Big problems seem to require big solutions. When the housing bubble burst and millions of homeowners fell into default and foreclosure, Wall Street and the big banks were subjected to great financial distress due to the over- and miss-use of mortgage-backed securities. The big solution was to bail out these institutions. The bail-outs enabled the banks and Wall Street to recover nicely (perhaps too nicely, especially considering all the unethical and most-likely illegal activities), but the underlying problems remain for many homeowners.
According to an article in the January/February issue of Money magazine, 2.5 million homes have fallen into foreclosure since the bubble burst, and another 4.5 million are in danger of reaching the same fate. Millions more are underwater (owe more than their house is worth) and may be tempted to give up. Help has been and remains available from both government and private institutions to assist borrowers so that they may continue to make their payments and remain in their homes. This assistance mostly consists of modifying mortgages by reducing interest rates and/or extending the term of the loan. According to Laurie Goodman, an expert on mortgage-backed securities cited in the article, these efforts do not work as they don't fix the fundamental problem -- an unsupportable debt load.
Goodman favors another approach, one that may be looked upon as a bailout for the little guy, but isn't it about time? Goodman proposes something very simple -- that lenders attempt to rehabilitate their delinquent borrowers by reducing the principal of the loans. She has statistics to prove that lenders and the investors in mortgage securities come out ahead by utilizing this approach vs. following the traditional course and allowing the mortgage fall into foreclosure.
Now here is the good part -- to avoid the "moral hazard" of allowing foolish borrowers to escape the consequences of their foolishness, Goodman recommends that lenders swap the principal reduction for a share of any gains when the house is sold. In other words, share the pain, share the gain.
This idea, "shared-appreciation mortgage modifications", does not have wide acceptance. Fannie Mae and Freddie Mac won't have anything to do with it. Banks don't want to take immediate write-downs, they would rather delay and hope for the best. Mortgage servicers don't like it because their fees are based on the amount of principal. And principal reductions often require those holding second mortgages to take a total loss on those notes.
Which brings us to Goodman's main point: "Many of the rules in place now are large-bank-friendly, but borrower- and investor-unfriendly."
And to my point: We are past due for a change in those rules.