Daily Archives: June 8, 2010

A Modest Proposal: Loan Modifications

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I originally wrote this post in December 23, 2008. I didn't think that it was too shabby of an idea, and I offer it up as though it might have some relevance.


I have an idea, likely hairbrained, but that will not stop
me from stating it.

Here are some simple facts to consider:

  • Anyone who bought a home 2005 and later
  • Some of those people who bought a home did so under false
    pretenses–I'd not extend these benefits to them.
  • Many of the
    those people are hard working Americans, who did not lie, who did not
    fully understand the egregiousness of loan resets etc, or simply
    believed that continually increasing home values would mitigate any
    concerns that they had.
  • Home prices are falling and LTV ratios
    are very unfavorable for lenders.
  • Payment/interest resets are
    putting borrowers (the good ones and the bad ones) under stress.
  • The recession will put more mortgage/home owners at risk.

My
proposal is not applicable to scammers or flippers, but rather homeowners. Here's my proposal.

Objective: To find a
manageable way to help both borrowers and lenders to rework loan terms;
keep borrowers in their home to the extent practicable; not deal an
egregious blow to lender balance sheets for principal modifications.

Example:
Borrower (qualified, and no falsification) bought a home for $400K and
the loan value was $400K (LTV=100%). At the time of purchase the home's
fair value was not impaired. Interest rate is 6.%; term is 30 years;
payment is $2,400.

The home can now has a fair value of $320K.
That is an asset impairment of $80K affecting both the borrower and the
bank. The bank and the borrower agree to modify the loan provisions. We
bring in another party. The Fed. (Why not?). The bank records a
temporary loan impairment of $80K. This impairment is guaranteed by the
Fed (or through some other arrangement) so the bank creates a deferred
loss that is carried on the balance sheet and shown as a contra
receivable.

The loan is modified so that the principal is now
$320K, the payment term is 35 (420 months) years and the interest rate
is 3%. The payment is now $1,232 per month, for a reduction of 49%. Each
time the borrower makes a payment, the amount of the temporary
impairment is reduced by 1/420 or $190 ($80K/420). The bank will record a
loss in the amount of $190 for each payment made. (One could fashion
some tax consequence to the borrower in the amount of reduced tax
benefit of interest payments).

Periodically, the amount of the
impairment unamortized balance will be reviewed. To the extent that the
impairment can be recouped (there is a recovery in home prices that
would make the $80K temporary impairment now $60K, the bank will reduce
the impairment prospectively. The decrease in the impairment (net of
expense already recognized) would be added to the principal amount of
the mortgage and the future amortized expense reduced. (Loan receivable
would be increased and the deferred liability would be decreased).  This treatment has the benefit or recognizing that over time an economic recovery could gather some steam.

I'm sure that there are lots of
problems with the above, but I see a few benefits:

  • Induces
    borrowers and lenders to work together;
  • Allows the lender to
    not recognize an immediate loan impairment (as the Fed guarantees the
    temporary impairment); keeps the loan from becoming a non performing
    asset (so the bank stabilizes their asset ratios, but interest expense
    is reduced); reduces foreclosures; supports housing values;
  • Allows the borrower to reduce their liability on the temporary
    impairment so long as they are making payments–so that is an inducement
    for them to make payments;
  • Pings the borrower by reduced tax
    benefits of mortgage interest to the extent that they have received a
    benefit. (Rather than having to pay income taxes on debt forgiveness).
  • Reduces the "freebee" perception by those who did not get
    themselves into the pickle.

The above was meant to be broad brush–the devil is always in the details.

I hope that you are still awake by the end of the post.  It has a soporific effect on folks with normal DNA.

The Tail WAGs the Dog

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The markets, like war, are long stretches of boredom interrupted by brief moments of terror. I think we're heading back into boredom for at least a little while. The fun, exciting drops, tinted in purple below, have long spans of grind between them. I think we're back to grind for an indefinite amount of time. It could be days. It could be weeks. I'm guessing days.

0608-excitement

At this point, we've all unwittingly become FOREX traders. My view is that once EUR gets back up to about 1.21, shown below, we can get serious about shorting again. My 174 shorts would indicate I'm serious already, but they are almost all small positions, and I've got no big index shorts or ultras at all, plus I've got one long DIA to balance things out for now.

0608-eur