John Burns*
February 3, 2009
Double mortgage deductions for all homeowners
We propose doubling the mortgage deduction through 2010 for the first $15,000 in annual interest on all fully amortizing, fixed rate, 40 year or less, owner-occupied mortgages. This policy will encourage more people to stay in their homes and increase disposable income for homeowners, which they will use to save and spend. Additionally, the policy will encourage responsible people to own homes rather than rent and help qualified renters become homeowners. We believe this expensive policy should be extended one year at a time until no longer needed, therefore creating an urgency to buy a home.
We estimate the cost of this policy at about $188 billion per year. We calculate this cost by assuming 50 million Borrowers times $15,000 deduction times the typical top Federal tax rate of 25%. Therefore, a two year program would cost $376 billion.
4. Support Responsible Loan Modifications
Congress is under tremendous pressure from their constituents to encourage loan modification programs that will help stem foreclosures. We believe loan modifications are ideal for responsible owners, but irresponsible buyers should return to the rental market. There are currently about 500,000 foreclosures started every quarter, and we believe that will rise to 600,000 foreclosures in 2009.
Loan modifications will generally help the lowest income areas the most, as that is primarily where the foreclosures are concentrated. The greatest distress has been in the outlying areas and in inner-city areas. The maps below provide a good visual on the concentration of foreclosures – the heaviest concentration (red) are in the outlying suburbs where most of the new homes were built over the last few years, with high concentrations also occurring in the inner-city areas.
Failure of past programs
Loan modification programs historically have a high failure rate. In a recent study by American Banker, 44% of borrowers who obtained traditional loan modifications in the fourth quarter of 2007 re-defaulted within 8 months. The reasons behind loan modification failures include: 1) the owner does not occupy the house (18%), 2) the borrower does not respond to requests (23%), and 3) the loan modification was not sufficient (future monthly payments set to increase, the borrower is left with no equity or negative equity, or the borrower has a track record of not paying bills on time) to solve the problem (29%).
Recommended Loan Modification Plan
Our recommendation is for the Government to create liquidity for loan modifications. In other words, create a government vehicle to buy good loans that have been modified responsibly. The loans should be good assets that can be sold in the future, and therefore will have minimal taxpayer risk. Smart mortgage owners and/or servicers will opt for this program if it recovers more of the principal than if there were a foreclosure.
In order for this program to be successful, the loan modifications must provide payments to the borrowers that are affordable and sustainable. This is achieved by providing for payments that have 35% or less total debt to income including all monthly debt obligations, and a 30-year or less fixed rate payment using prevailing market interest rates and terms. Additionally, a 100% or less LTV must be achieved.
Complex ownership of pooled mortgages can possibly be resolved by creating a vehicle for service providers to put the mortgage or group of mortgages in bankruptcy. We also realize that government incentives may be needed to finance the servicer to do the loan modification.
Finally, in order for this loan modification program to work, it must be fair to the taxpayers. It must be only available to borrowers who have, at some point in the past or present, invested their own money. Additionally, the borrower must have recourse in the form of an IRS tax lien if there is future default.
The Home Owners Loan Corporation (HOLC) is a successful precedent to our proposed program for loan modifications. The HOLC bought mortgages from banks and issued new loans. In two years, it bought more than 1 million loans (1.9 million applied), or 20% of outstanding mortgages at a 20% discount from the banks. The HOLC was established in 1933 to refinance homes to avoid foreclosure, with the goals of protecting homeowners from foreclosure and relieving homeowners of the higher interest and principal payments incurred during periods of higher property values and higher earning power. Additionally, the HOLC declared that it was a national policy to protect home ownership and tried to do so by imposing the least possible cost on the Federal Treasury and avoid injustice to the investor. The HOLC was abolished in 1951 after reportedly turning a profit over its lifetime, although some argue that not all of the costs were counted, and it was able to borrow at below market rates.
Summary
This downturn is unlike others experienced in the nation’s past. The problem does not lie solely with consumer confidence; rather the lack of confidence is built upon real fears that cannot be alleviated with rhetoric.
We recommend four courses of action in order to stabilize the economy and housing market.
- Banks: Stabilize the banking system. Major institutions have failed, and we need to end the failures.
- Jobs: Stabilize the job market. People know their employers are struggling, so they are worried about their job. They are saving to build up cash reserves in the event of a problem, and they need to regain confidence.
- Stimulate responsible home buying. People know their college savings and accounts just fell by 30% or more, the equity in their home has declined, and that their pensions (both Social Security and now their employer) are in serious jeopardy. To compensate, they are saving. Give them a reason to buy a home, which will occupy empty homes and end price declines.
- Support responsible loan modifications. Let the private sector deal with their bad investments, but provide liquidity opportunities for the private sector to be rewarded for dealing with the borrower fairly.
All of us have learned some important lessons from the excesses of the 1990s and early 2000s. Let’s fix the problem and then make sure this never happens again.
John Burns is CEO and Founder of John Burns Real Estate Consulting, which provides objective, independent advice to executives at large corporations, including builders, developers, banks, private equity firms and large investment firms. Mr. Burns can be reached at
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