A Realistic Approach To “Foreclosure Rescue”

I’ve been thinking about homeowner rescue plans and it occurs to me that the banks are ignoring a fairly obvious solution, consider this:

Outside of loss of income/sudden financial hardship situations, many of the people facing foreclosure are in those situations because they purchased a home they couldn’t afford with an exotic mortgage, correct?

In other words any relief that comes from “loan modification” or “foreclosure rescue”  is either the result of forgiving principle (unlikely),  creating a new exotic loan situation that only temporarily makes the payment affordable, and/or just delaying foreclosure proceedings. The latter is especially pointless because waiting a few months isn’t going to magically increase the income of the homeowner, thus making their mortgage affordable.

So what to do?

How about some sort of arbitrage transaction?

Think about the following scenario:

You’re a bank that recently foreclosed on a home with a $250k mortgage balance, a home that you’re probably going to wind up selling for less than that amount at auction because the current market price has dropped to say $200k.

At the same time you have a customer that is currently struggling with a $350k mortgage who could reasonable only afford something in the $250k-$280k range,  a mortgage you’re desperately trying to modify despite the fact that all you’re really doing is buying time.

In other words you’re a bank with two losing situations on its hands.

How about making it ONE losing situation via having the bank assume possession of the more expensive house, while the homeowner takes over the cheaper one under the condition(s) that he/she remain in the house for 5-7 years and agree to take on a mortgage of 10-15% higher than the mortgage balance on that home.

This sort of transaction would instantly put the homeowner into a situation they could afford, mitigate the bank’s losses and leave the bank with ONE losing situation instead of TWO.

If you think about this isn’t an especially innovative idea, nearly everyone who has managed rental properties has dealt with situations where they move cash strapped tenant to a unit they could more easily afford in order to avoid having to evict them.

I.e. it’s better to have one of your existing customers paying you 20% less on a go-forward basis, than to have them paying you nothing at all.

Now yes, I’m fully aware that something like this would be easier said then done after all we’re talking homes not an everyday widget like a Cellphone, you’d have supply issues, legal issues, real life issues around people’s willingness to move to another part of town (or another one nearby), location preferences,  etc. In all likelihood the banks would have to coordinate and possibly trade/exchange foreclosed properties between one another in order to address the supply issues, thus opening  several cans of legal and financial worms.

BUT

Just because something may be difficult doesn’t mean its impossible.

Furthermore the end result is likely to be significantly more positive for everyone involved than the results derived from the current arsenal of tactics, which at best only are delaying the inevitable and at worse are just grossly ineffective.

Truth be told it all comes down to whether or not people are willing to accept the reality of a situation, instead of attempting to preserve the unsustainable because it’s more appetizing to do so. Politicians and bankers shouldn’t be promising to keep people in their current house because that’s the answer everyone likes, they should promising to TRY and put them into an affordable housing situation while being honest about the fact that it could mean trading down to a cheaper home or renting.

The goal shouldn’t be to “keep people in their current homes”  per se,  it should be to put them into an sustainable housing situation, and while this may lead to unpleasant choices/consequences it’s a necessary part of stabilizing the overall housing market. While the current architects of the current arsenal of “rescue” tactics have their hearts in the right place, it doesn’t change the fact that by delaying the inevitable they’re only  prolonging the housing crisis.

The foreclosures, prices declines, etc, are all a necessary part of a market correction that is a requirement for stable markets in the future. It’s time for policy makers, politicians, executives, home owners, et al, to accept this fact, and focus on mitigating the impact instead of trying to prevent negative consequences altogether.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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