After the collapse of Lehman Brothers in the fall of 2008, the total value of U.S. mortgages was estimated at about $10 trillion. Backing out the premium included to cover the non-recourse nature of most of the loans, the value was about 10-12% lower. That’s still an awfully big number.
Recent estimates have put the percentage of underwater mortgages at about 29% of total U.S. mortgages. In dollars, that could be as much as $2 trillion.
The Obama administration’s attempts to help mortgage payers who hold these underwater loans has been, at best, a limited success. Now that mortgage interest rates have fallen below 5% again, is there anything that the government can and should do to keep the rates low and encourage borrowers either to buy a house or to refinance an existing mortgage?
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A model already exists that would allow the government to have a substantial impact on the weak market for housing and home loans. The model, once again, comes from a New Deal program that FDR created in 1933, just a few months after he took office. The Home Owners’ Loan Corporation bought defaulted mortgages a lower-than-market prices, then modified the loan payments turning the interest-only balloon mortgages into 20-year self-amortizing mortgages. Mortgage default rates dropped by 90% during the life of the HOLC, which put itself out of business in 1951, after earning a profit for the taxpayers who ultimatly paid for the program.
Nearly 20% of non-farm mortgage holders received HOLC loans totaling $3.1 billion. The average loan was just over $3,000. In 2009 dollars, that would represent about $46,000 or a total of about $48 billion. That’s a long ways from $2 trillion.
Still, current low interest rates combined with a HOLC-type program could get the US economy going again. Low rates should encourage buyers/refinancers to get back into the market. And the low rates could also reduce the risk of non-payment from a borrower who now has an underwater loan and faces a balloon payment that he can’t make.
At its inception, HOLC charged an interest rate of 5%, which it later reduced to 4.5%. Still, a study of loans made in New York and Massachusetts noted that more than 40% of loans were foreclosed. According to the National Bureau of Economic Research, the foreclosures were the result of “the borrower’s lack of determination to make the necessary effort [to repay] — not his economic inability to meet his financial obligations.”
And that brings us back to the non-recourse issue. In non-recourse states, like California and Arizona, if a borrower walks away from a mortgage the lender can only recover the foreclosed property and cannot pursue any of the borrower’s other assets. Borrowers pay for this privilege, of course, in their closing costs. If a mortgage is underwater, strategically it may make sense for the borrower simply to walk away.
Whether that is morally right is a different argument. Many borrowers believe they are morally obligated to pay their loans, even if it is not financially disastrous. Lenders, however, are free, and often required by fiduciary concerns, to do whatever maximizes their profit. That’s not a particularly level playing field.
Keeping interest rates low hasn’t helped homeowners much to this point. They see foreclosures and unemployment all around them and have got to be wondering if they’re next. Even a mortgage loan at less than 5% interest is difficult to repay if you lose your job.
Low interest rates are critical to a turnaround in the US economy. By themselves, though, they’re probably not enough.
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