Articles
A Judicial Solution to the Foreclosure Crisis?
by Brian Faas
Historians and economists will spend years analyzing our current recessionary woes to determine the root causes, just as they have studied the events that caused, deepened and prolonged the Great Depression. We already know that the housing bubble was one of those causes.
First, a little background. There is universal agreement that government policies over-encouraged the use of sub-prime loans. Credit was extended well beyond what was reasonable and prudent. Alt-A mortgages -- which were designed for a small minority of borrowers with income streams that are not consistent, such as the self-employed -- turned into “liar loans” allowing literally anyone to get a mortgage. Sometimes even multiple mortgages on multiple properties.
The current state of the housing market looks like this: January data from the
Case-Shiller Home Price Index shows that nationwide housing values have fallen more than 26% since their peak. In some areas, the slide has been much worse. According to an
October 2008 report, about 18% of U.S. mortgage holders are now “underwater”, meaning that they owe more on their loans than their homes are worth. Most found themselves under the heavy burden of dramatically higher payments from adjustable rate mortgages (ARMs). Many have already walked away, leaving massive tracts of foreclosures in their wake.
It would be easy to say that those people acted irresponsibly by borrowing more than they could afford. It’s equally easy to assume that the rest of us are isolated from that contagion. The problem is that we’re not.
As more value is lost in neighborhood home values, more borrowers slip underwater on their mortgages. That leads to more foreclosures which inevitably leads to further erosion in property values and the cycle continues. This housing death spiral affects everyone.
So what can be done? Sure, creating millions of new jobs for displaced workers would help. But that’s only part of the solution. With their payments ballooning out of control, even a new source of income may not be enough to keep millions of families from losing their homes, thereby driving down everyone’s property values even further.
Inspired by the
Hope for Homeowners program, many responsible borrowers have tried to renegotiate their ARMs with the lenders, but have been turned away. This is due to the complicated system by which their loans have been chopped up, combined with other mortgages, repackaged and sold to groups of investors. These loan products are called Collateralized Debt Obligations (CDOs), which you might imagine to be like packages of ground beef. One package might contain meat from several cows, or an entire herd. A single mortgage, like a single head of beef cattle, may be sliced into as many as 50 parts, with each part owned by a different investor. Before the loan can be modified, all 50 investors must agree to the new terms, but that rarely happens. A few stubborn investors think they will lose less money if the home goes through foreclosure.
What is urgently needed is for judges to be granted special temporary authority to issue new terms on these troubled mortgages. Today, judicial authority does not include the ability to rewrite lawful contracts. But in these difficult times, that may be the best hope for a conclusion to the foreclosure crisis.
Here’s how it would work: After hearing evidence from both borrower and lender, a judge would decide on new payment terms that are in their mutual best interest. That could include changing to a fixed interest rate (4-7% has been suggested), and/or increasing the length of the loan to as much as 40 years. Any outcome which allows a responsible borrower to stay in the home, yet still pay as much as they reasonably can afford, is good for all of us.
Owning a home is still a major investment. But it no longer offers the consistent returns that we once thought it would. In the future, home ownership will likely not be a significant part of one’s retirement strategy. And it certainly cannot be used as a cash machine, as millions of Americans did over the last decade.
(Editors note:
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