principal forgiveness (moral hazard)

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so_scared

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Interesting piece yesterday on 60 minutes. Basically, in Cleveland, defaults and strategic defaults have become so bad that banks aren't even bothering to auction off the properties anymore. They just foreclose and let the houses rot. The city is then forced to send 8k to 10k tearing down the house because of the blight that these houses become to the neighborhood. They estimated they have to spend $150M to tear down houses!

The argument was being made by one former public official that banks should write down principal because it represents a smaller loss than these foreclosed homes which get ripped to shreds by looters. The looters actually subscribe to foreclose notices so they can step in the day after the owners get evicted. They also only loot the downstairs because it is more efficient!

Obviously the risk of moral hazard exists with writing down principal but it seems in certain locales like Cleveland, it is truly turning into a lose/lose for everyone involved. Maybe tearing down the houses and making everyone suffer and maximizing the losses to the banks is the way to make sure this never happens again but it only took 10 years from the RTC fiasco to create another banking real estate bubble/scandal and it look only 10 years for everyone to forget pet.com and give new "social media" darlings ridiculous funny money again.

60 minutes obviously picks sympathetic profiles to make their case, but makes one wonder if the case against principal forgiveness is as cut and dry as some insist.
 
I used to work in the mortgage servicing industry (IT side) and let me tell you, the cities do not let the cost of tearing down the houses stay on their books.  Whenever the company I worked at screwed up and did not fix repeated code violations on a REO property, the city would send a notice, then tear down the house and send the bank the bill for tear down and all the code violation that were levied against the property before it was demolished.
 
Typically in the cases similar to Cleveland Banks exercised such a strategy when land value is low and home's physical structure is worth more than its land and the total value is less than $75,000. It costs more in man power $$ to maintain and fix up a scrapper than to just write up the loss from razing it.

When your old dvd player don't work anymore you just throw it away. It costs more to fix it.
 
The day my neighbors gets an unwarranted principal reduction is the same day I stop making my house payment. It's easy to get a modification through trickery and I'd assume from past experience that a principal reduction could be had as well with the right documentation. Once the herd is spooked, they'll run and what a catastrophe for mortgage investors that will be.

Principal reductions are a very slippery slope, one that most banks are going to avoid at all cost. Witness the FHA Short Refinance program - hailed as a way to turn bad loans into good ones, but all told I thing under 500 have been completed nationally since 2010. The fight to stop principal reductions for mortgage holders is fought house by house, street by street, by banks. 
 
Soylent Green Is People said:
The day my neighbors gets an unwarranted principal reduction is the same day I stop making my house payment. It's easy to get a modification through trickery and I'd assume from past experience that a principal reduction could be had as well with the right documentation. Once the herd is spooked, they'll run and what a catastrophe for mortgage investors that will be.

Principal reductions are a very slippery slope, one that most banks are going to avoid at all cost. Witness the FHA Short Refinance program - hailed as a way to turn bad loans into good ones, but all told I thing under 500 have been completed nationally since 2010. The fight to stop principal reductions for mortgage holders is fought house by house, street by street, by banks.
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completely agree in principal (no pun intended). But if the current owners had the know how and credit/financing/capital available, wouldn't they just go to court house and buy it at auction for 10 cents on the dollar vs. a principal reduction of 50%?

Is the "net net" difference the damaged credit? If so, if anyone who gets a principal reduction takes the same credit hit and must demonstrate an ability to pay the new loan, would the net result be the same as having gone through the foreclosure process? What if the process allowed other "competitive" bidders to bid on the house and the bank were allowed to choose between the competitor bidders and the principal reduction, whichever has a better outcome (including reserves/costs for future losses or re-foreclosures etc.)

I assume you wouldn't default on your current house in this type of set up because

1) you won't take credit hit
2) you could get thrown out because a better bid may come that allows banks to get more out than your "walk away" threat.
3) your house is your home and just a financial instrument.

(I am assuming all those things about you  :) )

But I just assume there must be a better solution for cities like Cleveland but I guess practicality and political/legal process are mutual exclusive....
 
You'd need some pretty big onions tied around your belt to try that. Imagine being foreclosed, then outbid by a flipper! Too scary for me. Wonder if it's been done yet.  There isn't a whiff of illegality to trying to re-buy your foreclosed home so why hasn't it been tried before?
 
Soylent Green Is People said:
You'd need some pretty big onions tied around your belt to try that. Imagine being foreclosed, then outbid by a flipper! Too scary for me. Wonder if it's been done yet.  There isn't a whiff of illegality to trying to re-buy your foreclosed home so why hasn't it been tried before?
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good question. Maybe it has been tried and we just don't know about it but in apparently in Cleveland, there are no bidders and after eviction, the houses get stripped and ruined further almost immediately.
 
Soylent Green Is People said:
You'd need some pretty big onions tied around your belt to try that. Imagine being foreclosed, then outbid by a flipper! Too scary for me. Wonder if it's been done yet.  There isn't a whiff of illegality to trying to re-buy your foreclosed home so why hasn't it been tried before?
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I don't think this would work unless you created an LLC or some type of entity to hide your identity at the auction.  I've never heard of anyone trying it, probably because most people with a mortgage don't have the capital to buy their own house for cash, even at a 50% discount.

On the other hand, I have heard of a scheme where a company buys your short sale and then turns around and sells it back to you at a slight markup.  I'm not sure how you pull this off legally.
 
Liar Loan said:
Soylent Green Is People said:
You'd need some pretty big onions tied around your belt to try that. Imagine being foreclosed, then outbid by a flipper! Too scary for me. Wonder if it's been done yet.  There isn't a whiff of illegality to trying to re-buy your foreclosed home so why hasn't it been tried before?
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I don't think this would work unless you created an LLC or some type of entity to hide your identity at the auction.  I've never heard of anyone trying it, probably because most people with a mortgage don't have the capital to buy their own house for cash, even at a 50% discount.

On the other hand, I have heard of a scheme where a company buys your short sale and then turns around and sells it back to you at a slight markup.  I'm not sure how you pull this off legally.
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I'd have to think that alarm bells would go off at the lender if they saw that the winning bidder was the owner or had the same last name as the owner.  Remember, the auctioneer will put down the name of the person/persons who bought the property and that document is sent off to the lender so they release/sign over the deed so the new owner/s can record it. 
 
The title doesn't transfer instantaneously.  Many foreclosure auctions get reversed for varying reasons and the lender could easily put a stop to this, assuming it was detected.  If the cashiering associate at the lender had any brains at all, they would notice that the funds came from the same party that was on the loan.  That's why I recommend buying the property in the name of an LLC if you want to pull this off  ;).
 
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