Principal Reduction and Refinancing of Mortgages for Economic Recovery in the U.S.

Principal Reduction and Refinancing of Mortgages for Economic Recovery in the U.S.

One major failure of economic and financial policies since the onset of the sub-prime mortgage problems in 2005 has been to let the most important part of the economy deteriorate while trillions of dollars have been injected into the financial system to save it. The argument is that it has allowed us to prevent a depression. Yet real estate has continued to experience a downward cycle of high unemployment leading to lower incomes, mortgage delinquencies, foreclosures, more delinquencies, more foreclosures, lower housing and real estate values, plus a growing stock of unoccupied properties.
Actual foreclosures, as reported in the press, grew from 268,532 in 2006, to 2.8 million in 2009, totaling about 4.5 million from 2006 to 2009. Another 5 to 6 million are expected in 2010 and 2011. There is no end in sight.
Many remedies have been attempted including a variety of loan modification programs, mortgages purchases by the Federal Reserve, Fannie Mae and Freddie Mac, FHA insured mortgages, and refinancing under the Home Affordable Modification Program. Unfortunately these have not prevented delinquencies and foreclosures from rising.
One solution completely missing from public policy until now is the modification in the principal value of the mortgage balance. This remedy would serve the home owner, the neighborhood, the financial institution, the state, and the national economy, and must be pursued aggressively by Congress before the economy is allowed to slip into another downward spiral.Some 29 percent of mortgaged properties are valued below the mortgage balance, about the same number are behind in payments facing foreclosures. Unemployment is expected to remain in the 9 to 10 percent range leading to more problems in mortgage payments and more foreclosures.
We could avoid a further drop in sales and prices by providing massive refinancing to homeowners and commercial property owners similar in scale to the help given to the financial industry in 2008 and 2009: refinance all houses and commercial real estate in foreclosure or default as of a certain date. Federal funds should be used to nationalize the loss of value between the mortgage balance and the estimated current market value. For example if a home is $50,000 below mortgage value then the Federal government and banks could take the loss in 50-50 ratio or $25,000 each. The homeowner would pay a special annual capital gains tax at a rate of 20 percent on any increase in equity value after refinancing for a period of five years or pay this special capital gains tax if the house is sold by the owner with any gain above the normal capital gains tax applicable. This will help recapture the federal subsidy and reduce costs to the taxpayer as property values improve.
Refinancing of the market value at FHA insured mortgage rates like 4% for 30 years and 3 percent for 15 years will keep the owner in the property. This is even better than the new short sale program which requires homeowners to sell and further depress home values and increases homelessness. The lender would receive 50% liquidity of the loss. They would be required to use these proceeds to make new loans for autos, home and energy efficiency improvements by individuals, homeowners and commercial real estate owners. The homeowner gets an estimate of the market value annually and pays capital gains taxes on the build-up of the equity above the refinanced value. The estimated funds required initially to refinance and to re-liquefy the financial system may be as little as $50,000 per property--for 5 million units that equals $250 billion ($125 billion cost to the tax payer and $125 billion to the banking system). This is much cheaper for everyone than the loss of property values in trillions, and the loss of jobs and foreclosures in millions.
No new funds are needed to implement the proposal made here. The proposal can be funded easily by expanding the Home Affordable Modification Program (HAMP) to include a permanent principal reduction in a refinancing. A temporary lowering of monthly payment and short sale proposals currently suggested by the Treasury and the White House are unlikely to stem the tide of foreclosures.