We can aid strapped homeowners – responsibly.
Troubled homeowners across the nation heaved a sigh of relief when Obama's Homeowner Affordability and Stability Plan was announced last month.
The $75 billion plan aims to keep about 5 million owners in their homes by modifying troubled loans. Not bad, right? As it stands, that plan may help responsible but distressed homeowners avoid foreclosure. But the only way to reduce the bulk of foreclosures is by reducing the amount that borrowers owe lenders (principal reduction).
The good news is that principal reduction is not precluded in the Obama plan; it's just buried. Yet discussing this solution has been skirted in the debate: Why?
There are five roadblocks to implementing principal reductions. These impediments aren't as difficult to deal with as they might first appear to be. And once we remove them, we can make Obama's homeowner plan a home run:
1. Lenders don't want to recognize the loss, even though they know it's real.
This is irresponsible behavior and regulators should not permit it. A $250,000 mortgage on a $200,000 house is not worth $250,000. Not recognizing this leads to bad economic decisions and foreclosure. Foreclosure in this circumstance would yield a lender recovery estimated at $125,000. A much higher recovery could be obtained by recognizing the mortgage loss, and restructuring.
2. Loan servicers are afraid they would be sued for not recovering the full amount. This is a pathetic if somewhat understandable excuse for not doing the right thing. Thankfully, legislation has been proposed to come up with a safe harbor if a loan modification provides a higher recovery.