Obama’s Loan Modification or “Strip-Down” Will Make Housing Situation Worse
One of the most controversial parts of the Homeowner Affordability and Stability Plan announced by President Obama is the provision for mortgage modification by bankruptcy judges sometimes called “strip-down”. Currently bankruptcy judges cannot change the ultimate value of the mortgage and change the terms for payment. Under the Obama proposal judges would be able to sign away portions of debt and rewrite the terms for repayment.
The borrower’s payments would be limited to no more than a certain percentage of income and the interest rate would be reduced to a very low level initially for five years than allowed to rise to the market level. The Treasury would “share” in the costs by paying an up-front fee of $1,000 for each eligible modification. As in incentive for borrowers to keep current in their payments the Treasury will contribute $1,000 a year in payments for 5 years.
The guidelines for use of modifications will be issued by the Federal government to Fannie Mae, Freddie Mac, and all private institution participating and will be mandated as a requirement to participate.
Supporters of the concept of strip-down point to a study published last year by Adam Levitin and Joshua Goodman in which they claim that permitting bankruptcy modification would not substantially affect the loan market. Advocates say that hundreds of thousands of homeowners could avoid foreclosure if strip-down is enacted.
There are many critics, however, who say that strip-down is the wrong solution and will have exactly the opposite effects of those intended.
By conservative estimation there may be 3 to 4 million homeowners who might be eligible to undertake mortgage modification in bankruptcy. Evan Newmark of the Wall Street Journal points out that that this will be a bureaucratic nightmare requiring millions of meetings between bank officers and lenders verifying and agreeing to terms. Further he, Andrew Grossman of the Heritage Foundation, and many other experts point out that this program will not really help the millions of of homeowners who paid no down payment and are clearly in mortgages for property that was really above their means to purchase. Most of the credit challenged borrower’s will likely walk away than pay 31% of their income for a home they will never own within a lifetime of payments.
Chapter 13 bankruptcy currently affords borrowers relief from foreclosure and revising the law is unnecessary says Grossman. For a three to five year period payments can be reduced until a borrower gets back on his/her feet than the schedule resumes until the loan is paid off. Discussions of reductions of principal or long term payment changes are allowed between debtor and lender but unlike the proposed loan modification mandate are not rigidly fixed to a government approved schedule. Many of the experts fear that the proposed system would encourage those who do not need to file bankruptcy to proceed with it for financial advantage and would waste time on those who will end up in foreclosure anyway.
The Obama administration believes that the “strip-down” program will not increase the costs of mortgage but again many experts disagree and say that the overall cost of mortgages will be higher for all Americans especially for those first time home buyers. Mortgage lenders will need to increase the up-front costs of loans and demand higher down payments. A Federal Reserve Board Senior Economist, Karen Pence found that increasing the costs to lenders resulting in higher costs to families to buy smaller houses in Review of Economic and Statistics 2006. There will be tremendous pressure to increase mortgage rates.
Another issue that could determine whether an housing initiative will be successful in preventing foreclosures significantly is what is the future of housing prices. Noted economist Robert Schiller was quoted in MSN Money as saying that home prices are likely to decline for the next two years. Credit challenged troubled borrowers may still end up with mortgages worth more than their homes. The taxpayers will have paid billions of dollars (the cost of the program is estimated officially at $75 billion) in a futile attempt that will not change the outcome for most of those whose loans are modified.
In the end the measures of the Obama proposal are not likely to help stabilize the economy say most of the above quoted experts. Many more families will be put in bankruptcy than if the measures were not instituted, many will still lose their homes, and paradoxically housing will likely become less accessible and more expensive. Government will be taking over the financing of the housing market by pushing out private lenders. Corrections in the real estate market that need to happen to allow recovery will only be delayed.
Tony Magaña grew up in McAllen Texas, attended Texas A&M University, served as an officer in Army Reserve, and holds a doctorate from Harvard University. The co-founder of Contempo Magazine has participated in Valley business for over 20 years.He is a member of the National Association of Hispanic Journalists.
