan, they have to agree to "take a haircut," i.e., write down the principal on the loan. This step spreads some of the economic pain around between the lender and the government (taxpayer), who in return for the write down, guarantee that the mortgage will be repaid. Second, Dodd-Frank requires that homeowners who benefit from a lower mortgage and more stable monthly payments share some of the upside benefit with taxpayers when the values of their homes recover. Together, these steps ensure mutual responsibility - that lenders, borrowers and the government each share in the process of stabilizing the housing market while protecting taxpayers to the maximum possible extent. Or then we can go with a "Resurgence Homeownership Plan" and just write checks to financial institutions and hope it trickles back to the rest of us.

      Unless something is done now to aid "under water" or "upside down" mortgages there will be a second and even greater tidal wave of foreclosures here in America. People who bought homes at inflated prices, borrowed on the homes with little or no equity and now owe much more than the houses are worth are on the verge of foreclosure or simply walking away. The Treasury Secretary under the 700 billion dollar bailout or the Troubled Asset Relief Program (TARP) already has authority to deal with the issue of "under water" mortgages but apparently banks and Wall Street investors having capital to lend and invest is more important than "under water" mortgages and more foreclosures. Since both Barack Obama and John McCain voted for the 700 billion dollar bailout or TARP, instead of political posturing and pandering with the issue, why don't they just say they will demand the TARP be immediately applied to solving the housing crisis from the "bottom up" by helping those with "under water" mortgages now. Better yet why doesn't Chris Dodd, Barney Frank and Congress get on Paulson's ass to do something now for homeowners on the verge of foreclosures. As I see it, there is no need to wait for the next President. Just do it!

tags: under water mortgages  business  tarp  capitalism  politics  takebackamerica  obama  mccain  paulson  the economy  

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