I have viewed with some trepidation the various "fixes" to the mortgage foreclosure crisis espoused by different states, the judiciary, and Congress.
These solutions invariably call on banks to relinquish their rights under contract law by letting some other party decide how much and when they should collect on a debt signed willingly by a borrower.
Traditional community banks do not make a living on the sale of foreclosed property, hoping for appreciation.
They rely on the spread between interest and fees from loans and interest on deposits.
The practices that led to the current crisis were not conducted at all banks, particularly not at small community ones.
In fact, these small banks were shut out of making their traditional loans to homeowners, because they could not compete with the low fees and low initial rates offered by the large banks or their affiliates that were anxious to corner that market for CRA and Fair Lending credits from their regulators. Poor grades affect a regulated bank's opportunity to expand.
Thus, small community banks were forced to rely on other niche markets for profit.
Some chose to make loans to investors on one- to four-family residential properties as a logical extension of their traditional lending; the collateral and underwriting were similar. Rates were higher for investors, so there was a larger spread to cover the seemingly slightly expanded risk.
These banks have suffered the same delinquency and foreclosure problems as the other banks, but not because of homeowners. The problems came from investor difficulties with housing depreciation (making it hard to obtain cash-out refinancings, the investor's real bread and butter) and the steeply rising costs of utilities (impeding cash flow).
As a result, abandoned properties abound, forcing foreclosure action, not to mention the presence of dilapidated properties in communities as upkeep becomes too expensive for the investor's taste.
Some have proposed that banks unilaterally decrease the amount of principal due on loans to avoid foreclosure.
They say the bank will lose money anyway at the sheriff sale, so why not take the loss now and leave the homeowner in place? This will mean huge losses for the banks. And with the economy in a prolonged funk and energy costs increasing, there is still no guarantee that the homeowner will be able to afford the lower loan amount.
Some simpler solutions come to mind that do not result in the loss of homes or monetary losses for banks. The two methods below may take some amendment to accounting standards, but these have been amended in times of crisis before.
The foreclosure process should be significantly shortened to allow the community banks to obtain and clean up these properties. Then allow them to value the property with a discounted cash flow analysis using anticipated fix-up rents as the cash flow and current interest rates for the discount rate.
In this way, the bank can avoid booking enormous losses from the current distressed-market appraised values.
For banks with large numbers of homeowner delinquencies, allow the borrowers to continue to pay at the initial interest rate for an extended period and evaluate their repayment ability every three years. If the repayment capability increases, so will the mortgage payment.
The contract is extended, not nullified, and the mortgage is repaid, though extremely slowly — possibly up to 100 years.
However, sometime in that very long period, property values will probably increase, so the borrower could sell it at a profit to eliminate the debt.
