How to Help Both Homeowners and Lenders, at No Public Cost

I really like this idea from the Office of Thrift Supervision: it looks like it can reduce foreclosures and help provide liquidity to struggling mortgage lenders at the same time. Here's how it works: take a borrower who's underwater, with a mortgage for more than their house is worth. Refinance the mortgage so that it comes down to the value of the house, and then give the lender a tradeable warrant for the difference. Mortgage payments come down, because the mortgage has come down, and the lender, if it needs cash, can simply sell the warrant on the secondary market. If the house gets sold for more than the value of the new mortgage, the excess goes in the first instance to the warrant holder; the homeowner makes money only if the house is sold for more than it was bought for.

The big problem, as I see it, is securitization - the legal obstacles to doing this with a securitized loan are huge. But they may not be insurmountable, especially if this scheme is shown to work for mortgages held by a lender.

Bob Lawless is more skeptical: his problem is that the homeowner has very little incentive to maximize the sale price on the property. I have three responses to him:

If you're under water on a non-recourse mortgage, you already have no incentive to maximize your sale price. This changes nothing.
The homeowner does share in the upside, so long as the house is sold for more than it was bought for.
In any event, the whole point of this plan is to prevent people from putting their houses on the market in the first place, and rather to find a way to help them to stay in their houses.

I reckon this plan is definitely worth a try. If it catches on, it could be very helpful indeed. And the great thing about it is that it can all be done unilaterally: there doesn't need to be any legislation first.

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