The Mortgage Elephant In The Room

March 6, 2009 at 12:23 am (Banking Crisis, Housing)

“When will the housing market stabilize?” everyone wonders.  It’s very simple, actually.  When the government forces holders of mortgages to reduce the principal owed.  Let me explain.

First of all, at the end of 2008, 1 in 5 mortgages were “underwater,” meaning the cost to pay off the mortgage was more than the house was worth.  Since this is March of 2009, the number is probably closer to 1 in 4.  Being as it is cheaper to rent than own in all 50 states, even considering the interest tax deduction, this means the underwater homeowner has only two reasons to keep paying.

1) They don’t want to ruin their credit.
2) They feel the housing prices will rise in a short enough timeframe to justify paying all the interest in the meantime, and will rise steadily thereafter enough to (after factoring in inflation and the value of lost investment opportunities with the lost interest payments) eventually sell and make a profit.

There is no third reason, such as “they intend to pay off the mortgage in full in 30 years and don’t care about the current price.”  The people who fall into that category are the ones who bought at a reasonable price and are satisfied with their purchase because they are not upside-down. 

So, let’s look at the first reason.  Nobody wants to ruin their credit — unless, well, it costs thousands of dollars a month in wasted money to maintain.  Or perhaps unless credit no longer matters, since no one is lending anyway.  Or if everyone around them has trashed credit, making trashed credit not a problem.  Eventually, many people will find that the savings of not paying on a losing mortgage outweigh the credit loss.

The second reason is hinged upon a relatively quick economic recovery which no one anywhere can give any indication will happen.  The vote of no confidence in this is shown by the fact that, at the end of 2008, 1 in 8 mortgages were behind on payments.  Again, since this is March, that number is likely closer to 1 in 6.

So then, what could possibly motivate people to hang on and resume payment?  Only one thing: a stake in the eventual profit.  If all the upside down people were no longer upside down, and actually had some equity, or at least no negative equity, they would be motivated to keep paying (providing they had the means of course — some simply won’t be able to pay no matter what).

Therefore, the only solution is loan modifications that adjust the principal owedThis article explains the fact eruditely, speaking of the much-touted (and reviled) mortgage rescue:

The Obama administration’s failure to close the negative- equity gap means that its plan “will likely join the dud parade of federal rescues,” says John Kiff, an International Monetary Fund economist in Washington.

DellaCamera, 55, the principal of DellaCamera Capital Management LLC, says that government reluctance to force banks to write down the value of distressed loans and securities to prices that buyers are willing to pay creates “gridlock,” delaying bad-debt workouts and an eventual recovery.

That’s exactly right.  The banks don’t want to reduce the principal, nor the interest rates, because then the cat is out of the bag and there is no more maneuverability: the mortages are not worth what they say they are.  And since all the major banks are still on the edge, after all the baoilouts, acknowledging reality might be the same as acknowledging insolvency.  So, of course, the inevitable outcome, like it or not, will be that the government does one of three things:

1) Force the banks to lower the principal, and bail them out or buy their preferred stock as much as necessary to keep them afloat
2) Force the courts to allow bankruptcy judges to force the banks to lower the principal, with the same effects
3) Nationalize the banks in one form or another and modify the mortgages themselves.

This is beyond the debate of right or wrong, smart or stupid.  It’s going to happen.  It is the only thing that will stop housing prices from continuing to fall, because as more mortgages fall underwater, and more people see no recovery is forthcoming, more will stop paying.  And please don’t think anyone in charge cares enough to ask the question whether we should simply let housing prices fall back.  They don’t care what you think.

These guys get it.  They worked for the failing banks that are still pretending they are solvent and their mortages are worth the money they lent.  They know it’s all fake.  Now they’re buying mortgages the government was forced to own, through takeovers of failed banks, at pennies on the dollar, adjusting the principal for the homeowner, and pocketing the difference.  This is the way of the future.  The government (therefore taxpayer) loses, the bankers win, and we all live… whatever ever after.

Today’s article of doom: Think I’m negative?  Check out this guy.



  1. Bill Cash said,

    I just stopped by your blog and thought I would say hello. I like your site design. Looking forward to reading more down the road.

  2. CrashingDownNow said,

    Thank you. Sorry, your comment got lost in my spam filter.

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