I read an interesting article on MSN Money yesterday – Next shoe to drop: Prime mortgages. The article covers the correlation between the housing market, consumer spending, and the economy.
Basically, the more often banks foreclose on houses, the less people are willing to spend on consumer items, which further weakens the economy, potentially causing a downward spiral and leading to a recession. Of course, there are other issues causing the current economic landscape in the US – the weak dollar and higher oil prices play a large role in our economy.
Reducing foreclosures can help the economy
One of the interesting parts of the article was about home foreclosures. When it comes down to it, foreclosures are bad for everyone involved – people are forced out of their homes and have a horrible mark on their credit for years, banks lose large amounts of money, and the housing market is damaged. The entire US economy is affected by multiple foreclosures.
This has lead some mortgage lending institutions, including Fanny Mae, to provide borrowers more loans to cover their mortgage. Yes, you read that correctly! People cannot pay their mortgage, so banks are loaning them more money to cover their debts!
Something about that just doesn’t seem right.
Here is a quote from Fannie Mae’s latest quarterly financial report (emphasis mine):
“We recently introduced a new HomeSaver Advance initiative, which is a loss mitigation tool that we began implementing in the first quarter of 2008. HomeSaver Advance provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS (mortgage-backed security) trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses we record in connection with those purchases.”
Translation: Fannie Mae offers borrowers with delinquent mortgages an unsecured loan to cover their delinquent mortgage payments to prevent foreclosures from occurring (more like delaying foreclosures).
You can’t borrow your way out of debt
I understand how this might work for a few people who were temporarily out of work or hit hard times… They are late $10,000 on their mortgage payments, so they can take out a $10,000 personal loan which they can pay back over several years. If you stretch it out long enough, perhaps some people may be able to afford to stay in their house for a few more months. Perhaps they may even be able to honor the entire mortgage and unsecured loan.
But most people who can’t meet their current obligations aren’t going to be able to meet the same payments, plus an additional payment. The math just doesn’t work.
This reeks of creative accounting: get the delinquencies off the books for a couple months, slow down the rate of foreclosures, and hope to appear under control. Perhaps the loan can even be packaged off and sold as “current.”
In any case, borrowing your way out of debt is not a solution. All this does is delay the inevitable.
{ 8 comments… read them below or add one }
What this will do however is delay a large pile of the foreclosures to other quarters which could possibly smudge the numbers enough so that the USA won’t actually have a ‘recession’ per say because the quarters won’t actually be negative growth. It looks to me like they are trying to stretch out the problem as far as possible in order to mask the impact. Hopefully the media won’t be able to sensationalize it and that will make the public think everything is hunky dorey (spelling?) and continue to let bankers and the government steal their hard work until eternity.
I think Patrick is right here. This only delays the inevitable. The best path for the economy is to take its lumps, no matter how painful it will be, and move on. The market will float sideways until the inefficiencies are removed from the market.
What amazes me the most is how people love free markets as asset prices and wealth increases, but they expect the government to step in and halt any losses. It doesn’t work that way. Never has, never will. Artificial intervention makes things worse.
The banks may have some sort of an unterior motive. Like Triacitim says, this move may allow the bank to postpone reporting losses, by making good delinquent loans for a while.
(In Malaysia, banks cannot recognise interest income from loans that are 3 months overdue.)
Still, I feel, that a free market approach may not be the best thing to do in this situation. Allowing the axe to fall, might take away more than anyone expected and may end up in a “operation was successful, and the patient is dead” situation.
The US affects quite a fair bit of the rest of the world. I would like to see some better measures from the financial leaders of the US. I am not sure what, but I do feel that what is coming out like tax rebates etc., is not going to help much.
I agree that propping up the housing market is necessary to keep the economy going but borrowing on top of borrowing is taking it too far. The US Govt is going to do what it takes though. Policy makers know that the housing market is key for us to turn this thing around.
I think it would be best if banks were to recognize that their best interests would be to allow people to stay in those homes by reduce payments for a period of time. They could easily tack the lost interest on the back of the loan.
The bank wins because they kept a home out of foreclosure and would probably retain a customer for the long run.
The homeowner wins because he/she keep their credit report clean and doesn’t lose their home.
The economy wins because if people are able to weather this storm and stay in their homes, they will be better able to support the economy.
This is a scary idea. Unsecured loans? That sounds like it will just make the problem worse. Yikes!
Next thing you know they’ll allow payday loan places to offer mortgages… unsecured loans? Are you kidding me?
Just another way to hide the fact that the federal government is going to be using my tax dollars to pay for all of these homes.
Interesting post.
I think some people are just irrational about owning houses – they buy more than they can afford and then when they can’t make the payments, they do stupid things like trying to hang on which just costs them more money.
Sometimes you just have to abandon ship.
Mike