Good old American free-enterprise vultures may be trumping Obama’s Treasury theorists in slowing down the rate of mortgage defaults.
Instead of complex schemes to lower interest payments for under-water home owners, speculators are buying up loans at distress prices and cutting the principal but still keeping it high enough to profit–a market-based solution if there ever was one.
The media have been quicker to endorse this approach than the government. A New York Times editorial notes that, rather than reducing interest, “A better way to lower the monthly payments for these people is to reduce the principal remaining on the loan. That way, the payments become affordable and, as equity is rebuilt, the borrower has both an incentive and the means to keep current. The Obama plan provides subsidies for lenders to reduce principal balances, but the option is not promoted as prominently as simply reducing the interest rate. That’s a shame. It is a better way to go…”
The day before, an OpEd piece had argued: “For subprime and other non-prime loans, which account for more than half of all foreclosures, the best thing to do for the homeowners and for the bondholders is to write down principal far enough so that each homeowner will have equity in his house and thus an incentive to pay and not default again down the line. This is also best for taxpayers, who now effectively guarantee the securities linked to these mortgages…
“For these non-prime mortgages, there is room to make generous principal reductions, without hurting bondholders and without spending a dime of taxpayer money, because the bond markets expect so little out of foreclosures.”
Bloomberg reports a December study by the Comptroller of the Currency showing that, after six months, more than 55 percent of the loans modified last year re-defaulted while only 28 percent of homeowners whose modifications trimmed their principal by a fifth or more were late after six months.
Banks and other mortgage holders are resisting such immediate markdowns in the value of loans in the hope of more taxpayer bailouts and/or a rebound in the real-estate market.