Originally Posted October 9, 2008
Seeing as we as taxpayers now have access to $700 Billion of federal money to play with in the mortgage market, I thought it would be irresponsible of me if I did not put forth a legitimate plan for what to do with this money. Yes it involves restructuring debt loads, but I think it does more to solidify the real estate market more than anything I have seen thus far from our friend Sec. Paulson.
This post began, as did the preceding post, as a reaction I had when listening to the debate on Tuesday. Sen McCain offered that as part of our helping the middle class, we should use the $700 billion to buy back the mortgages of sub-prime and Alt-A debt that are having difficulty paying back the debt. Once purchased, we would re-set the principal to the new value of the home, so that people are not underwater in equity.
In all fairness to both parties, Obama has said he wishes to do the same, although I did not hear him say it on Tuesday.
This is a horrible idea. A miserable idea of massive proportions.
Let’s dissect the value of this proposition and why it is being bantered about. The goal is that if we don’t have foreclosures, we won’t have diminishing property values. If we halt the fall in prices, it will restore confidence, and thus the world will be all good. Well, the other obvious thing is that people love getting something for nothing, and that’s just what this does. It rewards people who borrowed too much and are now unable to pay for it. Further, if we remove the burden of being underwater, what is to stop people from dropping the sales price of their house dramatically to get out from under the loan.
So, what is The Davis Plan?
Rather than adjusting the principal, adjust the interest. This has multiple purposes. If a borrower qualified for the teaser rate in the beginning, he (theoretically) should still be able to do so in most cases. So, the borrower should be able to make the monthly payments. Because he can make the payments, he won’t get foreclosed. However, because his mortgage is still underwater, he can’t sell. This is a GOOD thing. Because he can’t sell, he stays. This reduces inventory on the market. This produces a stable market. This provides for liquidity to those persons who can sell and wish to sell.
How does this really play out? Well, if a person bought a $400,000 home with 100% financing at 5.5% teaser, his original payment (assuming no negative amortization) would have been $2,271 + Taxes and Insurance. With interest rates resetting, that rate could be 8.5 or 9.5%. If we assume 8.5%, then the borrower is now paying $3,075 +T&I. Under the current plan touted on Tuesday night, the principal would be reduced to the market value. Let’s say it’s dropped 25% in Ohio, that borrower now owes $300,000 at 8.5% interest and the payment is all the way down to $2,306 + T&I. And the cost to the taxpayer is an instant $100,000. With no chance of ever seeing that money again.
Now, under The Davis Plan, the borrower returns to paying $2,271 (less than the proposed plan). The borrower stays in his home. He doesn’t sell because he can’t afford to; remember, he still owes $400,000 on a home that has dropped in value. But he still has his home which is really what he wanted anyway.
Now, I know what you are thinking: what if the borrower needs to move because of work or family. Well, I have that covered.
Remember how I said people like getting something for nothing. That doesn’t exist in The Davis Plan. People will have the option of putting their house into The Plan or not. If they choose not to, they can be foreclosed upon, face bankruptcy, and see what the court allows them. That’s fine. I don’t think most people will take that route. I think they’ll opt for The Plan.
Upon agreeing to this workdown of debt, the borrower agrees to one simple change in their mortgage. Just like government insured student debt, you won’t be able to bankrupt your way out of this one. It is with you to your death.
So, if in five years you need to sell your home and you only get $350,000 for it, you still have a $50,000 – 30 year note with the Government. You can take it to your next home. You can prepay it if you would like. It will be tax deductible to the same degree that any other mortgage is – provided that loophole remains.
We now have a method for helping out the middle class, keeping them in their homes, removing excess inventory from the market, stabilizing the housing market, restoring confidence to the markets, and all of this without giving away something for nothing.
How much would all this cost? I have no idea. But I don’t think anyone really knows if $700 billion is enough to do what little they want to do anyway.