Posts tagged ‘short sales’

Single-Minded Obsession on Home Ownership

This article from the LA Times confused me greatly:

Advocates for borrowers took such comments to mean that the banks would prioritize debt write-downs on first mortgages, which banks resisted before the [$25 billion] settlement. Now, with nearly all the promised relief handed out, it is clear that the banks had other ideas.

The vast majority of the aid to borrowers, it turns out, came in the form of short sales and forgiveness of second mortgages. Just 20% of the aid doled out under the national settlement went to forgiveness of first-mortgage principal, the kind of help most likely to keep troubled borrowers in their homes. In terms of borrowers helped, just 15% of the total received first-mortgage forgiveness.

The five banks collectively delivered twice as much aid using short sales, in which owners sell their homes for less than the amount owed and move out, with the shortfall forgiven.

In all, the lenders sought credit for nearly $21 billion related to short sales and $15 billion related to second mortgages. That compares with $10.4 billion in write-downs on first mortgages.

Critics on the Left (example) are calling this a failure of the program, that most of the relief went to short-sales and 2nd mortgage forgiveness rather than first mortgage forgiveness.  The original article has this quote:

"It just shows you that the banks are running the government," Marks said. "There's virtually no benefit to borrowers, and yet you give the banks credit for short sales and getting second liens wiped out — something they were going to have to do anyway."

Hmm, well I am not the biggest fan of bankers in the world, but short sales and second lien forgiveness are principle forgiveness as well, just of a different form.  If they wanted a settlement that was first-lien forgiveness only, they should have specified that.

In fact, both short sales and second lien forgiveness have tremendous value to individuals if one considers individual well-being one's goal rather than just this obsessive fixation on home ownership.  

For many people, the worst part of their negative equity is that it created a barrier to their moving.  Perhaps they could find a job in another part of the state or country, or they wanted to move into a home or apartment with less expensive payments but were stuck in their current home because they could not afford to bring tens of thousands of dollars to closing.  In such cases, a short sale is exactly what the homeowner needs and facilitating and expediting this likely helped a ton of people  (It is also an example of just how unique our mortgage rules are in the US -- in almost any other country in the world, the amount of the negative equity in a short sale would get hung on the seller as a lien that must be paid off over time.  Only in the US do buyers routinely walk away clean from such situations).  Given that first mortgage loan forgiveness more often than not does not save the loan (ie it eventually ends in foreclosure anyway), short sales are the one approach that lets lenders get away clean for a fresh start.

As for second mortgages, I can tell you from personal experience that it is virtually impossible in the current environment to restructure or refinance a first mortgage with a second lien on the house -- even in my case where everything is performing and the underlying home value is well above the total of the two liens.  Seriously, what is the point in reducing principle in the first mortgage if there is a second mortgage there, particularly when the second mortgage is likely far more expensive?  For people with a second mortgage, forgiveness of that is probably the first and best gift they could get.  They may end up still losing their home, but they can't even begin to discuss a restructure or refinance without that other mortgage going away.

More Cargo Cult Regulation

Apparently, the Obama administration may soon put limits on short-selling.  If so, this is cargo-cult thinking at its worst.  Prices fell really fast, so it must be the sellers' fault!  If we could just stop all this selling, then prices would never go down!

Here is my previous explanation of why short selling is in fact a critical tool to moderate bubbles, adding to the irony that we should be considering limits on this tool while suffering a bubble-induced recession.

At the start of the bubble, a particular asset (be it an equity or a commodity like oil) is owned by a mix of people who have different expectations about future price movements.  For whatever reasons, in a bubble, a subset of the market develops rapidly rising expectations about the value of the asset.  They start buying the asset, and the price starts rising.  As the price rises, and these bulls buy in, folks who owned the asset previously and are less bullish about the future will sell to the new buyers.  The very fact of the rising price of the asset from this buying reinforces the bulls' feeling that the sky is the limit for prices, and bulls buy in even more.

Let's fast forward to a point where the price has risen to some stratospheric levels vs. the previous pricing as well as historical norms or ratios.  The ownership base for the asset is now disproportionately made up of those sky-is-the-limit bulls, while everyone who thought these guys were overly optimistic and a bit wonky have sold out. 99.9% of the world now thinks the asset is grossly overvalued.  But how does it come to earth?  After all, the only way the price can drop is if some owners sell, and all the owners are super-bulls who are unlikely to do so.  As a result, the bubble might continue and grow long after most of the world has seen the insanity of it.

Thus, we have short-selling.  Short-selling allows the other 99.9% who are not owners to sell part of the asset anyway, casting their financial vote for the value of the company.  Short-selling shortens bubbles, hastens the reckoning, and in the process generally reduces the wreckage on the back end.

Megan McArdle hilariously commented:

I don't understand why the Commission doesn't focus on something more effective, like installing lavish statues of Mammon on trading floors so that traders can better propitiate him.

Update: By the way, this could be argued to be just another piece of corporate welfare.  CEO's hate short sales of their stocks, and would love Congress to ban the practice altogether.  The fact that the practice enforces accountability on them, I am sure, has nothing to do with it.  The reality is that if buying and selling are thought of as voting for or against a company's or asset's value and prospects, then banning short selling is a way of disenfranchising most of the world from this process.

By the way, not that I think it should matter from a policy perspective, but have you noticed that the shorts seem to be right an awful lot?  In retrospect, more shorting of bank and insurance stocks 3 years ago would have been a good thing.