

Time to tackle the real evil: too much debt - lackbeard
http://www.ft.com/cms/s/0/4e02aeba-6fd8-11de-b835-00144feabdc0.html?nclick_check=1

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skushch
So I'm somewhat confused with the article's suggestion that:

"The only solution is to transform debt into equity across all sectors, in an
organised and systematic way. Instead of sending hate mail to near-insolvent
homeowners, banks should reach out to borrowers and offer lower interest
payments in exchange for equity."

As I understand it, most that will walk away from their homes are upside down,
meaning they owe more on the property than it is worth. That is also the
reason that they're unable to refinance.

So the authors suggest that the bank lower the interest on the loan in
exchange for equity which the homeowner has none of?

~~~
sokoloff
Imagine you bought a million dollar house, with nothing down (for simplicity's
sake).

It's now worth $900K and you're considering walking away.

What if the bank took 15% ownership of your house, in exchange for reducing
the principal balance to $800K? You'd pay less on your mortgage (balance of
$800K instead of $1000K), and while you'd be slightly upside-down (you'd owe
$800K on $765K worth of house), you're still much closer than when you were
$100K in the hole. (Plus, you don't have the PITA, stigma and credit rating
destruction of getting foreclosed on.)

Fast forward a few years and you can sell the house for $950K and decide to do
so. You get $807K, the bank gets $142K (compensating them partially for
forgiving $200K of your original balance in exchange for the 15%). In almost
all cases, that delayed $58K loss is better than an immediate $250K loss from
foreclosing and selling for $750K or so.

That's but one way to accomplish the debt-to-equity exchange.

~~~
anamax
> Fast forward a few years and you can sell the house for $950K and decide to
> do so. You get $807K

Hmm - no. You get a little bit over $7k. You still have to pay off the
mortgage, and very little of that happens in the first few years.

Note that you're assuming another housing boom because you need it to make the
"equity forgiveness" look less insane.

The big problem is the assumption that these folks can pay an $800K loan yet a
$1M loan is completely out of their range. For a small minority, maybe but
most of the people in this situation can't afford the $800K loan either.

Yes, some folks are bailing on loans that they can afford, but the vast
majority of foreclosures involve people who can't afford their loans. They're
not 20% away from making it, they're 50-70% away. (Banks don't foreclose on
folks who are current.)

~~~
sokoloff
6% housing appreciation in a few years is FAR from another housing boom. In
fact, it's under most estimates of inflation. And with the way we're printing
money over here, I think inflation is far more likely to increase than
decrease.

I don't think that this is necessarily a "great idea" but I was just trying to
explain how the bank can get "equity" (a share of ownership) from a homeowner
who is underwater in their current mortgage.

~~~
anamax
> 6% housing appreciation in a few years is FAR from another housing boom. In
> fact, it's under most estimates of inflation.

If it's under inflation, this equity deal is a bad one for the bank.

> I was just trying to explain how the bank can get "equity" (a share of
> ownership) from a homeowner who is underwater in their current mortgage.

No - you were claiming that this sort of deal made sense for a bank. Getting
equity isn't actually a problem. And, there are many deals that a bank can do,
so inventing one isn't actually all that interesting.

The relevant deals are profitable.

And, you still haven't addressed the real problem, that the vast majority of
these folks can't afford an $800K loan either.

~~~
sokoloff
> If it's under inflation, this equity deal is a bad one for the bank.

The bank is already in a tough spot. They're $100K+ in the hole in a
foreclosure situation, so going a lesser amount in the hole is an improvement
in their situation. You cannot compare to the "don't make the original
mortgage loan case" and say that because they're "giving away" $65K in value
that it's the worst of their available options.

> No - you were claiming that this sort of deal made sense for a bank.

Please show me the text that makes that claim. (I happen to think that it
does, but I don't believe I actually made that claim.)

> And, there are many deals that a bank can do, so inventing one isn't
> actually all that interesting.

> The relevant deals are profitable.

There are many. OK, please propose maybe two alternate deal structures under
the above facts/circumstances that are materially different and better for the
bank. (Saying they'll take 18% equity for otherwise the same loan mod is not
materially different IMO, even though it's obviously better for the bank.)
Ideally your proposed deals would have a chance in hell of the bank offering
and the borrower accepting.

> And, you still haven't addressed the real problem, that the vast majority of
> these folks can't afford an $800K loan either.

The fact that people who once got a million dollar mortgage and now can't
afford an $800K mortgage is not my problem to address. I didn't loan them the
money, and unless they're in my neighborhood, it's such a vanishingly small
part of my damn business or concern that I'll choose to spend time on things
that do matter to me or that I can influence.

If the bank lent to someone who couldn't possibly repay on the day they took
the loan, that person needs to get foreclosed on, the bank needs to take the
losses and look at its underwriting standards, and the borrower should have
their credit rating dinged for their own irresponsibility.

If a job loss or income change prompts the foreclosure, then I feel more
sympathetic to both the lender and borrower, but some portion of loans are
going to go bad, and in the "less than 20% down" loans, the bank was knowingly
taking larger risks, so I don't feel too bad about their larger losses. The
borrower in this case has still made and failed to keep a commitment, which
speaks to creditworthiness, so again the credit downgrade is fair/appropriate,
even if it seems like "piling on".

For people who could afford an $800K mortgage (and many of them could afford
to keep current on their $1mm mortgage), but there are some who would choose
not to because their mortgage is non-recourse and they're far enough
underwater on the house that it's literally in their best financial interest
to walk away. Those people are the ones for whom a loan mod could make more
sense to both sides than a bank foreclosure.

~~~
anamax
> Please show me the text that makes that claim.

You wrote that it was better than foreclosure.

> The fact that people who once got a million dollar mortgage and now can't
> afford an $800K mortgage is not my problem to address.

Technically, none of this is your problem. However, you claimed to be offering
useful suggestions for banks' problems. Trading a loan that doesn't work for a
loan that can't work doesn't help the bank.

