Bankruptcy

OTS ... ?4U ... WITW

By Bob Lawless

Office of Thrift Supervision, I have a question for you. What in the world is this?

CNN reported that the OTS is in the early stages of a plan that would give some lenders an incentive to write down mortgages where the value of the debt now exceeds the value of the home. According to CNN, if a home was worth, say, $100,000 and if the mortgage was $120,000, the lender could write down the mortgage to $100,000 and get a $20,000 warrant. If the house later sold for more than $100,000, the warrant would entitle the lender to receive up to value of the $20,000 warrant plus interest. The OTS also is suggesting that these warrants could trade on a secondary market. The idea is the lender would be able to share in any recovery in the value of the housing market.

I don't get it.

I am very much in favor of any plan that would help the U.S. out of its mortgage mess, especially potentially innovative solutions that harness the power of the marketplace. I really want to believe the OTS plan would work, but isn't there a huge stumbling block? Once a warrant is given, the owner of the home knows he or she would not share in any upside appreciation. In our example, what is the incentive of the owner to sell the house for more than the $100,000?

Two possible solutions came to my mind. One is that you might allow the owner to share in some of the upside appreciation. I don't think that fixes the problem, however, as it still diminishes the incentives of the owner to sell for the market price. The math is just more complicated to get to the same point.

We also might give the holder of the warrant a right of first refusal to purchase the property at the proffered price, but I can't imagine that would work in the reality of the residential housing market. Home purchasers are not going to want to put down bids on housing subject to a right of first refusal. Maybe investors would do this, but then we are talking about a radical reshaping of the residential housing market. Do we really want a housing stock that has a substantial ownership block by real estate speculators?

I must be missing something. (Hat tip to one of our regular readers for pointing the way to this story.)

Full post as published by Credit Slips on February 21, 2008 (boomark / email).