But President Obama needs to be bolder when it comes to solving the mortgage mess too. Last March I wrote:
Details of the Obama plane to help mortgage borrowers were released this morning. The order in which the mods will happen: interest rate reduction, term extension, principal reduction.
This is backward. Suppose a $100,000 loan has a 7 percent coupon, and its rate is modified down to 4 percent. The payment drops from $665 per month to $477 per month. This helps, but leaves the borrower underwater, making it difficult for her to sell if she needs to move to a new job.
But a $477 payment, at 7 percent annual interest, has a present value of $71,759. So if the interest rate remained the same and the loan balance was written down by 28 percent, the payment would be the same as an interest rate write-down to 4 percent, but the borrower would have her head above water. If she later sells for more than $72K + selling costs, she can split the proceeds with the lender, who would now basically be a shared equity owner.
I think the people in the Obama Administration are very smart. Why aren't they doing this?
The President's rescue program has not taken off. The redefault rate on modified mortgages is high--because they don't solve the negative equity problem. I am not alone in thinking some wort of debt-for-equity modification would make sense. John Quigley has supported such an idea. The Milkin Institute has supported the idea. I was on a radio program with Ken Rosen last week, and I am pretty sure he supported the idea.