Pay Whatever You Want

The US government announced a rather interesting policy change about how mortgage lenders are to treat unemployed homeowners. Essentially, they have been told to write down the loans to what a government formula says the borrower can afford instead of what the property is actually worth. As outlined in the attached article, lenders are supposed to write down the loans so that payments do not exceed 31 percent of the borrowers can afford. What is even more interesting is that in some cases there can be no payments made, period.

This is definitely the most aggressive move that the federal government has made to keep people in their homes. They have, effectively, made it so that many unemployed individuals do not need to worry about making mortgage payments which they can not afford. The government will subsidize the lenders so some of the pain in writing down these loans is blunted. Obviously lenders have previously been reluctant to foreclose on homes and write down the value of their loans, until absolutely necessary, as doing so would force them to admit losses. Neither of those actions were desirable for the holders of mortgage debt.

Such a move by the government was likely made in response to a very high recidivism rate amongst borrowers who have previously had their loans modified along with the abnormally high unemployment rates. This move was made not only to keep people in their homes, but also to prop up home prices and prevent additional mortgages from going under water. The government has long been hesitant to make such policy changes in the past because they realized the numerous moral hazards which would arise from this type of program.

This program is one that will make life easier for a large number of people who have fallen on tough times. Yet it does so with incredible costs, both immediate and potential. The government has essentially taken the losses of the lenders onto its own books with little potential upside. Additionally, they have added a huge incentive for all borrowers to abuse the system. Individuals who purchased homes they could never afford using exotic mortgages now have the potential of their debt being (practically) forgiven. To say this practice would be unfair is a huge understatement and as such there will be a great deal of resentment.

It is impossible for a system to work where a person purchases something based on its market value and then has the value changed, after the fact, not to what the market dictates but to what they can afford. This violates the concept of a contract. Yes, people who are unemployed should have certain safety nets below them. However, they should not be rewarded for failed gambles they have taken.