March 11, 2012

A Fairness Argument

Readers suggested a topic on loans in default. “Design a ‘fair’ way to undo a bad loan made by a bank. Here’s my shot. And, for the record, I’m not talking law here, or not exclusively. I’m talking fair within a framework of a contract. And lets assume for the exercise that the bank actually owns the loan. It will just make writing this all out a lot easier.”

“If the person cannot reasonably pay the loan, then it has to be undone somehow. However, being approved for more loan than they could reasonably pay, doesn’t change the fact that they borrowed money. Here is a place where I can see a fairness argument coming into play. If the person was steered into a rate much higher than the rate they actually qualified for, that is a place where the bank should take a hit. If changing that rate to the rate they should have had in the first place is enough to make the loan affordable to them now, then we are done. That should happen, no closing costs, not credit ding, nothing. Remember we are talking about the fixed rate, fully amortizing loan they should have gotten with their real data and the market rates at the time the loan was taken.”

“What if the rate they should have been offered back then isn’t enough? A mortgage is secured debt, so if you can’t pay, the item securing the loan has to be taken and sold to pay off the debt. If the loan was recourse, then you are responsible for any amount of the loan over and above the amount that was received for selling the house. So, you lose the house (once the bank finds the proper documents or goes through the state’s onerous requirements for foreclosing when the documents can’t be located - they all have them).”

“If you have a lot of money and a recourse loan, you have to pay any difference - people who have a lot of money (still) should have known better. If you have a lot of money and a non-recourse loan, you don’t have to pay the difference, but you do lose the house.”

“If you are broke and you have a recourse loan, I could see that fairness might dictate a slightly easier form of bankruptcy just for the purpose of dealing with the excess house loan. Do it the real way if you want to get rid of your credit card debt too. If you are broke and have a non-recourse loan, you don’t need a special bankruptcy to get rid of the excess house loan, so nothing special is required.”

“Now, what about the people who lived in the house for free for time well in excess of the expected time between defaulting and foreclosure. I’m inclined to dump most of this responsibility on the banks, but I can see an argument that the defaulter should have to pay rent on the time that they were living there and not paying the mortgage. I think this could use a lot more discussion.”

“And, finally, what should the borrowers ‘get’ for being the ‘victims’ of the banks. There are plenty of documented instances of the people helping with application inflating job titles, salaries, assets, etc. Perhaps they would not have gotten loans and gotten in trouble without that. Perhaps they would have. And if you signed the papers it is still your responsibility, but the problems were almost everywhere and I can see the need for something other than lose the house, go bankrupt if you need to, pay the back rent. What about this? They can get a new loan for the amount they would have qualified for using their original, documented information without closing costs and assuming they can still afford it. So the strawberry pickers with $35K combined income? They can qualify for a $70K mortgage, not a $700K one. Couple with $70K household income? They can get about $170K. Let them use a credit score calculated by excluding the mortgage payments they didn’t make. And maybe let them finance the back rent they owe as part of the new loan, so that even if they qualify for $x they would only get $x less the ‘rent’ they owe the bank.”

“So that is where I come out. You don’t get the house for free. You don’t get the loan cancelled. You lose the house. You maybe have to pay rent for the years you lived for free. And you qualify for a good loan at the level you would have qualified for using traditional metrics on the loan to income ratio back then assuming that you can still afford it.”

“I’m still not sure about this. I’ll have to think some more. Any other ideas?”

A reply, “All of these plans reward the idjits who participated. But if you were smart enough to walk away from the whole mess? No government cheese for you.”

“The whole mess was enabled by government laws/policies at all levels. Until that gets unwound, and government stops handing out carrots, while beating the crap out of some people with whup-azz sticks, nothing will have been gained, and the cycle will be repeated.”

Another said. “I greatly oppose all such plans. All such plans undermine the foundation of our legal system: Contracts. A contract already exists in each and every deadbeat case: The mortgage.”

“Once again, if these deadbeats had flipped their houses for even more sweet cash, they would have kept those gains or sunk them into even more outrageous risks (i.e. a bigger Garage Mahal), and nobody would have claimed anything was wrong or that some policy needed to change or anything like that (except us, the ‘doomsayers’). Fortunately for my sense of completion and justice, all of this became so huge that it was too big to bail without creating serious social consequences for the nation. All choices at this juncture will producing screaming agony for some sector, even the widest possible sector (the taxpayers).”

“A certain inevitability has entered the social future of the United States, and I welcome it. Bad behavior on this level deserves punishment.”

Bits Bucket for March 11, 2012

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