Toxic Mortgage Suggestion

So here in California we have the highest three unemployment rates for cities in the nation.  From almost 19% unemployed in Yuba City to almost 25% in El Centro.  A friend of mine bought a condo in Yuba City back about six years ago for $120k.  He called me the other day to say that condos in his complex are now selling for about $50k.  My old house there that sold just three years ago for $263k recently foreclosed and was back on the market for $116k.

Word is that the banks are refinancing the variable rate loans they sold to people for fixed rate loans and the current rates.  The problem is this, the houses and condos are not worth the value of the loans by any stretch of the imagination, nor will they be anytime soon.

So the issue is this, how can we dig our way out without revaluation of the real estate market so that new loans reflect the actual value of the homes.  Why isn’t the bailout money being used to reimburse the banks for their losses?  Why are they allowed to keep the money AND refinance the old loans at the same levels with new interest rates?

The issue with keeping the old values of course is that the new payments will stay high relative to the value of the property.  If the person holding the mortgage loses their job – likely here in California – then the banks will still have toxic assets to deal with and we as a nation will go through another period of instability.

It seems to me that the real answer is to somehow revalue the real estate.  The inflation that drove us into this mess is still in place for everyone who owns a home and who bought it in the recent past.  It is true that many of these homes have gone into foreclosure but a lot of them have not yet like my friend’s condo.  It’s worth 41% of its purchase price and at the peak of the market those condos were selling for $160 k so on paper it has lost more than 70% of its value in less than three years.

It seems to me that the best thing to do is to force banks to use the bailout money to make up for loss in principle on all home mortgages.  The figure could based on the median drop in real estate values by state and perhaps in the case of California it could be split into North and South.  The amount written down then would be 50% of the average drop.  So if a home was valued at $200k at the time of purchase, and the average drop in value in the state was 50%, then the reduction in principle would be 25%.  If the homeowner had a loan of $200k on the property then they would be able to refinance on a principle of 150k since the actual drop in value would be 100k.

Banks would only be given the amount by the Federal government that reflected 50% the lost in principle on mortgages that they actually refinanced reflecting the lower real estate valuations.  The bank would receive the 25% difference in the loss in value from the Feds to make up for the lost equity.  This would spread out the bailout money, ensure that people’s home mortgages more closely reflected the property’s actual value, and also ensure that the banks are required to make new loans if they want the bailout money.

If freeing up credit is the real purpose of the bailouts and if the toxic mortgages are the real culprit behind the downturn then why not implement something that offers some relief to homeowners, offers some relief to banks, and holds banks accountable to DO something in order to get any more money?

Perhaps the answers are a lot more complicated than the one I present here but perhaps the best ideas aren’t complicated at all.  Perhaps it’s really about helping everyone and not just the fat cats.