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Tag Archives: Strategic Default

10 Cents on the Dollar: How to pay off your home equity line of credit

NY Times columnist David Streitfeld’s article entitled, “Debts Rise, and Go Unpaid, as Bust Erodes Home Equity”, published in The New York Times on August 12, 2010, asserts that most investors expect less than 10 cents on the dollar for defaulted home equity lines of credit such as second mortgages.

“Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote of on primary mortgages, government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter. Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. ‘People got 90 cents for free,’ Mr. Combs said. ‘It rewards immorality to some extent.'” Mr. Combs is a realty lawyer in Phoenix, AZ, who tries to negotiate deals with home equity line of credit HELOC loans.

Utah Loan Servicing chief executive Clark Terry buys defaulted home equity loans from lenders, and reports that he does not pay more than $500 for any one loan, regardless of how big it is, “Anything over $15,000 to $20,000 is not collectible. Americans believe that anything they can get away with is O.K.”

The delinquency rate on home equity loans was an astonishing 4.12% in the first quarter of 2010, down slightly from the fourth quarter of 2009, when it was the highest in 26 years of such record keeping, according to Mr. Streitfeld.

Mr. Streitfeld reports that during the “great boom” homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their homes as loan security. With the money now spent, some homeowners cannot pay. Surprisingly, it seems that delinquencies on this type of debt is greater than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard. Mr. Streitfeld cites info from the American Bankers Association on this point.

Ideas for Action: Is it time to contact your second mortgage company and negotiate–offering 5 to 10 cents on the dollar?

Is there a “flexible mortgage” in your future? – new thoughts and trends in mortgages – article by UCLA Law Professor Katherine V.W. Stone

Professor Katherine V.W. Stone, of UCLA law school writes that in the “old economy”, periods of joblessness were a clear sign of an unreliable borrower, but not any more, as we are in a “new economy”. Professor Stone’s article is entitled “The 30 Year Prison”, and appears in the August 12, 2010 edition of The NY Times.

Professor Stone calls for a major changes to mortgages–a “flexible” mortgage with the borrower having an option to request a two-year period of “interest only” payments. She suggests that the Federal Housing Administration require that any mortgages it insures be set up to mandate that borrowers who are involuntarily out of work be allowed to convert to an interest-only loan for up to two years. She points out that since the FHA insures almost one-third of the mortgage housing market, in short order the mortgage industry would very likely follow suit, and that this practice would become the norm for all mortgages.

Professor stone writes: “It’s not as if the 30-year self-amortizing mortgage has been around forever. In fact, it is a fairly recent invention. Before the 1930s, homes were financed by three-to-five-year balloon loans. Homeowners made interest-only payments for the duration of the loan, then typically rolled them over into new loans when they came due. During the Great Depression, however, many borrowers were unemployed when their loans came due; banks were reluctant to offer new loans, and owners had not accumulated enough money to pay off their loans. The result was a wave of foreclosures. In response the Home Owners’ Loan Corporation, created as part o the New Deal, developed a new kind of loan: instead of a few years of small payments followed by a very large one, homeowners would make regular payments of interest and principal for 30 years. In the old economy, periods of joblessness were a clear sign of an unreliable borrower. Today, they are simply a function of the job market, which flexible mortgages would take into account.”

Loan Modifications in Washington: How much is the government spending through HAMP and TARP?

Washington will get some share of the $1 billion disbursed to HUD to help with house payments so if you are unemployed and falling behind on house payments, hit HUD up for a loan.

Unfortunately, Washington homeowners get NOTHING from the recent $2 billion disbursed by the Troubled Asset Relief Program to other states. The benefited states as to the $2 billion include Alabama, Illinois, Kentucky, Mississippi, New Jersey, and Washington D.C., as part of the Hardest Hit Fund disbursements.

This $2 billion is the third large grant to the Hardest Hit Fund. Washington has not received any portion of those three grants. The Hardest Hit Fund receives disbursements from the $45.6 billion set aside for housing issues in the Troubled Asset Relief Program. Hardest Hit Fund disbursements to those favored states to date now total about $4.1 billion in three disbursement. The Hardest Hit Fund is, for now, out of money.

To date, the other funds in the $45.6 billion earmarked from TARP to be expended for housing issues include $30.6 billion for loan modification programs (such as HAMP, AKA the Housing Made Affordable Program) and $11 billion for a FHA refinancing program. Thus, there would now seem to be no funds–zero dollars–left to disburse to the Hardest Hit Fund except that, as reported by Mr. Streitfeld in the New York Times, the government has up until October 3, 2010 (the two-year anniversary of TARP) to shift the $45.6 billion in committed funds around within the housing assistance program. Perhaps the government could issue one more Hardest Hit Fund disbursement which would make house payments for people by giving them outright grants or interest free loans to make house payments while unemployed, underemployed or suffering from some other sort of financial stress or strain. If the past is a guide to future policy actions, I doubt that Washington state would be a beneficiary.

While frozen out of the $2 billion Hardest Hit Fund to date, Washingtonians may see a little benefit from the $1 billion that was just disbursed to HUD (Housing and Urban Development) from the new Financial Overhaul Law. This $1 billion HUD disbursement apparently is not part of TARP, so it is $1 billion in “new money” in addition to the $45.6 billion in TARP for housing issues. As to this $1 billion, Mr. Streitfeld reports that HUD indicates it will work with local aid groups to offer bridge loans of up to $50,000 to eligible borrowers to help them pay their mortgage principal, interest, insurance and taxes for up to 24 months by way of interest-free loans to such affected homeowners.

Mr. Streitfeld reports that between the $1 billion HUD funds from the Financial Overhaul Law and the $4.1 billion pumped into the Hardest Hit Fund in three installments, up to 400,000 borrowers could ultimately benefit. However, given the reported 14.6 million unemployed or the 3 million households contemplating foreclosure, this assistance is modest, given the size of the foreclosure problem.

Economy slowing down again, and Federal Reserve Bank is running out of traditional stimulus options says UCSC Economics Professor Carl E. Walsh

The economy is slowing down again despite interest rates being lower than ever: What is the government going to do next? Here is the answer, by NY Times Reporter Sewell Chan:

“The challenges the Federal (Reserve Bank) faces aren’t going to get any easier in the coming months,” said Carl E. Walsh, a professor of economics at the University of California, Santa Cruz. “The choices ahead are only getting worse as the economy seems to be slowing down.” Professor Walsh was quoted in the New York Times Thursday, August 12, 2010 edition, Section B1

Sewell Chan’s August 12, 2010 NY Times article introduces us to a new term, “Quantative Easing”, and says that after lowering short term interest rates, about the only thing that the Federal Reserve can do is to pursue a policy of “Quantitative Easing”. According to Mr. Chan, Quantitative Easing is a controversial and uncertain central bank tactic. There is little modern historical precedent by which Quantitative Easing can be studied and analyzed by economists to predict results.

Mr. Chan explains that because short term interest rates are already close to zero, that now the Federal Reserve Bank’s last and final option is more “Quantative Easing”. Will it work?

What is “Quantative Easing”? Simply put, it is the printing of additional money to purchase financial assets in the market place, by using government money to buy instruments held by investors. The instruments purchased by the Government Treasury in “Quantitative Easing” are things such as (a) mortgage backed securities (b) buying/cashing out debts owed by the government such as Fannie Mae and Freddie Mac obligations/bonds and (c) buying Treasury Securities like government bonds.

How does “Quantative Easing” seek to help the economy? My understanding is that Quantitative Easing intentionally creates some inflation as it increases the money supply, and thus with more money rolling around, there is an incentive to invest it by lending it to others. People and investors who now have this freshly borrowed cash then go on spending sprees, and it is these sprees which are supposed to stimulate economic growth by more lending to people who buy things with the newly borrowed proceeds.

In short, more people buying things with borrowed money increases demand for goods and services and such. Increased demand keeps prices for goods and services higher, which is supposed to offset the deflation of prices of goods and services that is occurring in this recession. (See following blog post describing why deflation is “bad”)

Shortly put, deflation is supposed to be “bad” during a recovery from economic recession because deflation will result in a further economic slowdown as people conserve their cash and do not spend it in order to wait for lower prices on everything from TVs to cars to houses to ocean cruises.

This would be a “Second Wave” of “Quantitative Easing” as the Federal Reserve Bank already took a first “Quantitative Easing” step between January 2009 and March 2010 by printing money in the amount of $1.725 trillion (that is 1,000,000,000,000!) dollars to purchase $1.25 trillion in mortgage-backed securities (essentially buying mortgages from private investors), $175 billion in debts owed by government-controlled entities like Fannie Mae (more mortgages) and $300 billion in Treasury securities.

Here are the pros and cons:

Pros of “Quantitative Easing” to buy mortgages and investment instruments held by private investors when lowering interest rates doesn’t seem to be getting the job done to stimulate the economy: Sewell Chan of the NY Times writes that the Federal Reserve Bank’s Chairman Ben Bernanke is an astute student of the Great Depression and that Mr. Bernanke has long argued that the central bank (The Federal Reserve Bank) has the additional tool of Quantitative Easing which should be somewhat readily used to avoid deflation in prices, as deflation will slow, stop or reverse a recovery as people look at cash as an investment in and of itself instead of spending the cash. For example, if you know that the $500 TV set will reduce to $475 in six months (a mere 5.0% deflation in price) then you are more inclined to wait six months to purchase. If you know that your $300,000 home you are looking at buying will decrease 5.0% in one year to $285,000 then you will keep in renting one additional year and will not buy the home, thus stagnating the housing market.

Cons of “Quantitative Easing” More conservative voices (according to the NY Times Swell Chan) propose that the Federal Reserve Bank should not go out into the marketplace to buy mortgages, and that the most aggressive steps taken should be to lower short term interest rates (please note that short term interest rates are almost zero!)

Problem #1: Those economists wary of “Quantitative Easing” say that in a “perfect storm” of circumstances, Quantitative Easing can lead to 1970s style “stagflation” as the government floods the economy with too much available money when it buys out the debt obligations of (a) mortgage backed securities (b) debts owed by government entities to investors such as Fannie Mae bonds and (c) Treasury securities, in an atmosphere when the economy is operating at a reduced level, because there is a surplus or bumper crop of money floating around, but not so much to buy.

Problem #2: According to economists skeptical of “Quantitative Easing” say that further purchases of mortgages, government debts and treasury bills by the Federal Reserve will undermine faith in the US dollar as an accepted stable world currency and the safety of the US Treasury bill as keeping ahead of inflation because it fosters “perceptions of monetizing indebtedness,” according to Mr. Chan’s analysis of economist Kevin M. Warsh, in that it looks like it is the printing of money to pay off the public debt. “On a very simple level [with Quantitative Easing], the Federal Reserve Bank is printing money so the Treasury can spend more than it’s collecting in tax revenues…these are highly unusual circumstances, so no one is too worried about it [right now]. But it is always a temptation to use the central bank to finance government expenditures.”

Mr. Chan writes that economist Kevin M. Warsh notes that the Federal Reserve already has purchased 2.3 trillion worth of debt which includes vast sums of Treasury Bills, perhaps too much. The Treasury Bills are essentially a large share of the national debt. (Note that the Chinese probably now hold the remaining balance. That is a none too funny note for another day). Mr. Warsh notes that the Federal Reserve Bank’s institutional credibility is at stake, if it threatens the currency’s stability to pursue domestic growth.

Problem #3: Economists wary of Quantitative Easing relate that economists “don’t have a lot of good historical episodes in modern economies to know exactly what the effects of quantitative easing are.” Mr. Chan quotes Professor Walsh.

Zillow.com chief economist and Yale Professor of Economics both say: “HOMES ARE NO LONGER GOOD NEST EGG INVESTMENTS” in Tacoma, Renton, Olympia, Bremerton and Chehalis.

“People [wrongly] think it’s a law of nature [that housing prices always go up so as to always beat inflation]” says Yale University economics professor Robert J. Shiller and economist Karl E. Case. Interviewed by the New York Times, Yale economist Mr. Shiller relates that there has been an overall “bubble” since the end of World War II that is unlikely to be repeated, but that even during that historically unprecedented 60 year post WWII boom, that housing values outpaced inflation by only 1.1% per year. Quite to the contrary of the 1947-2005 point of view, during the 1900-1946 time period people saw houses quite differently. They saw them like they were cars. Houses 1900-1946 were seen as a consumer durable that the buyer eventually used up says Yale economist Shiller.

According to Yale University economist Shiller, the first notion of housing as an investment first began to blossom after WWII, when the nesting urges of returning soldiers created a construction boom. Demand was then further stoked as the “baby boom” of post WWII babies grew up and bought places of their own in the 1970s.

Adding fuel to the post WWII housing boom, (1) the inflation of the 1970s (which increased the value of hard assets) and (2) liberal tax policies (like deductible mortgage interest and property taxes AND lack of significant capital gains on housing appreciation) both helped make housing a good bet to at least slightly beat inflation.

Nevertheless, Yale’s economist Shiller says that despite all of these accelerating economic “tailwinds” prices rose moderately for much of the period, providing a mere 1.1% annual increase in value after inflation. However, during the extraordinary housing bubble that began in the late 1990s, housing prices were beating inflation by an average of 4.0% per year.

Zillow.com chief economist Stan Humphries echos Mr. Shiller, saying housing prices will be lucky to beat inflation, as quoted in the New York Times on August 23, 2010: “There is no iron law that real estate must appreciate…all those theories advanced during the boom about why housing is special – that more people are choosing to spend more on housing, that more people are moving to the coasts, that we are running out of usable land – didn’t hold up.”

I urge all of my customers in Tacoma, Renton, Olympia, Bremerton, Chehalis, and throughout Washington state to please read David Streitfeld’s front page article in the Monday, August 23, 2010 New York Times , which provided the content for this blog post.