Salvaging Team O’s Mortgage Foreclosure Plan

Most taxpayers support giving aid to workers who lost their jobs to the sputtering economy, but they are livid about Team Obama’s plan to stem foreclosures by rewarding irresponsible borrowers with extraordinary government subsidies. 

Obama’s brain trust appears  blinded by their politicized sense of social justice and so enamored with the elegance of their mortgage math that they miss the fundamental holes in their plan. While their intentions may be good, they lose sight of the forest in the trees.

The good news is that Team Obama’s problematic program can probably be salvaged —  by simply tightening the program’s qualifying criteria and changing the basis for determining the taxpayer subsidy going to distressed borrowers.

First, consider program qualification criteria.  Even Team Obama agrees that only mortgages on owner occupied primary residences should qualify.  That eliminates speculators, flippers, and vacation homes.  It also eliminates rental housing provided by  investor-landlords, but so be it.

Going a step further, why not explicitly limit the program to people who have a history of filing U.S. tax returns?  That would limit the program to  legal U.S. residents with proven (and determinable) earnings potential.

FDIC Chairman Sheila Bair … told public radio that it would be “simply impractical” to review old mortgage applications and try to distinguish between honest and dishonest borrowers.

Not so, Ms. Bair.  Simply set fair but tight qualifying criteria  based on the borrower’s past mortgage repayment history.

Rather than trying to qualitatively evaluate a borrower’s level of financial responsibility and good faith, they should look quantitatively at the borrower’s actual behavior.   For example:

Did the borrower make a down payment from his own resources? If not — if he made no down payment or funded one with a second home loan — then he doesn’t really have much of an ownership stake.

If the borrower had an ARM, did he make all payments before his ARM was adjusted upward? If not, it’s hard to blame his financial  fix on deceptive loan practices.

Did the borrower make at least a year or two of loan payments before defaulting? If not,  he doesn’t have much equity in the house — financial or psychological.

The point is that there are non-disputable behavioral metrics that can be used to sort “owners” from “occupants” and responsible borrowers who may have been duped from outright deadbeats.

Similarly, for those who qualify, Team Obama should determine the  level of any government subsidies based on the borrower’s past mortgage repayment history, not income.

Team Obama’s plan pressures lenders to bring a borrower’s payment to income ratio down to 38% by cutting interest rates or principal. Then, taxpayers share the cost (dollar-for-dollar with the lender) of bringing that ratio down to 31%. 

In other words, the borrower gets a taxpayer subsidy equal to 3.5% of his income.   So, a guy in an American average $200,000 home who earns $35,000 gets a $1,250 annual taxpayer subsidy.  Plus, he gets a $1,000 annual incentive rebate (for 5 years) if he does the right thing and makes his payments. That boosts his taxpayer subsidy up to the equivalent of a 6.5% refundable income tax credit — “earned” by defaulting on a mortgage.

Team Obama sees great beauty in that arrangement.  Many taxpayers do not. 

As an alternative, why not scale any taxpayer subsidy based on past mortgage payments made rather than proportionate income?  That is, give borrowers credit for having demonstrated good faith in the past by having made payments before their ARMs exploded or the economy imploded?

Illustratively, consider this rule: add the borrower’s down payment to the sum of P&I payments he made against the mortgage, then divide that total by 12 (or some other equalizing factor) and use the result as the basis for his subsidy.

For example, assume that a good faith guy earning $35,000 buys a $210,000 home with $10,000 down and makes $5,000 in P&I payments before his  teaser rate ARM gets upped to an unexpectedly high (and unreachable)  payment level.  Give the guy $15,000 in good faith ownership credit, and allow him a maximum taxpayer subsidy of $1,250 per year — the same as Team Obama’s income based subsidy.

Now, assume that a bad faith guy, also earning $35,000, buys a comparable $210,000 home with no money  down and makes a couple of payments totaling $2,400 before starting to skip payments.  Give this guy $2,400 in good faith ownership credit, and allow him a maximum  taxpayer subsidy of $200 per year — a much smaller subsidy reflecting his proven irresponsibility.  If that’s enough to get him to the 31% payment to income ratio, that would be fine.  ut, it’s not, so too bad.

The numbers are arbitrary, but the guiding principle is not: don’t help deadbeats. do help people who have demonstrated good faith and responsibility, but have run into hard times. 

Keying the maximum  taxpayer subsidy to a borrower’s past payment history has an added benefit: it provides help to the guy who has made years of on-time payments before getting laid off.  Since his near-term income is zero, Team Obama’s income based subsidy would provide him with no help.  That’s not fair.

The bottom line is that the plan proposed by President Obama is seriously flawed and, understandably, has aroused taxpayer ire.  But, if Team Obama shows some flexibility (and some rational creativity), the plan can be salvaged to rally taxpayer support for helping responsible but distressed  home owners.

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One Response to “Salvaging Team O’s Mortgage Foreclosure Plan”

  1. JM Says:

    I agree with your points. I understand why they picked a rule of thumb for the 31%, but that does seem to open the door wide for deadbeat who had mortgages at 40 & 50% of their income before the market collapse. To me, another idea is to also work with mortgage lenders to get the rates back down to what people paid before their ARMs reset, regardless of income, either through subsidies to the lender or to the borrower. That method would only subsidize those who could afford the house in the long term.

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