Last week, Federal Reserve Chairman Ben Bernanke said banks should consider writing-down principal on outstanding home loans to help slow foreclosures. The media is calling it “principal reduction”.
Every party has something to gain and lose with principal reduction. This is one reason why it may be a phrase forever remembered to 2008, much like “dot bomb” to 2001.
In some interviews, I am pretty interesting. In others, I am fairly dull. Put this one with the latter.
Sean Purcell says:
Dan,
More than philosophically, what is the real advantage of this idea? Sounds like political posturing more than anything. The problem is only made larger by extending it. Rip the band-aid off and move on (he said with the most cavalier tone) 🙂
March 9, 2008 — 12:09 pm
Bob in San Diego says:
There are some practical reasons for doing this on a case by case basis. If the option is a short sale or foreclosure where a sold out junior is going to get wiped out anyway, cutting a deal with the 2nd so the borrower can service the 1st and keep the house is a benefit to all.
March 9, 2008 — 12:18 pm
Craig Tone says:
Sounds nice in theory. Try getting a servicing lender to reduce the principal in practice is another story altogether. What’s the alternative to Pricipal Reduction?
Principal Destruction.
March 9, 2008 — 1:32 pm
Brian Brady says:
“What’s the alternative to Pricipal Reduction?
Principal Destruction.”
Hmmmm…I’m going to echo a Robert Kerr statement from months back; this is loan sharking 101.
When the mook can’t pay, and the loan shark has to kick up to the Godfather, he cuts the vig to the mook. He does everything he can to keep the mook in the deal. He can’t kill the mook or the Godfather wants HIS principal, too. He can’t chase the mook away, he needs him to pay SOME of the vig so the Godfather doesn’t call the loan.
March 9, 2008 — 5:34 pm
Dan Green says:
@Sean: I understand what you’re saying, but if banks continue to lose 50% of their principal through foreclosure, it could freeze money for EVERYONE.
Mortgages pay a modest return to investors and if investors know that every foreclosed mortgage will lose 50% of its value, it creates a VERY large incentive to stop buying mortgage bonds at all.
That keeps the cycle going that reduces home values, then reduces overall LTVs, and then leads to more foreclosures.
I am not saying Principal Reduction is just; I am only observing.
That said, I wouldn’t be surprised to see Principal Reduction treated as taxable income by the IRS — despite the “short sale” tax rule it recently revoked.
March 9, 2008 — 7:16 pm
Craig Tone says:
“When the mook can’t pay, and the loan shark has to kick up to the Godfather, he cuts the vig to the mook. He does everything he can to keep the mook in the deal. He can’t kill the mook or the Godfather wants HIS principal, too. He can’t chase the mook away, he needs him to pay SOME of the vig so the Godfather doesn’t call the loan.”
I see the parallels, Brian. Problem is the loan shark (and master servicer) would rather control the mook’s ARM pain as a way of inducing payment.
The mook knows he doesn’t have to pay the marionette godfather anyway. He’s not afraid of him either.
Cosa Nostra, Countrywide, and all the others are a shadow of what they once were. It’s a shame.
March 9, 2008 — 7:28 pm
Sean Purcell says:
>Mortgages pay a modest return to investors and if investors know that every foreclosed mortgage will lose 50% of its value, it creates a VERY large incentive to stop buying mortgage bonds at all.
I think you are describing the real problem here. Investors (let’s assume) make rational investment decisions. If I know that some % of loans are going to default and I will lose 50 cents on the dollar within that percentage, I have no problem. I simply price this information into my purchases and away we go. But if some well intentioned but economically ignorant entity (read: government) is going to change the rules mid-game… I will take my marbles and go home. This was most obvious when the talk was of freezing and/or lowering rates on adjustables. Investors are buying income streams. Lower my return by fiat and I will find a new income stream.
I really do not mean to be cavalier here. But investors will return to the table sooner if the game is not rigged. It hurts to have your house foreclosed (I know), but the EXTREMELY small percentage of homeowners going through that process (painful as it may be to say) should not be saved at the expense of the entire system.
The faster the inventory (of homes AND bad loans) is cleared out, the sooner we will have stability.
March 9, 2008 — 8:18 pm
Brian Brady says:
I hear ya, Craig. Look what Dan said:
“Mortgages pay a modest return to investors and if investors know that every foreclosed mortgage will lose 50% of its value, it creates a VERY large incentive to stop buying mortgage bonds at all.”
It’s true.
The bosses are Wall Street; and they know they ain’t got no leverage. If the mooks run (and they will), they will get hammered. Why would they lend at all?
Here’s why. To get out of the hole. The way out of this mess is to originate more product; better priced product against safer collateral.
Bernnanke’s suggestion is loansharking 101 and it works- it buys time
March 9, 2008 — 9:56 pm
jimi says:
I don’t think this proposal buys time at all. It will extend the crisis by rewarding failure. Those who remain current on their mortgage, despite negative equity, are punished. Eventually, they recognize the injustice and say, “What am I, Chopped Liver?” … then they go three pay down to qualify for the deal. Rinse and repeat.
March 10, 2008 — 5:14 am
David says:
I see chase bank is taking a customer’s payment as a Principal Reduction, as shown in monthly statment. Say, a payment of $1000 is splited into 3 parts:
$90 for paying the interest
$820 for paying the principal
$90 Principal Reduction
so, total is $1000 of the payment
What does this Principal Reductin really mean?
February 7, 2009 — 12:11 am