These weekly pieces are written by a very influencial "Banker with a Conscience," and submitted to my Blog as Guest Op-Eds. These pieces get you into the mind of someone at the very top of the financial services sector; how they see the current global economic crisis (the mess), as well as various government and private sector solutions to get us out of it.  Hope you enjoy reading them.

You Are “Underwater”……So What?

Of all the things that have happened in this housing crisis, the one that just completely eludes my understanding is the handwringing and concern about people who have a home loans that are greater than the value of the home.

First let’s look at the real issues.  Clearly having a home loan that is greater than the value of the home negatively affects the likelihood that a borrower will pay on their loan (even if they have no diminished capacity to pay).   The second, and very practical problem, is that some people find themselves in changed circumstances—divorce, need to move for a better job, family circumstances requiring a different house, etc.  Being underwater makes it difficult for people to deal with the required change without defaulting on the loan so they can move on.  The default certainly limits their options the next time they set out to finance a home.  The third issue is that if the borrower has diminished capacity to pay, they are unable to sell the home to pay off the debt.

The one issue that is completely bogus is the issue of people realizing that they have a loan that is more than the home is worth and they are just plain upset about that—no diminished capacity to pay (in fact, if the home were going up in value you wouldn’t hear a peep out of them).  I have talked with and exchanged emails with numerous borrowers in this situation.  I just don’t have any sympathy for them if the only issue is they want their loan and their house to be the same (or better).   We all want that.

Look—mortgage debt in America is estimated to be about $750 Billion more than the underlying real estate value.   This doesn’t even consider the loss in value experienced by people who have very low or no mortgage debt on their property.  It is simply mathematically impossible to close that gap without bankrupting the banks (if that is who we expect to pay to close the gap) or plunging the country deeper in its fiscal morass (if it is the taxpayer we think should close the gap).  Last time I looked, no one else is standing around that might foot the bill.  Congress is fighting like mad over budget cuts in the range of $4 Billion—that ought to help size the impact of the $750 Billion above.

Nearly everything else American’s own is worth substantially less than the day they bought it.  It would be more than far to say, in effect, “you bought it, you pay for it”.  The moral hazard of stepping in to be “gap closers” for asset buyers—whether it is real estate, automobiles, recreational vehicles, stock purchases, bond purchases, diamonds, gold or whatever—is simply and quite definitely outside of the American tradition.

And there is the practical side of things.  If we can’t help everyone, who shall we help?  My house is worth less than I paid—my mortgage is still below the now lower value—do I deserve help?    My parent’s home is paid for, but their house has gone down in value since the peak—why shouldn’t they be helped.  They are low income (as if that matters in this case).

Well the answer, and the only practical answer, to the question of who to help is to help those that have faced diminished income (not diminished capacity to pay because they took on other debt to buy cars, boats, second homes, etc.) due to job loss, or other economic impacts.  The assistance offered should be proportional to the problem.  If income is diminished, modify the loan—until the income is regained, then continue the old loan terms.   In other words, let’s have compassion for the unemployed and underemployed until their situation is improved.  Let’s not give them a windfall that is simply the difference between debt amount and market value.  There is no reason to do that.  It, in effect, would reward the use of excessive leverage in some cases and eliminate the risk of having used excessive leverage. 

What about the individual in tough circumstances as described above.  If they cannot resolve the problem with a rental arrangement or other individual solution, then default and/or bankruptcy are probably the remaining solutions. 

The big point here is that this is not a problem we can “kiss and make it go away”.  The only solution that we can afford is to expect people to honor their commitments and pay their debts.  As a taxpayer, banker and neighbor, I have zero interest in making you better off, unless you are willing to do the same for everyone else.  I haven’t heard much about that.

A final thought.  Every time a person in this situation that can afford their debt but chooses not to, tosses the bank the keys and defaults, they put another foreclosed house on the market.  Instead of celebrating their victory over the bank, we ought to recognize them for what they are—neighborhood value wreckers.  They are literally stealing value from their neighbors.

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