The Mod Solution

There is a lot of speculation out there surrounding what the root cause of today’s financial meltdown, and how best to cure it. In actuality, the cure has to happen in two parts, one in the short term, and one dedicated to a long term solution. These two phases should be completely separate, as the long term solution will do nothing for the problems we face right now, and conversely, the short term solution alone would only exacerbate the problem over time.

To understand the issue, you first need to identify the causes, and there are many. Real estate values over the last 20 years increased at an artificial, and completely unsustainable pace, creating a market where the average Joe could not afford to join the ranks of American homeowners without some creative help from both the government, and the banking industry. This lead directly to what we are now referring to as ‘toxic’ loans. Basically Adjustable Rate Mortgages (ARMs), that started off with a minimum payment (often not even enough to cover the interest-only portion of a normal payment, which caused the loan to negatively amortize. Meaning that with every payment made, the homeowner slipped further into debt.), and then, after a predetermined amount of time, the loan would re-cast, and the payments would increase dramatically. Borrowers were either not informed properly and had no idea that this could happen, or they took the loans on the belief that values would continue to increase, and they would be able to sell for a profit, or re-finance at a lower rate before the loan re-cast. Unfortunately, the system crashed before many were able to get out.

At the same time, people had begun to depend more and more on credit to sustain their lifestyle. They bought anything that could be broken down into affordable monthly payments, regardless of the rate of interest, or the actual cost. At worst, they figured that they could pay everything off when they sold their house and made an obscene amount of profit. This happened gradually, and no one considered the possibility that they might lose a portion of the income that contributed to the monthly payments that financed the whole thing, much less the possibility of a housing collapse.

Now fast-forward a couple of years, and the first round of folks who couldn’t pay the mortgage after re-cast start to go into foreclosure. This creates two situations: 1) Property values begin to decrease, and 2) Others in similar situations begin to try to dump the properties before they get sucked down into the vacuum, causing values to plummet further. This cycle continues, and values fall at an unprecedented rate.

Now you have a situation where the public sees what’s happening, but doesn’t really understand it, so they lose confidence in the economy and begin to spend less. Not a bad thing, right? Well, when everyone stops spending money, the economy comes to a screeching halt. Businesses that were booming just a few months ago, all of the sudden had no customers, and therefore no income, and started to cut back on their spending, starting with the single biggest expense of any company: Employees. The layoffs began, and consumer spending decreased further, and that led to more layoffs, etc, etc.

Now unemployment rates are the highest they’ve ever been, banks are afraid to lend any money so no one can buy a home, people aren’t spending money because they may not have a job next month, and the government is trying to spend us back into prosperity by engulfing the country in the biggest deficit we’ve ever seen. How do we escape this downward spiral? I won’t address the long term, as it is too in depth to convey in this media, however, the short term options are fairly simple.

 

The Plan

In the short term, we have only two viable solutions to stop the bleeding. The first, and most likely to succeed, is basically pushing the universal ‘reset button’. Take a look at every mortgage on the books today, and for the ones that are ‘under water’, Immediately write off the difference between what the debt is and what the actual value is, in essence dropping the principal to within 5% of current market value, and fixing rates at whatever the current rate happens to be. This would allow a majority of homeowners to remain in their homes, and increase consumer confidence across the board. This will never happen, which leaves us with loan modification.

 

Liberal application of loan modifications is the only doable option that we have available to get people out of the situation we find ourselves in.  Do not confuse this idea with one of ‘fairness’. Investors will say that it’s unfair to reward those who allowed themselves to get in ‘over their head’.  It is necessary though, and will ultimately save them a very real fortune, as well as possibly saving the American economy, and by extension, that of the entire world. 

Without modification, a large percentage of these loans will default, putting an enormous strain on the banks. The costs associated with the process foreclosures alone would devastate most of our financial institutions, let alone the vast inventory of bank-owned property which would need upkeep and maintenance, as well as having the capital tied up in worthless property that they can’t liquidate. The risk of not endorsing widespread modifications far outweighs the risks involved in creating a more affordable loan product out of one that will eventually go bad. The value of a loan after modification is MUCH higher than the value of a loan which has been short sold or foreclosed upon.

In conclusion, and I know a ran a little long today, the last best hope for our current mortgage crisis is loan modifications, and a lot of them. It’s the least of all evils, it’s a marketplace solution, and with real effort on the side of the banks, can be done very quickly. They just need to decide to get it done.