In its attempt to save the housing industry, government regulators have come out with one dumb bailout after another. The FDIC may have topped them all however in their recent proposal to pay borrowers up to $20,000 to walk away. [Thanks L!]
The five biggest US mortgage servicers were told this week at a private meeting with regulators to consider paying delinquent borrowers up to $21,000 each as part of a broader settlement of the foreclosure crisis.
People who attended the meeting, chaired by the Federal Deposit Insurance Corporation on Monday, said the industry-wide “cash for keys” program would involve the biggest servicers, led by Bank of America, paying borrowers as an incentive to leave their homes.
Banks would pay borrowers who are more than 90 days behind on mortgage payments up to $1,000 to seek independent financial advice and up to $20,000 in cash as a “fresh start” payment towards living costs in a new home. They would have to vacate their properties quickly and leave them in good condition.
23% of all mortgage holders are now underwater. What motivation would any of them have to continue paying their mortgage if they could be paid $20,000 in cash if they quit paying their mortgage for several months and walked away?
If the FDIC is looking to punish lenders, this certainly ought to do it. It would also punish the rest of us:
[T]he write-offs would reward the most financially irresponsible borrowers, while punishing responsibility. If you were thrifty, and made a big downpayment, you will not be eligible for a write-off, since your mortgage will still be smaller than your house is worth, even if your house declined in value. But if you saved little money, and took out a no-downpayment loan, your loan may be bigger than the value of your house even if the value of your house didn’t fall much. Even a small fall in value would leave you “underwater” on your loan, and thus eligible for a bailout under the proposed settlement, to reduce the size of your mortgage to less than your home value.
(Eligible doesn’t mean you will necessarily get a bailout; the settlement requires banks and mortgage services to satisfy numerical “quotas” of how many mortgages to write down, not to write down the vast majority of such mortgages. The banks actually have perverse incentives under the settlement to give such help to the people who least need it, according to sources cited in a Washington Post story.) Banks say the proposed settlement would discriminate against people who “paid on time and honored their obligations,” that it raises “serious moral hazard issues,” and “could retard the recovery by encouraging borrowers to default.” The settlement will also increase borrowing costs in the future for home buyers, since banks will have to hedge against the risk of future loan write-offs by charging higher interest rates (much as credit card companies raised interest rates and fees after Congress passed a law limiting penalties for irresponsible credit card holders). So credit will become more expensive for those of us who are responsible in paying our creditors regularly.
Why is this plan even on the table?
The Department of Justice; state attorneys-general; banking regulators, including the FDIC; the Treasury; and the new Consumer Financial Protection Bureau are among the agencies trying to come to a settlement with the industry. A combined penalty of about $20 billion has been discussed, with one idea to use the money to write down the outstanding debt of struggling homeowners.
However, prospects for a single “mega settlement” have worsened because officials disagree on the level of penalty and whether money raised in fines should be used for a principal writedown. The banking regulators, who do not agree among themselves, are nonetheless keen to come to an agreement quickly.
The “mega settlement” may be an attempt for a simple solution, but the situation for every borrower is different, and needs to be treated as such. There is no “one size fits all” solution to mortgage fraud when it’s not always clear in each instance who was defrauding whom, or even if fraud occurred. Here’s hoping this “walking away for fun and profit” proposal dies on the table.