ROBBING PETER TO PAY PAUL

The Government has announced the details of the plan to bring home values more in line with the debt owed on them, you know, correct the many homes that are financially "underwater," (we used to use the term "upside down"). To be specific, the balance due on the mortgage is more than the value of the house on today's market. As I said before this is a very difficult process and there are few who are able to actually do it. But let's go through the numbers.

There are about 60 million homes in the USA that are owner occupied or some 68% of all homes. Of these two thirds have mortgages. The total value of these homes is estimated at some $20 trillion. Of the total about 8.3 million have negative equity, i.e. they are "underwater."

The latest plan is to reduce the monthly payment on the "underwater" loans to 31% of one's income. This can be done by reducing the interest rate or reducing the balance due. Reducing the interest rate is relatively easy, Uncle Sam can subsidize the interest rate to allow a reduction. But reducing the balance due is a goal just short of finding the "Holy Grail."

Using the numbers I cite above, and they are best estimates, not hard and fast facts, we can see the Government attempting to write down some $2.6 trillion in mortgage balances. The plan is to get the lenders to share this cost with the Feds. I fear, however, that any write down will require the Feds to compensate for the loss. Of course, there is a new Federal Law being considered to allow courts to mandate write downs of mortgage balances. The consequences of this are too dire to contemplate. Let's say for the moment that Uncle Sam will have to shoulder any write downs of loans. If the average write down is 30% that would mean an expenditure of some $800 billion. Still another big chunk of change for Uncle Sam to borrow.

I see two killer problems with this plan. First, just how does one insure that the cost of the home - mortgage, taxes and insurance - is less than 31% of income? I can see every Tom, Dick and Harry busily hiding income to show a lower income stream and thus force a loan write down. And if you think this doesn't happen, remember how many people created "phantom" income when they had to show sufficient income to get a mortgage in the first place. (The 31% rule is that used by the Federal Housing Authority, FHA, to give a loan.) The issue here is fraud and I see widespread fraud being committed to comply with this measure.

The second problem with this plan is that it will be seen as being inherently unfair to those who continue to pay their home costs without this relief. I can see Harry looking across the fence at Tom who gets his home costs reduced by one-third. Both bought their homes at the same price, at the same time with the same mortgage terms, taxes and insurance. However, Tom's income is less than Harry's, or at least that is what he is showing. Now the Feds will pay part of Tom's mortgage so that his house costs no more than 31% of his income.

Will Harry be mad, you betcha. Especially if Tom works alongside of Harry at the same job. The difference is that Tom and his mortgage advisor are smarter at hiding Tom's income. Harry will see this as a ruse to use his tax money to pay part of Tom's mortgage. And he will be right.

Of course I am simplifying the process. It is far more complex than any mortgage business done to date and is fraught with mistakes as well as the certain fraud. Moreover, if those granting mortgages got us into this mess, why turn to them to get us out? They don't have the capacity to do the job, so as far as I am concerned, the plan will be a dismal failure.

I fear that this plan could undermine the entire Obama recovery effort. I see the downside far outweighing potential benefits. I would urge the Obama team to reconsider this plan. Stay with working to prevent foreclosures, don't go to correcting personal balance sheets.

Leo Cecchini
March, 2009