Short Sale Pilot Program Not the Answerby Tim Manni
Fannie Mae has begun a pilot program in two of the worst housing markets in the U.S. to determine if short sales can exist as a viable alternative to foreclosures. A short sale enables a homeowner to avoid a foreclosure by selling their home for less than the value of their existing loan. Yet, getting mortgage investors to agree upon who takes a loss has been the main hurdle preventing the measure from becoming a viable, broad-based solution.
In general, there are three knowable outcomes for a home loan that investors can prepare for. History says the loan will be either repaid in full, refinanced or paid off early (refi sale), or fail (foreclosures). Lenders, brokers, and guarantors are now being socked — and are unprepared — for mass volumes of alternative outcomes — loan modifications, short sales, and now potentially “cramdowns.”
In the case of Fannie’s pilot initiative, the program can only work if the GSE owns the loan in its entirety — where they agree to eat the entire loss. However, once a home loan is securitized, every investor must agree on who takes the haircut (a decision that requires a difficult-to-achieve, and time-consuming consensus among all parties).
While foreclosures usually net the least return on their investment, it’s a knowable path for investors that’s well established and can even be protected against. Investors have little protection against these alternative outcomes (loan mods and short sales).
Another initiative that could cripple investors’ returns are cramdowns. A practice utilized by bankruptcy judges to reduce the sum of a filer’s debt, the practice is now being pushed in Washington to include mortgage debt (click here to read the opposition). As lenders are encouraged to lend with little or no loss protection against these three new outcomes for loans, is it really any surprise that the cost of credit remains stubbornly high — and could potentially be pushed higher in the future? Where’s the protection for lenders against the numerous and perverse incentives for borrowers? “Ultimately there needs to be some help to investors against these new risks,” said HSH Vice President Keith Gumbinger.
“To address these issues at it’s core — the difference between what is owed and what the asset is now worth, two things need to happen: investors need some form of loss mitigation, and homeowners need to be made whole on an individual basis in order to stop foreclosures and short sales,” said Gumbinger.
A possible solution could be to utilize the second half of the TARP funds to bridge the gap between the value of the home now, and what is owed. “There needs to be a recovery of the differentials on an individual basis, or else people will continue to be incentivized to fail.”