Policy Implications
Although home prices appear to have stabilized temporarily and housing affordability has been restored, the housing market still has some problems
1. The first problem facing the mortgage market is the shadow inventory, or housing overhang, of 7 million units. This number represents a considerably larger volume than one year of existing-home sales and usually these loans have a low chance of being recovered.
2. The second problem is borrowers with negative equity. If nothing is done by policymakers to mitigate the problem, a huge percentage of those borrowers will default and their loans will be liquidated.
Taking these two problems into account, author estimates that there is a housing problem that affects 11 to 12 million units. If nothing is done, more than one homeowner out of every five will face eviction.
Moreover, government officials are concerned about the consequences of placing a large number of additional homes on the market, generating a “death spiral” of lower prices, which would result in more borrowers with negative equity; these borrowers would be more likely to default, go into foreclosure, and be added to the housing supply, which, in turn, would force prices still lower.
To avoid this problem author thinks that government should embark on one modification program after another in order to prevent mass displacement. Author believes that the housing market intervention must take the form of the following two measures:
1. Reduce the potential supply of homes on the market by encouraging sustainable modifications through complete documentation, consideration of the borrower’s total financial circumstances, and the explicit acknowledgement that negative equity matters. Such a program will keep more borrowers in their homes and thus reduce the potential supply
2. The second point that author points out is that there should be an increase in the demand for viable mortgages. The demand must be sufficient to absorb those homes that borrowers simply cannot afford
Sustainable Modifications
To create a program that encourages sustainable modifications, three conditions must be in place:
1. First, the modified loans must be re-underwritten to verify income and assets. Ideally, the re-underwriting should be performed by originators, who know how to collect documentation, rather than by servicers.
- In fact, starting on June 2010, the Treasury required that documentation should be provided for HAMP modifications before the modifications can proceed. This step will help ensure that the modifications are sustainable, if originator or servicer collect more information on assets and other debt obligations
2. Second, the borrower’s total financial obligations, not just the first mortgage, must be considered in making the modification offer
- Under HAMP, the borrowers who have converted to a permanent modification program have had their front-end debt-to-income ratio fall from 45 percent to 31 percent. This aspect should be considered as a part of the re-underwriting.
3. Third, negative equity must be explicitly acknowledged as a significant driver of defaults
- It is evident that payment reductions alone are insufficient, so a way to deal with negative equity is to forgive principal. In fact, the treasury has proposed that servicers should look at the NPV of a modification by using both the current and alternative waterfalls.
- The current waterfall reduces the interest rate, extend the term, and forbear principal, while alternative waterfall forgives