Par­tial Mort­gage Jubilee Plan from US Fed

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Eco­nomic Reform Aus­tralia has just alerted me to a pro­posal for a par­tial mort­gage debt for­give­ness pro­posal put for­ward by econ­o­mists from the US Fed­eral Reserve in Jan­u­ary 2009. ERA repro­duced this post from WhoWhat­Why, which in turn referred to a Boston Fed pub­li­ca­tion Com­mu­ni­ties & Bank­ing and the paper “A pro­posal to Help Dis­tressed Home­own­ers”.

The pro­posal includes the sug­ges­tion of a grant to home­own­ers who are both in neg­a­tive equity and unem­ployed, where the grant would pay up to 25% of the repay­ment costs over a 2 year period.

I’m not­ing it here both for its own merit, and because it shows that a direct grant to debtors is fea­si­ble within the Fed­eral Reserve system–something that I have seen dis­puted else­where. So a full debt-Jubilee, which I dis­cussed in my BBC HARDtalk inter­view, is also fea­si­ble. Since the Jubilee issue is likely to rise in promi­nence in com­ing years, it’s worth record­ing this very early pro­posal that emanated from within the US Fed.

Below is the text of the paper.

A Proposal to Help Distressed Homeowners

by Chris Foote, Jeff Fuhrer, Eileen Mauskopf, and Paul Willen

With job losses gen­er­at­ing more mort­gage delin­quen­cies, pol­i­cy­mak­ers might con­sider whether fore­clo­sure-pre­ven­tion efforts should help home­own­ers with pay­ments for a while. We pro­pose a gov­ern­ment pay­ment-shar­ing arrange­ment that would work with the homeowner’s exist­ing mort­gage and sig­nif­i­cantly reduce monthly pay­ments while the home­owner is unem­ployed.

We believe a pay­ment-shar­ing plan stands a bet­ter chance of pre­vent­ing fore­clo­sures than longer-term but less sig­nif­i­cant pay­ment reduc­tions achieved through loan mod­i­fi­ca­tion.  More broadly, pay­ment shar­ing could not only ben­e­fit par­tic­i­pat­ing home­own­ers, but also could pro­tect the hous­ing indus­try from esca­lat­ing fore­clo­sures and could sta­bi­lize finan­cial mar­kets and the econ­omy.

In our view, pre­vi­ous plans based on long-term loan mod­i­fi­ca­tions, have been stymied because (a) con­trary to the com­mon wis­dom, lenders and mort­gage ser­vicers will not always find a mod­i­fi­ca­tion to be in their best inter­est, and (b) extant plans are gen­er­ally unable to offer mod­i­fi­ca­tions to those who become unem­ployed.

The pay­ment-shar­ing plan we pro­pose has nei­ther of those draw­backs. It could take the form of either a loan or a grant. In both ver­sions, the home­owner would have to pro­vide proof of job loss—or other sig­nif­i­cant income disruption—and proof of the home’s neg­a­tive equity.

Plan Features

Neg­a­tive equity does not by itself lead to default unless the amount is extremely high. Own­ers with neg­a­tive equity who have not suf­fered adverse life events (for exam­ple, job loss, divorce, or ill­ness) gen­er­ally stay cur­rent on their mort­gages. Neg­a­tive equity is, how­ever, a nec­es­sary con­di­tion for default. Bor­row­ers who have pos­i­tive equity usu­ally can sell or refi­nance. The rea­son that fore­clo­sures are ris­ing today is that falling hous­ing prices have increased the preva­lence of neg­a­tive equity at the same time that unem­ploy­ment is rising—the so-called dou­ble-trig­ger effect.

The best way to pre­vent fore­clo­sures right now is by the gov­ern­ment offer­ing bor­row­ers who have expe­ri­enced income dis­rup­tion some tem­po­rary but sig­nif­i­cant assis­tance. The two ver­sions of our pro­posal have five fea­tures in com­mon. First, the gov­ern­ment pays a sig­nif­i­cant share of the household’s cur­rent mort­gage pay­ment (25 per­cent and up) directly to the mort­gage ser­vicer. Sec­ond, the government’s share of the mort­gage pay­ment is equal to the per­cent­age decline in fam­ily earned income. Third, proof of a recent and sig­nif­i­cant income dis­rup­tion is required. Fourth, the assis­tance ends upon resump­tion of the borrower’s nor­mal income stream—or after two years. Fifth, the plan caps the max­i­mum gov­ern­ment pay­ment (say, at $1,500 monthly).

Addressing Challenges

The most dif­fi­cult design chal­lenge is to avoid attract­ing home­own­ers who don’t need help and inad­ver­tently let­ting them game the sys­tem (a phe­nom­e­non called moral haz­ard). Eli­gi­ble home­own­ers would have to prove that their equity is either essen­tially zero or neg­a­tive. In the loan ver­sion, pro­gram par­tic­i­pants would pay an inter­est rate reflect­ing the ele­vated risk the gov­ern­ment is assum­ing. And the grant ver­sion would explic­itly exclude home­own­ers hav­ing enough income (or wealth) to con­tinue mak­ing mort­gage pay­ments despite neg­a­tive equity.

The Loan Version

In the loan ver­sion, the government’s pay­ments  accrue to a loan bal­ance to be repaid with inter­est at a future date. Gov­ern­ment pay­ments end when the homeowner’s income stream has been restored, or after two years, whichever is sooner. Because the household’s mort­gage pay­ments may rise (for exam­ple, with an adjustable-rate mort­gage), the government’s pay­ment is capped at a pre­de­ter­mined amount. When bor­row­ers stop receiv­ing gov­ern­ment pay­ments, they begin repay­ing them. They have five years to do so. If the home is sold for more than the value of the mort­gage bal­ance, the gov­ern­ment has first claim on any remain­ing equity, up to the value of the loan bal­ance, includ­ing accrued inter­est.

If after the pay­ment-assis­tance period, the home­owner still can­not  afford the monthly pay­ment on the orig­i­nal mort­gage, the fore­clo­sure process may begin. The gov­ern­ment might then seek loan repay­ment as it would for edu­ca­tion loans—for exam­ple, by plac­ing liens on future income.

The Grant Version

In the grant ver­sion, the gov­ern­ment would pro­vide at least 25 per­cent of the monthly mort­gage pay­ment for up to two years with­out requir­ing repay­ment. Home­own­ers whose adjusted gross income (aver­age income in the two years prior to income dis­rup­tion) exceeds a to be spec­i­fied mul­ti­ple of median fam­ily income in 2008 would not be eli­gi­ble, a use­ful if imper­fect means of exclud­ing very high-income home­own­ers who likely have accu­mu­lated sig­nif­i­cant wealth to self-insure against tem­po­rary income loss.

Advantages and Disadvantages

The plan pro­vides a sig­nif­i­cant but tem­po­rary  reduc­tion in the homeowner’s pay­ment dur­ing the period of income loss—an advan­tage over loan-mod­i­fi­ca­tion pro­grams, which do not always lower pay­ments suf­fi­ciently and some­times even raise them—by adding missed pay­ments to the out­stand­ing loan bal­ance. For lenders, ser­vicers, and sec­ond-lien hold­ers, the plan con­tains a more real­is­tic recog­ni­tion of their incen­tives and no pres­sure to do mort­gage mod­i­fi­ca­tions. Even if fore­clo­sure can­not be avoided when the gov­ern­ment aid ter­mi­nates, the hous­ing mar­ket is likely to have recov­ered enough that dis­posal of the prop­erty will gar­ner a higher price.

On the down­side, the plan prob­a­bly can­not stop home­own­ers who have extreme neg­a­tive equity—say, 40 per­cent or greater—from default­ing when gov­ern­ment aid ends. Indeed, the plan may merely delay fore­clo­sure with­out any guar­an­tee of eco­nomic or social ben­e­fit. Another con­cern is that the bor­row­ers who should get help may choose to default rather than pur­sue a gov­ern­ment loan. Mean­while, the grant ver­sion raises the poten­tial for moral haz­ard.

Finally, admin­is­ter­ing the pro­gram does require some coop­er­a­tion from mort­gage servicers—for exam­ple, giv­ing appli­cants their out­stand­ing loan bal­ances and some home-price infor­ma­tion. If the gov­ern­ment chose to offer pay­ment for such assis­tance, that would add cost.

Estimating Costs

The cost of the grant ver­sion is eas­ier to esti­mate than the cost of the loan ver­sion. The civil­ian labor force is about 155 mil­lion per­sons. With the unem­ploy­ment rate at 9.4 per­cent in July 2009 and con­tin­u­ing high, more than 14 mil­lion work­ers will be unem­ployed. An upper bound on the share of unem­ployed per­sons who are likely to be home­own­ers is the national home­own­er­ship rate of about 68 per­cent. That sug­gests 9.5 mil­lion unem­ployed home­own­ers. A very high upper bound on the share of unem­ployed home­own­ers likely to have neg­a­tive  equity is 35 per­cent, which implies that about 3 mil­lion per­sons would be eli­gi­ble for the pro­gram. Accord­ing to nation­wide data on indi­vid­ual mort­gages, the aver­age  mort­gage bal­ance of those who are 60-plus days delin­quent is approx­i­mately $200,000, with an aver­age inter­est rate of 7.7 per­cent.

Assum­ing a 30-year amor­ti­za­tion sched­ule, the aver­age yearly pay­ment is $17,111. If the gov­ern­ment pays 50 per­cent of the yearly cost on aver­age, then the cost of pro­vid­ing help to 3 mil­lion home­own­ers is about $25 bil­lion annu­ally, per­haps $50 bil­lion over­all. That amount is lower than the costs of other fore­clo­sure pre­ven­tion plans.

The loan version’s cost would be smaller. Indeed, if all par­tic­i­pants paid back their gov­ern­ment loans, the pro­gram would cost vir­tu­ally noth­ing in present value. Some bor­row­ers, how­ever, will default, and the gov­ern­ment may there­fore incur unre­cov­ered costs. It is hard to esti­mate  the degree of default, but the num­ber is likely lower than in exist­ing pro­grams. Although no pro­gram for pre­vent­ing fore­clo­sures is per­fect, we believe that ours has the best chance of suc­cess because it addresses two of the lead­ing causes of cur­rent fore­clo­sures in a way that other plans can­not. Pol­i­cy­mak­ers may decide the plan needs tweak­ing, but the spillover effects of esca­lat­ing fore­clo­sures call for urgency.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • real wealth after rent is reduced.”

    Which is still a change in the stan­dard of liv­ing, not an infla­tion as (most) econ­o­mists gen­er­ally describe it, ie a gen­eral rise in prices, includ­ing the price of labour. 

    The extra is moved to the ren­tiers who con­trol the land monop­oly from more dis­cre­tionary items. And where there isn’t a nat­ural monop­oly like land you will start to get sub­sti­tu­tion effects as entre­pre­neurs move into the newly prof­itable area.

    One of the prob­lems with the cur­rent malaise is that there is nowhere sig­nalling that it needs sort­ing out. It is near impos­si­ble to make a decent profit, so nobody is tak­ing a risk on invest­ment.

    Prices have to move or there is no sig­nal as to which areas need sort­ing out. 

    It’s the over­all price sta­bil­ity that needs anchor­ing and that is done in MMT via the employed buffer stock sys­tem as described by Bill in his lat­est blog

  • alain­ton

    NeilW
    so no infla­tion then in euro­zone coun­tries where wages are falling! — how arbi­trary, as is the deci­sion in some coun­tries to exclude hous­ing costs from infla­tion, why include trans­port costs which tech­ni­cally is an addi­tion to rent and exclude hous­ing? Prior to 1983 in the US house prices rather than imputed rents were included in the US infla­tion index, In the UK and ECB I belive they are not included at all.

    I would define infla­tion as an ero­sion in the amount of con­sumer goods pur­chasable caused by a rise in prices.

  • glu­bilee

    In the US, if you are unem­ployed and you are under­wa­ter on your mort­gage, any deal that involves you pay­ing any­where near your pre­vi­ous mort­gage pay­ment and keep­ing the entire prin­ci­ple on the books is a very bad deal. It’s no jubilee, at least in US we can walk away and have bank fore­close with­out it ruin­ing the rest f our finan­cial lives, that is an unnec­es­sar­ily costly to soci­ety and neigh­bor­hoods and investors method of jubilee (because investors take big­ger hit than mort­gage bor­rower gain in default) but at least it’s a form or jubilee, bet­ter than debt, which is worst than nothin.

    I’m in a mid­dling real estate mar­ket in the US and we have expe­ri­enced 30 to 40 per­cent decline in house val­ues. Con­dos and cer­tain loca­tions were hit worst. I have a coworker that had an extremely low inter­est, vari­able rate on the home loan, around 3 per­cent (and in US we get to deduct that interst from tax­able income, so know of another 15–25 per­cent off that interst cost) They were lucky, their loan reset after rates had dropped, but even with the low cost of the money, they ended up walk­ing away, as we can do in US, not with­out con­se­quences, but not end of world. Any­way, they bought their condo in 2002, well before peak in 2005 2006, for $180k, they paid that down to about $145k before they walked. Their neigh­bors had bought con­dos for up to $250k in 2006 and there was a rash of fore­clo­sures shortly after that ruined their whole development’s value. When they went to sell in 2010’ they couldn’t com­plete a short sale for offers around $100k after 6 months of bureau­cratic frus­trat­ing bank paper work and many failed deals. So they walked. Since fore­clo­sure can take 9 months to two years, they gains 6 months free rent, (lets put that at about $4k value at least) and the $45k in neg­a­tive equity, that was no longer hang­ing over their heads, and they lost by hav­ing to pay 7 per­cent on their next car loan instead of 3 per­cent, due to fore­clo­sure on the credit rat­ing. So really, if some­one had cut their prin­ci­pal 25 per­cent and given them 0 per­cent loan, which would seem like a crazy out­lier jubilee idea her in US, this would not have been a bet­ter deal for them. And what of their neigh­bors that bought in 2005 and had not paid any prin­ci­ple down.

    I have sev­eral young sin­gle cowork­ers that bought houses in 2003–2006, and they feel sooo stuck. They are $20-50k under­wa­ter on mod­est starter homes, their jobs/careers are going nowhere, they want to move, do some­thing, but they don’t want to default either. After going to col­lege, work­ing hard, buy­ing a fixer upper house, work­ing on it, they have zero wealth, in fact less than zero wealth, includ­ing their tanked small retire­ment invest­ments. If they are stuck, what does that say for the future growth of the US econ­omy? The only ray of hope is the kids mak­ing it out of schools now can get much cheaper houses, but then they have stu­dent loan debt, that can’t be wiped out even in a bank­ruptcy.

    A prin­ci­ple cut is the only form of hous­ing jubilee that would be any improve­ment in the US. Peo­ple could have stayed in their houses, house val­ues would have not dropped as much because dete­ri­o­ra­tion of hous­ing stock and neigh­bor­hoods, would have been less, investors would have been bet­ter rep­re­sented becuase remain­ing prin­ci­ple would have been higher than amount recov­ered after costs of fore­clo­sure process. Only mort­gage loan ser­vice­men, that make more money doing fore­clo­sures than mak­ing deals, would have lost. But it’s too late for us.

    In Aus­tralia, while low­ered inter­est rates will instantly give peo­ple more money to spend into domes­tic econ­omy (unlike US wher a refi is only way to get that, and when under­wa­ter, you cant refi); the reduc­tion in house val­ues will wipe out most peo­ples wealth, this will have a very very bad long term effect on econ­omy, espe­cially as cur­rent home­own­ers age. So for Aussies, I would sug­gest learn­ing from US. If your govt could hand out huge sums to buy a house, why not to do same to pay off mort­gage debt. What is the freak­ing dif­fer­ence? I sus­pect instead you will be a nation of house debt zom­bies, a whole gen­er­a­tion wiped out need­lessly.

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