By John Gittelsohn and Prashant Gopal
Jan. 7 (Bloomberg) -- Efforts by U.S. banks to help distressed homeowners have focused mainly on temporary fixes such as interest-rate reductions that may only put off the day of reckoning, despite policy makers wanting them to do more.
Banks may be forced to resort to a remedy they’ve been trying to avoid -- principal reductions -- as another wave of foreclosures looms and payments on risky loans rise, Bloomberg BusinessWeek magazine reports in the Jan. 18 issue.
While interest-rate reductions or extending loan terms reduce homeowners’ monthly payments, they don’t give much comfort to borrowers who owe more on their homes than their properties are worth. Borrowers who don’t have equity in their homes are more likely to hand over the keys when they run into trouble. “The evidence is irrefutable,” Laurie Goodman, senior managing director of Amherst Securities Group in New York, testified before the U.S. House Financial Services Committee on Dec. 8. “Negative equity is the most important predictor of default.”
The 25 percent plunge in residential real estate prices from their 2006 peak has left homeowners underwater by $745 billion, according to research firm First American CoreLogic -- a number that tops the government’s $700 billion bailout for banks. That’s why Federal Deposit Insurance Corp. Chairman Sheila Bair is considering incentives for lenders to cut the principal on as much as $45 billion of mortgages acquired from seized banks. “We’re looking now at whether we should provide some further loss-sharing for principal writedowns,” says Bair. “Now you’re in a situation where even the good mortgages are going bad because people are losing their jobs.”
Deepening Crisis
The foreclosure crisis is likely to deepen this year in part because payments on many adjustable-rate mortgages are set to balloon. Unless there’s a sharp recovery in property values or a change in lenders’ willingness to cut principal, at least 7 million borrowers currently behind on their payments will lose their homes, Goodman estimates.
Some lenders may be coming around to the idea of principal reduction. “If you can right-size the mortgage and return to an equity situation, the incentive is to stay,” says Micah Green, an attorney at Patton Boggs in Washington and a lobbyist for a coalition of mortgage bond investors. Banks can either forgive principal outright or defer it. In deferrals the borrower must pay back the full amount on the original mortgage when he sells the property; if the ultimate sales price doesn’t cover the principal, the homeowner has to pay the difference, making it a less effective tool.
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