February 26, 2010 – Ken Gross
Help for Homeowners – announced last year, has, unfortunately, evolved into nothing more than government acronyms. HARP (Home Affordable Refinance Program) and HAMP (Home Affordable Modification Program). HARP permits a refinance of a home if the homeowner but the homeowner must be current for the last year and meet normal underwriting criteria. The only benefit to the program is that the lender can refinance up to 125% of the market value of the home. In practice, the government mandated appraisals have been on the low side of market so that few properties can fit within the 125% framework. Worse than that, this program affords no help for people who have sustained financial hardship because if they were 30 days late on a payment in the last year, they are not eligible.
The HAMP program allows modifications to reduce the mortgage payment down to 31% of the Gross Monthly income of the homeowner. This program helps people who have sustained a reduction in their income so that if their present payment exceeds 31% (i.e. Monthly Income is $7,000 per month, Mortgage Payment $4,000; the reduction could go to $2,170 if all other program requirements are met) they are able to obtain a reduced monthly payment. The problem with this program is that the participating lenders have not made the effort to adequately process the modifications applications. Homeowners are told to fax papers in, and then weeks pass and they are informed that the paperwork is missing – so refax. When you call a lender, such as Bank of America, they will not even allow you to speak to a negotiator for the modification. All you can get is a status report. As an attorney, we want to speak with someone to make sure they are properly evaluating the file – but that is impossible because they refuse to come to the phone. End result – of the estimate 4,000,000 people who to be helped, few modifications have been put in place – with only 66,000 permanent modifications in place as of January of this year.
The poor outcomes of HARP and HAMP are not the big story. The biggest problem facing our country – is an economy that is undermined by high unemployment and nonexistent stimulus for the growth of small business. What Washington has missed, is understanding that the dismal real estate market is the underlying problem that must be solved in order to stimulate small business growth.
It does not take a Rhodes scholar to understand the process. Consumer spending drives our economy. Consumers cannot spend if they are unemployed. Even employed consumers will not spend if they have no available credit from the credit card companies and live in fear of losing their jobs. We all recognize to correct this problem, small business must begin to thrive – thereby employing more people, offering more goods and services and driving our GNP. Small business, however, will not and cannot thrive unless banks make credit available to businesses. Banks, however, are not lending. The reason – banks require collateral to underwrite loans. The collateral typically pledged is inventory and accounts receivable and real estate. Real estate is acceptable collateral ONLY if and to the extent there is an “Equity Cushion” in the property.
Here lies the problem. The “Equity Cushion” on residential and commercial real estate has been lost in the Financial Crisis. Because there is no equity in real estate, the banks will not accept it as collateral and therefore ½ of the historical collateral used to support lending is gone with the result that the banks will not lend due the lack of adequate collateral. You can scream and holler all you want about how the banks have improperly conducted themselves in the context of executive bonuses, credit card abuses and everything else. It is not going to matter – unless there is equity in real estate to support lending, you are not going to see lending occur, which means continued virtual no growth for our economy.
So where does the solution lie? The answer is we must return to an economy where there is equity growth in real estate. Right now, ¼ of all homeowners are underwater in their homes. This statistic was revised from 1/3 based on a change in accounting assumptions – but the reality is that there is virtually no Equity Cushing that homeowners have in their residential homes that can support a second mortgage to finance the start up costs of a new business. The commercial sector is even worse off.
The return of an Equity Cushion in real estate will come from only two outcomes. The foreclosure process is one. The other is modification of mortgages that include a reduction in the principal balance of the loans. Equity in real estate will not return if we modify mortgages that only reduce interest rates and extend mortgage terms to 40 years. This is what HAMP allows and what the banks are pushing. The modification process, as it presently is situated, is in reality a method which hampers our return to and Equity Cushion in real estate and therefore delays the goal of returning to a vibrant economy.
Another obstacle to a return to an Equity Cushion that has evolved is the problems that are occurring nationwide in completing short sales on homes facing foreclosure. The short sale, if approved by the lender, accomplishes the task of transferring the property to a new buyer at fair value, thereby giving the new buyer equity in the real estate and future growth. The problem that has occurred, however, is that lenders are refusing to release the selling homeowner from the deficiency on the first mortgage arising from the short sale. The result of this intransigence by the lenders is that the short sale process is far too slow and a selling borrower would be well advised to refuse to a short sale unless the lender gives the release of the short liability as part of the deal.
The clear solution is that our government must intercede to expedite the return to the creation of an Equity Cushion in real estate so that banks will then loan money based upon valued collateral. The foreclosure process take too long and the current effort to modify mortgages without principal reduction only serve to delay the process longer and thereby extend the time it will take for a true recovery. To correct this, we must shift the modification process to mandate principal reduction of the property to within reasonable estimates of fair market values. The “Cramdown” legislation that was voted down by the Senate last April, which allowed a cramdown of the mortgage in a Chapter 13 bankruptcy of a borrower’s primary residence to the fair market value of the home, would have accomplished this goal. Accomplishment of the goal would have occurred not as much through the actual bankruptcy process but by virtue of giving the homeowner’s the leverage of the “threat of bankruptcy” as a means of bringing the lender to the bargaining table to voluntarily reduce principal. This legislation was advocated by the President during his campaign. Unfortunately, with Health Care and the many other items on the agenda in 2009, the banking lobby pervaded on the issue and the Administration did not push for the passage of the bill when it hit the Senate floor last year. This legislation should be reintroduced and pushed forward. Alternatively, the government needs to adopt a mandatory Modification With Principal Reduction Program.
The gist of the opposition to principal reductions to mortgages as enunciated by the banking industry is that there is a “fear” that people who can afford to pay their mortgages on homes underwater would use this process as a means to reduce their mortgage. This argument is the fiction that needs to be resolved. If you accept that the critical goal is that we need to return to an Equity Cushion in real estate, as a critical component of banks lending money and thereby allowing our economy to grow, then there is no need for this alleged “fear” because the better result would be for all underwater mortgages to be modified.
The Banks, of course, fear this result because they will have to absorb greater losses. The Banks, however, are nearsighted. Eventually, the banks will realize that they cannot make money merely by charging usurious interest rates on credit cards, bank overdraft fees and renewal fees – but that they have to loan money to people and businesses. (Isn’t that what banks are supposed to do?) It may be true that in the end the banks do have to take the loss on the real estate that is underwater. It was, however, their lending practices and greed that drove us to where we now sit. So let them take the loss they deserve. Their stock value may decline, but we know it will return. Once this occurs, we will all, including the banks, be in a position to grow.
Ken Gross is a the Managing Shareholder at Thav, Gross, Steinway and Bennett, P.C. The firm is gaining national notoriety for its Financial Crisis Management strategies. Mr. Gross is host of the Financial Crisis Talk Center which airs at 8:30 AM, Saturdays, on Detroit Sports Talk Radio 1130 AM, www.detroitsportstalkradio.com, in the Metro Detroit market.