Obama’s Housing Plan: Will It (Or Any Feasible Plan) Work ?

As Joe has already reported, President Obama is in Mesa, Arizona today to announce a plan by the Treasury Department to deal with the housing crisis. Since I am a bankruptcy attorney in Northern California, this is an area with which I am quite familiar. Indeed I am somewhat surprised the President didn’t come here since we are the epicenter of the foreclosure crisis.

I should admit from the start that I do arguably have something of a conflict of interest here. Just as doctors technically depend on people getting sick to continue in business, I do need to have clients to come through the door to keep paying my bills. But given the massive impact of the housing collapse on our economy I certainly want to see a solution to this problem, but I am not sure that his plan will work, or indeed if any plan will work.

The main thrust of the plan seems to be reducing interest rates by allowing people to refinance their homes through the Fannie Mae and Freddie Mac programs (right there, I am kind of nervous to see these troubled programs doing much of anything). Obama has said that Fannie and Freddie will be allowed to refinance homes above the current 80% limits but this will only help those who are already in loans with these companies and who have some level of equity in the property.

This will help people who have some level of equity in their homes but it won’t hurt those who are underwater (i.e., owe more money than the house is worth). This has been the central problem with the mortgage crisis, when a house is worth less than the loan, the homeowner cannot get a new loan and the lender is understandably unwilling to work things out since they would be taking a loss.

I have long thought it made sense for the banks and mortgage companies to work something out with the lender since they were facing a choice between a lower payment and no payment, but I also understood that it would be hard for the bank to take too many losses before they went out of business.

My own suggestion has been that there should be a meeting in the middle, where the bank agrees to lower the loan amount down to the current market value but with the understanding that, as the value of the house rose in the future, that the bank be able to recover some of the reduced loan up to the level of the original loan. But this solution would not entirely solve the problem since some homeowners might not be able to afford the increased payments.

I have a feeling that Obama’s plan may run in to similar problems.

The plan offers ‘guidelines’ and ‘encouragement’ to lenders to refinance loans to lower the payments by making up some of the shortfall between the old and new payments, should a lender refinance a house that is underwater. But the plan also requires that the new payment be no more than 31% of the homeowners income. This could be a potential problem because the math would be tough to work out.

For example, if a homeowner has a house with a $500,000 mortgage that is now worth $300,000 and the income in the home is $50,000 a year, it is going to be very difficult to make the math work out. This is perhaps the central problem to any solution, that in many cases the numbers between the amount owed and the amount the house is worth are too large and the amount the homeowner can afford is simply too small to be realistic. It sounded like the modifications would only be through Chapter 13 cases and this requires that people have enough money to make the payments.

The idea that bankruptcy judges be able to modify the value of houses is a good one, provided that there is a balance on all sides (i.e., the lender and the homeowner both share the pain). Again however the problem could be that, even with a lowering of the loan to the value of the house, the numbers may still be too large for the homeowner to afford.

The President seemed to address this by saying ‘we won’t help people who bought homes that they knew they could not afford’ but then the problem becomes deciding who those people are. I feel for all of my clients who come in and have faced the need to lose their homes but I often find differences in my reaction to those who had genuine bad luck versus those who bought out of their means.

But in my case I don’t really need to make any decisions based on those feelings. In both cases, the people are giving up their homes and so whatever the circumstances behind them the loss is happening. On the other hand, under the proposed plan there would have to be somebody making choices between helping and not helping and you know that a lot of politics is going to play in to it.

I do think that this plan is a step in the right direction and will help solve some problems for troubled homeowners. But I also think we need to be realistic about the fact that there is probably no plan that is really going to solve the entire problem. There is simply too much to solve and many people are going to have to deal with the fact that they are going to have to give up the property and move on. It is not a nice solution but it is a realistic one.