So, if I understand this correctly, Rula Giosmas of Miami bought a condo/apartment in 2006 for $359,000. Before we go any further, can we all agree that that is an insane price for a two-bedroom apartment? She also bought other “investment” properties. According to the New York Times she made a large (unspecified) down payment on her primary residence. She works as an acupuncturist, but she somehow had a lot of money lying around to buy properties and plop down large down payments. I don’t know, maybe she inherited the money, was awarded it in a divorce, or makes more money putting needles in people than I would expect.
Regardless, she chose pay option adjustable rate mortgages (Option ARMs) for these properties and soon ran into trouble:
Banks are proactively overhauling loans for borrowers like Ms. Giosmas who have so-called pay option adjustable rate mortgages, which were popular in the wild late stages of the housing boom but which banks now view as potentially troublesome…
…Option ARM loans like Ms. Giosmas’s gave borrowers the option of skipping the principal payment and some of the interest payment for an introductory period of several years. The unpaid balances would be added to the body of the loan…
…She made a large down payment, but because each month she paid less than was necessary to pay off the loan, her debt swelled to about $300,000.
Meanwhile, the value of the apartment nosedived. By the time Ms. Giosmas got the letter from Chase, the condominium was worth less than half what she paid. “I would not have defaulted,” she said. “But they don’t know that.”
Now, Chase almost certainly did not issue this mortgage. They probably inherited it when they bought up Washington Mutual and its $50 billion portfolio of crap Option ARM mortgages. What they decided to do is interesting. They didn’t lower Ms. Giosmas’s monthly payment. Instead they lopped $150,000 off her principal and raised her interest rate to 5%, which left her payment roughly the same. The difference was that she then owed only about $150,000 on the apartment. She sold it for $170,000 and walked away with a chunk of change.
The new owner probably got a more sensible mortgage, and they certainly paid a more reasonable price. Ms. Giosmas was liberated from an underwater mortgage, made some money, and is now free to relocate if her career demands it. So, multiple problems solved, and everyone is happy except for whichever suckers invested in this mortgage through some credit default swap. I guess some of her neighbors might not be too pleased, both because they didn’t receive a $150,000 loan modification and because the sale of her apartment at such a low price only confirms their underwater status.
The banks did this modification without any prior notification. It was pre-emptive. The mortgage fit the profile of a “toxic” mortgage, so they modified it to make it more stable. Apparently, they’re doing a lot of this. What they’re not doing are loan modifications for people who have actually missed payments and are in the foreclosure process. They hope to avoid the moral hazard problem by not rewarding people who have gone broke, or who simply refuse to pay their bills, and thereby encouraging default. By rewarding people who’ve managed to make payments on crappy mortgages, they think they’ve found a fairer system that will clean up their books over time.
This is better than nothing, but it demonstrates that the banks are willing to give a haircut to investors when it suits their interests. The moral hazard issue is a tough one to navigate, no doubt, but getting people out from underwater mortgages makes sense whether the home-owner is current or behind on payments, and the banks still have a fairness issue because their modification program is somewhat arbitrary. These Option ARM mortgages were irresponsible and should never have been issued in the first place. The principle should be to do everything within reason to build a payment and interest structure that people can afford and that sets the amount owed more in line with the true value of the home.
And the banks should compensate the investors they defrauded by paying them out of their own future profits instead of trying to preserve every last dime for them out of failing mortgages.