Job Creation, Not Loan Mods, Should Be Next Step

December 10, 2008 by admin

Much has been made by those in the peanut gallery of the need to modify the terms of delinquent or defaulted mortgages. The logic behind this line of thought was relatively sound: after all, the reckless issuance of adjustable-rate mortgages (ARMs) to people who wouldn’t be able to make the payments once the rates were adjusted upwards was a major contributing factor in the downward spiral of the housing market, right? Beyond ARM’s, the statistics on houses currently in or nearing negative equity, in which a house is worth less than it was originally mortgaged for, are no less than staggering. First American Corelogic has reported that in Nevada, 48% of homes are, or will enter, underwater status. In Michigan, Arizona, Florida, and California, those numbers are all above 25%.

Those numbers mean that roughly 20% of homeowners in the United States are looking at a pretty bleak picture, where they have to pay to break even on their home. Fine, said the concerned banks (also on the hook if the loan defaults), let’s modify the terms to prevent foreclosures: lower the principle of the loan, alter the adjustable rate, extend the terms, do what needs to be done to protect the value of the loan and the value of the house.

Unfortunately, those steps are simply not sufficient in an economy that continues to deteriorate as rapidly as ours has over the past three months. The simple fact is that people without jobs and savings are going to have a difficult time making payments on their house, regardless of the amount they owe on their monthly statement. And as numerous observers have noted, the zero-percent down payment strategy only makes it easier for those homeowners to cut their losses and move on.

A new study shows that 53% of borrowers who received modified terms on their mortgages have defaulted within a six month time period. While Credit Suisse notes that defaults of loans whose interest rates were reduced were only 15%, that figure does not change the fact that a majority of these modifications have been ineffective. FDIC chairwoman Sheila Bair has called for the government to share losses of up to 50% on re-defaulted loans. This is a noble measure, but it could prove to be tremendously costly measure to enact. My suggestion is that the money which would have to be ponied up to cover those losses would be better used to create new jobs, something that would prevent the defaults from occurring in the first place.

It would also have the added benefit of allowing the market to function in a more normal fashion, by gutting the bottom end and moving homes back into a more affordable price range. Home values are still inflated…and they will continue to stay that way, as long banks and government try their hardest to maintain the status quo.