Academic

In the news these days are fairly pessimistic news about residential foreclosures.  No one likes to hear of someone defaulting on a mortgage and losing their home.  Devising a way to reduce the number of foreclosures seems like a great idea.  Maybe we can't prevent rain (job loss), but we can prepare for it.  Yesterday, law professor Katherine Stone penned an op-ed that suggested two reforms to help quell the tide of foreclosures, building on the assumption that job interruption is the norm these days, so a 30-year mortgage with steady payments is unrealistic for most people.  I have a few comments on these reforms, mostly pessimistic.

First, I'll assume that Prof. Stone is correct and that income disruption is more frequent now than in the 1930s when the 30-year mortgage was devised.  The first suggestion attempts to smooth over income-light periods by allowing borrowers to elect into interest-only payments because of job disruption.  This suggestion reminds me of student loan programs, where borrowers can get deferrals because of job loss, pregnancy or other income disruption.  However, Prof. Stone notes here that the principal amount would not change, the term would be extended, but "[b]anks would continue to receive the same amount of interest that they had bargained for."  Depending on the details, this may or may not be true.  If the homeowner misses 12 principal payments, do we stack them on the end?  Will those 12 payments include interest?  I suppose the devil is int he details. 

After discussing this with my neighbor, fellow colleague and consumer credit blogger, I was reminded that this reform may make it harder to securitize these mortgages.  Steady income streams beget securitization.  Also, the Dodd-Frank Act exempts from certain securitization regulatory reforms and risk retention requirements standard 30-year fixed conventional home loans.  This "interest only" option would probably throw these mortgages back into the subprime pool.  So, borrowers might be given an option of having this election, which would most certainly carry with it a higher interest rate to compensate the bank for the extra regulation and the extra risk.  And, this interest-only option is a substantial help only to borrowers who are in the later years of the mortgage, not the first ones, which are almost all interest anyway.  If job interruption is the norm, then it will hit borrowers in the first 5 years, not the last ones.

I also have a meta-concern.  I think the federal government should get out of the business of encouraging home ownership through borrowing.  We already encourage home ownership through myriad ways, including the preference of debt over equity, which may be part of the mortgage crisis.   How about getting in the business of encouraging home ownership through saving?  Prof. Stone tells us that before the 1930s, most mortgages were short, with balloon payments at the end.  People saved, put money down, then saved and paid off the mortgage.  (Prof. Stone says that most borrowers rolled these mortgages over, so maybe the paying off part was rarer.)  We are now in the era of no down payments and small down payments.  Prof. Stone calls the conventional mortgage a "30-Year Prison," but her reform turns it into a 32-Year Prison or more.

The other suggestion is to require all workers and employers to save pre-tax into a personal account, and these monies can only be withdrawn for purposes of paying mortgages because of income disruption or at retirement.  The maximum amount to be withdrawn is the amount put in, so I guess the government takes the float?  So, if you're an exceptional worker who is always in demand, you just paid a heckuva tax to the government for that good fortune.  I suppose this also overlaps with existing unemployment payments, which I would think are also meant to smooth job interruption and funded by employers, but I guess this would just be more.

I'm not a big supporter of prohibiting or mandating certain types of mortgage contracts, but if I were, I would be more supportive of reforms to incentivize saving on the front end of a mortgage, not extending the debt through interest-only holidays or requiring employers to subsidize job interruption any more than currently.