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Wednesday, February 20, 2008 11:26 PM

Postpone But Don't Forget

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The latest plan in a seemingly never ending series of plans to bail out housing comes from the Office of Thrift Supervision. This new plan does not have a catchy name like "Hope Now" or "Project Lifeline". Nor does it send out fake Wedding Invitations Worth Refusing.

In fact, the plan does not even have a name at all. The central idea behind the plan is "Don't forgive debt, just postpone repayment". With that idea in mind, let's call this the Postpone But Don't Forget Plan. Following are the sketchy details.

A new plan from the Office of Thrift Supervision would have lenders reduce mortgage balances, but let them collect the difference later. The Office of Thrift Supervision (OTS) is urging the federal savings and loans lenders under its authority to refinance loans by reducing mortgage balances to the current market values of the homes. Thanks to falling home prices, many homeowners are now stuck with mortgages that are actually worth more than the houses themselves.

But instead of having lenders forgive the difference between the old mortgage and a house's current resale value, called a short sale, the OTS advises that lenders issue a warrant or "negative amortization certificate" for the difference. If a home regains its market value and is then sold, lenders have first claims to the profits.

Few details about the plan have been settled, but it would not involve any legislation, nor would it be mandated in any way. Adoption would be on a voluntary basis by the hundreds of thrift institutions in the United States, like Washington Mutual (WASH) and IndyMac Bancorp (IMB).

Indeed, banks may not want to take this approach in markets where prices have fallen so steeply that it is unlikely they'll recover any money.

The plan's biggest attraction for lenders, according to Seiberg, is that rather than spending $50,000 to foreclose on a home or to write-off the negative amortization in a short-sale, they get a certificate that permits them to share in the up-side, if and when housing markets recover.

"The plan still needs to be discussed, but it has some attractions," said Ruberry. "We're putting it out there and urging our institutions to give it a look."
Another Attempt To Stop Walk Aways

This is clearly another attempt to prevent people from walking away. Details are scant and many questions need to be answered. For example, what happens if home prices keep falling? What happens if they rise? Who does the appraisal? From an accounting standpoint I am wondering if this is a blatant attempt to prevent writedowns based on potentially worthless certificates that permit recovery down the road. But most importantly why would someone hugely underwater on their home want to take part in this scheme?

Most of the bailout plans to date have had the fatal flaw of there being little or nothing in it for the person about to walk away. In this instance however, there is a benefit of a lower mortgage payment. But does that outweigh the advantages of walking away, saving money for a down payment, and reaping 100% of the rewards for future appreciation?

Assume you are a homeowner $100,000 in the hole on a house now worth $250,000. Are you better off giving the next $100,000 appreciation to the bank or are you better off walking away, sticking the bank with the property and buying something later where 100% of the profit is yours instead of the banks?

At first glance the answer seems pretty clear, but let's rework the example slightly.

Once again, assume you are a homeowner $100,000 in the hole on a house now worth $250,000. Perhaps you are attached to the house and want to stay. You agree to participate in this scheme. Then out of the blue (or negotiated in advance) you find someone willing to pay $250,000 for it. Like magic, you suddenly become unattached to the house. You accept the terms and sell the house for $250,000. Voilà! You escaped the debt trap. You owe the bank nothing, there was no short sale, and your credit is not even impaired.

House Swapping Anyone?

Unless there are sale restrictions, time restrictions, or unless the appraisals are ridiculously high, banks might get killed on this idea as presented. This scenario is a perfect solution for some set of homeowners but not the bank. Those with potential buyers at lower prices can take advantage of the offer and escape the debt trap scot-free, perhaps by swapping similar houses. Those without potential buyers or who simply want out now, can still walk. This sounds like a free option to me. I am all in favor of free options for the homeowners.

On the other hand, if too many restrictions are placed on the plan or the appraisals are too high, homeowners will see through it and just do what they were going to do and that is walk. Depending on the details, this plan is going to either backfire badly on the banks, or will simply be dead on arrival.

U.S. Thrifts Post Record Loss

While on the subject of thrifts, we may as well mention U.S. thrifts post record $5.24 billion quarterly loss.
U.S. thrifts and savings institutions lost a record $5.24 billion in the fourth quarter of 2007, mainly due to write-downs of good will, the U.S. Office of Thrift Supervision said on Wednesday.

The thrift industry, which is largely comprised of mortgage lenders, is facing a major downturn in the U.S. housing market and losses stemming from home loans provided to borrowers with poor credit history.

The loss in the October through December period of 2007 was the first for the industry since the third quarter of 1996, the OTS said.
Losses at thrifts have only just begun to mount. The ticking time bomb for many thrifts is pay option arms and massive negative amortization. A very ugly consumer led recession, now underway, is going to amplify nearly every credit problem, especially those of the thrifts.

Mike "Mish" Shedlock
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