The Obama Administration, only days old, is already in a terrible bind. For all the talk of fiscal stimulus, there is a very good chance that spending a quick $1 trillion or so on public works, tax reductions, and buying back bad loans simply isn’t going to do enough to foreshorten what is already a nasty recession. Some economists like Paul Krugman of the New York Times and Princeton University say the answer is simply to spend more money. If $1 trillion won’t do it, then try $2 trillion.
But there is another solution starting to bubble-up from the mortgage industry, itself. It’s a bit of lateral thinking that wouldn’t generally come to the mind of an academic like Fed Chairman Ben Bernanke, but just might offer a cheaper and easier way out of this mess – a way inspired by the Japanese. The Japanese of 1600 that is.
The problem faced by the Obama Administration is that this is, at heart, a housing crisis, yet most of the solutions tried so far have little direct effect on housing. We can use tax dollars to recapitalize the banks, but that doesn’t seem to result in more mortgages being issued, for example. There are simply too many houses available in the U.S. and WAY too many of those are worth less than their owners paid to either buy or build them. At least 10 million U.S. homeowners are effectively under water and therefore unable to refinance. Their options are to pay outrageous mortgage payments as their adjustable rate loans get more and more expensive, or to simply walk away from their homes, taking with them their problems yet leaving their empty houses as a further drag on the U.S. economy.
The White House has no new ideas for handling this crisis, or appears not to. Congress is equally stymied. The Treasury Department and Federal Reserve have used all the tools at their disposal and invented a few more, too, with little effect. What we need is a miracle.
So did Japan just before 1600. The country was in turmoil and had been for more than 100 years thanks to the introduction of western firearms in 1477. The B-movie culture of Samurai swordsmen had given way to armies of peasant soldiers with guns doing as they were told to do by officers who generally came from what was left of the Samurai class. Japan had lost culture, identity, power in the world, and had especially lost a hell of a lot of Samurai as they found it far more efficient to blow each other up in groups than to die one at a time in sword battles.
All the traditional Japanese feudal classes were threatened. Something had to be done. So Japan gave up firearms. After more than 120 years of shooting-off body parts, Japan under the rule of daimo Toyotomi Hideoshi after 1600 successfully repudiated firearms and went back to the old way of Samurai swords-for-hire hacking each other to bits in service of their feudal lords.
This idea of deliberately turning away from technology is foreign to western thinking, yet we seem poised to do something very similar to end the mortgage crisis – repudiating a specific technology that stands in the way of a quick and soft landing for the economy. Suddenly there is talk in mortgage circles of selectively giving up under certain highly specific conditions that stalwart weapon of home financing, the real estate appraisal.
There are millions of homes in the United States that are worth less than is owed on them. The Fed and Treasury are thinking-up ever more expensive ways of dealing with this problem – everything from buying-up sub-prime mortgages and holding them to maturity to buying up sub-prime homes, paying-off their mortgages, then simply tearing them down to reduce supply and help prices to firm. And the bogeyman most directly faced by politicians attempting to address the housing crisis is that houses under water can’t, by definition, be refinanced. The problem is lack of equity in light of FHA, Fannie Mae, and Freddie Mac rules that require a down payment that varies from five to 20 percent for replacement mortgages and refis.
And yet, in the bad old days of just over a year or so ago there were mortgage brokers selling all day long no-doc loans that required no money down to borrow up to 125 percent of a home’s value. Why can’t we do that today?
We can’t because the rules have changed – tightened – and it is harder to qualify for a loan. Yet to hear the Administration talk about it, this is just the time when it would help a lot if more people – not less – could qualify for a mortgage. People would buy houses, which means other people could sell houses and eventually prices would stabilize and even start to rise, leading the banks out of their current wilderness in the process.
The solution to this problem is simple and actually doesn’t require more money or even an act of Congress: just stop requiring an appraisal for FHA, Fannie Mae, or Freddie Mac qualifying refinance loans. Let the actual value of the house or property float.
For new loans on new property, yes, an appraisal would still be required. But for refinance loans on existing owner-occupied properties with no cash out, appraisals would not be required. Rather than assign a home value lenders would simply use the previous loan balance. The new loans could be fixed-rate, rather than adjustable, and at current interest rates payments would be lower. If they weren’t enough lower, the lenders could still use painless (to them) mortgage management tools like 40-year terms and zero-interest introductory periods. Few houses would be lost to foreclosure, less capital would be needed by the banks, and because bad loans were being replaced with better ones, the associated toxic derivative securities would be pulled from circulation.
This solution separates – as Wall Street has already done in effect through the use of derivative securities – the house from the loan. It isn’t the house that is toxic, it is the loan. Interest rates are down and millions of homeowners – and society as a whole – would be well served if these loans could be refinanced to reflect those lower rates, making the houses in turn more affordable. The method for doing this is to forgo appraisals and simply refinance the mortgage, not the house.
It’s don’t ask, don’t tell — a convenient ruse that lets us fix what needs to be fixed without too much introspection or analysis.
This isn’t such a radical suggestion. Many mortgages are already granted without appraisals for properties where large down payments and historical pricing precedents make appraisals just an added expense that lenders sometimes prefer to give up.
Not requiring an appraisal effectively raises the limits on how little equity a homeowner can retain in the property while still claiming to own it – in this case probably allowing financing of up to 109 percent of the market value by recent estimates. But we won’t officially know that because there is no appraisal.
By simply changing the rules in this manner millions of foreclosures can be avoided, families can avoid disruption, the economy can start to heal quicker, billions can be saved, and nobody has to know better.
It’s the Samurai way.
cringely Blog appraisals, Blog, down payment, mortgage, refinance, Samurai
Two months after Treasury Secretary Timothy Geithner began talking about new programs to help holders of federally insured mortgages who have lost all their equity in the housing bust and are now under water, rules for the new programs are finally starting to appear. But like most of the other federal homeowner initiatives described to date, early details suggest the Making Home Affordable Program will be of little practical help to those with low-to-negative equity and less-then-perfect credit scores.
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