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Saturday, March 08, 2008

The Feldman Plan: Just Get Yourself a Latte

by Tanta on 3/08/2008 04:25:00 PM

Via Housing Wire, I just read Teh Dumbest mortgage-related proposal I think I have yet seen.

The federal government would lend each participant 20% of that individual's current mortgage, with a 15-year payback period and an adjustable interest rate based on what the government pays on two-year Treasury debt (now just 1.6%). The loan proceeds would immediately reduce the borrower's primary mortgage, cutting interest and principal payments by 20%. Participation in the program would be voluntary and participants could prepay the government loan at any time.

The legislation creating these loans would stipulate that the interest payments would be, like mortgage interest, tax deductible. Individuals who accept the government loan would be precluded from increasing the value of their existing mortgage debt. The legislation would also provide that the government must be repaid before any creditor other than the mortgage lenders.

Although individuals who accept the loan would not be lowering their total debt, they would pay less in total interest. In exchange for that reduction in interest, they would decrease the amount of the debt that they can escape by defaulting on their mortgage. The debt to the government would still have to be paid, even if they default on their mortgage.

Participation will therefore not be attractive to those whose mortgages that already exceed the value of their homes. [sic] But for the vast majority of other homeowners, the loan-substitution program would provide an attractive opportunity.

Although home owners may recognize that the national average level of house prices has further to fall, they do not know what will happen to the price of their own home. They will participate if they prefer the certainty of an immediate and permanent reduction in their interest cost to the possible option of defaulting later if the price of their own home falls substantially.

The loan-substitution program would decrease the number of homeowners who would come to have negative equity as house prices decline. That reduces the number of homeowners who will have an incentive to default, thereby limiting the risk of a downward spiral of house prices.

Since individuals now have the right to prepay any part of their mortgage debt, the 20% reduction in the mortgage balance would not violate mortgage creditors' rights. Creditors should welcome the mortgage paydowns, because they make the remaining mortgage debt more secure. The 20% repayments to creditors would also create a major source of funds that should stimulate all forms of lending.

The simplest way to administer the new loans would be for the current mortgage servicer to collect on behalf of the government and remit those funds to Washington. There would be no need for a new government bureaucracy, for new appraisals, or for negotiations in bankruptcy. The program could be up and running within months after the legislation is passed.
OK, so we are going to ignore piggybacks (people do have more than one mortgage, you know), so we don't have to ask whether the second lien lender gets all the repayment, or what. We are going to ignore prepayment penalties that apply to substantial partial prepayments. We are going to ignore those sacred contractual rights lenders have to require you to continue to make the payment specified in your loan documents even if you make a partial prepayment (it takes a modification agreement to change the contractual payment). We are going to ignore the lack of a credit risk premium.

We are not going to ignore the elementary math of amortization. Not today.

Let's just pretend we have a single lien mortgage loan. The original loan amount was $200,000 at 8.5% for 30 years, and just for entertainment purposes we'll say the loan has been amortizing and it is now two years old. It's either a fixed rate or a "frozen teaser," so the rate is still 8.5% going forward. The original P&I was $1,537.83 and the current loan balance is $196,842.51.

We turn that into a 28-year 8.5% loan for $157,474.01, plus a 15-year 1.6% loan for $39,368.50. That gives us a first mortgage payment of $1,230.26 and a second mortgage payment of $246.15. Firing up my trusty 10-key, I see that totals to $1,476.42, or a 4% reduction in the total monthly payment.

A monthly savings of $61.41! Oh Lord, they'll flock to this! Non-dischargeable full recourse debt that prevents you from ever cashing out if home values do ever recover, until you've paid off that low-rate loan! Plus the new loan is an ARM, so it can get worse in two years! In fact, it only has to adjust up to 5.00% for the total payment to be higher than what you started with, given a 15-year amortization! But that's not a problem, because we know people will think about the lower interest costs over decades, not the higher monthly payment today! And besides that, when the hell has a 2-year Treasury note ever been five percent, huh? Oh, sure, if you're going to worry about some kind of a doomsday scenario . . .

Well, wait, you say. This proposal isn't aimed at those high-rate subprime borrowers who get so easily confused about the difference between the monthly payment and the total interest paid, because they're probably upside down anyway. This proposal is for us responsible types. Let's say we started with the $200,000 30-year at 6.00%, with a P&I of $1,199.10. Two years later we strip that into a $155,949.18 28-year loan at 6.00% ($959.28) and a $38,987.29 15-year loan at 1.6% ($243.77) giving us a new payment of $1,203.05! Cool! Economic stimulus! That $3.95 a month that would have been blown at Starbucks going to debt reduction! Just what we need in a recession!

Plus, we don't need any government agency to handle it! Servicers can do all the work, draw up the docs, execute them all, apply all the funds, modify the payments on the old loans, and then get that $243.77 check every month, which they can just mail to Washington! We don't need no steenkin' bureaucracy on the other side! The receptionist at the Treasury can probably handle it all in her spare time! Sure, she doesn't have any idea how much she's owed for what loan and when any given loan matures and what to do if the payment doesn't show up, but she doesn't have to! Countrywide will keep track of it all for her! There's nothing wrong with their bookkeeping ever! And you know they'll do all that for free, because they're good citizens! So there's no servicing fee eating into that 1.6% the government earns on these loans! No upfront fees to the borrower that offset the interest savings, because loan originators, like loan servicers, also work for nothing! Free lunch!

Sorry about the exclamation points. I should just be kept away from the Wall Street Journal.

UPDATE: Please note that "Marty Feldman" was a gifted comedian. "Marty Feldstein" is a gifted comedian who is also an economist.