NY Times Backs Principal Reductions

Last year I suggested that the way to solve the housing problem was to reduce the Principal amounts on Mortgages to get them more in line with the prices of the houses on which the loans were written.

The solution was a part of a bank nationalization wave that would remove the mortgage portfolios from the books of banks and then have the government modify the mortgages in those portfolios. It would have cost a lot of money, but it would have stabilized the housing market 8 months ago…

Principal Reduction is a simple concept
If somebody owes more than they can afford to repay and the amount is substantially higher than the current value of the house (Negative Equity), then you need to reduce the amount of the loan, or the homeowner will walk away. I posted on Negative Equity last week and it is pretty clear that the problem is now too big to ignore.

Team Obama’s Master Plan
The plan for Obama was to stabilize the Banks with Trillion of Dollars from the Taxpayer and changes to the Rules of Accounting and then artificially cap Interest Rates so that homeowners could refinance their variable rate mortgages at historically low long term interest rates. This was their “Humpty Dumpty” moment, when they tried to put the Securitization Market back together again – PIMCO’s “Shadow Banking System” bs.

The only entity to be harmed by this would be the US Taxpayer, as they would be stuck with Trillions of Dollars – and who in Washington cares about them when there is not an Election at stake. Wall Street and Bank Stock and Bond holders were the primary beneficiaries of Obama’s plan.

Obama’s “solution” was doomed to fail
It relied on Homeowners being willing to pay more to live in their newly-refinanced house than it would cost them to rent the house next door

It relied on Banks to let Homeowners off the hook on Mortgages that paid lots of Interest to the Banks

It required the International US Treasury Investor to look beyond the reality of US Economic Fundamentals and buy Long Term Bonds at 3% yields

It required the printing of so much money (Quantitative Easing) that gas prices rose to a high enough level to choke off the economy (it only took 3 months to get there)

And now it is all unraveling
An Op Ed from the NY Times on July 4th banks Principal Reduction as a new policy –

http://www.nytimes.com/2009/07/05/opinion/05sun1.html?_r=2

“Unless substantially more relief is forthcoming, Moody’s Economy.com projects that some seven million homes will fall into foreclosure this year and next. Of those, nearly 4.5 million will result in distress sales, prolonging the recession by adding to the downward pull on house prices, home equity and household wealth. And those dire projections may prove too optimistic.
Reducing principal is a better idea because it restores equity to borrowers, which gives them more of an incentive to keep paying their loans and makes re-default less likely. Banks generally loathe principal reductions, in part because they result in upfront losses, and the administration has not championed the idea.
The president and his aides must be prepared to rethink their position.
Done correctly, a loan modification should benefit everyone. For a troubled borrower, it is a chance to stay in the home. For lenders, it means that they will make more money than they would make from a foreclosure. For taxpayers, the cost of subsidizing the right sort of modifications will be far less than the damage to the economy from millions of more foreclosures.”

Where was the NY Times on this in September/October 2008 – several Trillion Dollars ago? (Your personal rant here)

I think Team Obama’s biggest fear is that Principal Reduction will by definition lower the value of the Mortgages Backed Securities that the banks currently hold on their books at artificially high prices. That means that the banks will have to raise still more money to remain “solvent”.

The only way out of this in a timely fashion is to nationalize the insolvent banks, strip their loans portfolios out, refinance the bad debt, recapitalize the banks and sell them in a few years for a profit to pay for all the losses they taxpayer will be hit with when they write down all the bad loans.

If we are lucky, this will become the main issue of the 2010 Election. My fear is that the Asset Price Appreciation policy wonks will win the day and inflate us into a bigger bubble later next decade.