To sort this mess, both banks and borrowers must do the right thing
Saturday, October 9, 2010; 7:49 PM
Listening to the fiery rhetoric about the mortgage mess emanating from politicians this week, you'd think that big bad banks were trying to foreclose on hundreds of thousands of homeowners who were current on their payments but had become victims of sloppy business practices. If that were the case, declaring a national moratorium on foreclosures would be the just and reasonable thing to do.
But if, as appears to be the case, the overwhelming majority of homeowners facing foreclosure have fallen far behind on their payments, then it is a good deal harder to summon up the same moral outrage over reports that the banks and loan service companies cut corners, failed to keep the right documents and engaged in shoddy and even fraudulent practices. Just because the banks and servicers have screwed up doesn't mean they and their investors are no longer entitled to get their money back.
Certainly banks and servicers should, at their own expense, be sent back to do things right. Those who engaged in fraud should be punished. And if there are legitimate questions about who owns a loan, those will need to be resolved before the proceeds of any foreclosure are distributed.
But none of that changes the basic reality that there are millions of Americans who took out mortgages they could not support on houses they could not afford. It may be necessary to postpone their day of reckoning for a few months to get the paperwork in order and ensure that all the proper procedures are followed, but the reckoning is inevitable.
There may be some good that comes out of this mess.
Stretching out the foreclosure process would reduce the number of houses dumped on the market over the next six months, which could help firm up housing prices in the short term and put some extra support under a sagging economy. But everyone should understand that the longer the foreclosure process goes on, the longer it will take for the excess supply of houses to be absorbed, for prices to stabilize and for the real estate market to return to something closer to a normal equilibrium.
A moratorium should also put pressure on banks and loan servicers to finally bite the bullet, as many of us suggested they do two years ago, and move more aggressively to restructure problem loans by writing off more of the principal and refinancing what remains at lower interest rates over longer terms.
The breakdown in the foreclosure system has also exposed serious weaknesses in the way mortgages are written, packaged and serviced that should force the industry to adopt instruments and structures that are simpler and easier to change when things go wrong. Based on the recent revelations, the consumer protection agency should require that mortgage servicers meet minimal standards of customer service and offer clear procedures for loan modification and third-party adjudication before the foreclosure process can be initiated. If this adds to the price of a loan, so be it.
That said, those who are cheerleading for a moratorium should realize they can only push things so far. It would not help the recovery of the economy, or the real estate market, if the foreclosure process became so hopelessly tangled that banks and investors effectively lose the ability to recoup the remaining value of their collateral. That would provide some immediate financial relief to households facing foreclosure, but it would encourage many more homeowners to begin shirking their mortgage payments in the belief that they would also be able to avoid the consequences. The long term consequences of that would be that mortgage rates would be higher and mortgage loans would be smaller and harder to get.
Perhaps it is only natural for Americans to take some guilty pleasure in watching as the big banks and Wall Street wizards who created this flawed and complex mortgage machine are hoisted on their own petards. But be careful what you wish for. The financial system is still fragile enough that we may not be able to afford a full helping of revenge.