Fixing foreclosures

Date posted: November 26, 2010

Home foreclosures are numbering in the millions today, with more likely coming. Why don’t the banks who own the mortgage on the home simply reduce or forgive a certain amount of the loan? Would reducing the payments to a level the homeowner could afford be a simple way out for everybody involved? N.C. State University extension economist Mike Walden weighs in.

“I’ve done some investigation and there appears to be several problems with this: First of all, because the mortgage process has become so complicated there may not be one bank or one investor that owns the mortgage. So that is one sort of institutional issue.

“A second one is that financial institutions like banks may fear lawsuits from investors who claim that the borrowers are being treated too well and that is affecting their investments in the bank. So that’s a second problem.

“A third problem has to do with an economic concept called moral hazard, and that is to say that if a bank were to … reduce or forgive some of the loan amount for some homeowners having trouble, that may motivate some other homeowners to say, ‘Hey, let’s just stop making our payments, and we’ll get treated equally.’ And so the banks worry about rather than this containing the problem, it would actually cause the problem of foreclosures to mushroom.

“So I think restructuring the loans may simply not work in many cases. And I think what many banks have simply come to realize they have to go the foreclosure route because the owner simply doesn’t have the money or the home value has sunk too low to even make restructuring, if it was likely, to even make that possible.

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