The Housing Bubble

Chicago, IL
By A.B. Dada
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On numerous housing bubble forums and blogs, I’ve noticed some people are recommending a tactic that may help stave off foreclosures while attempting to bring the market back to more realistic prices: the idea that the bank should re-appraise the property, and modify the loan downwards to the new market value. This would be the equivalent of a short-sale from the current owner to the current owner, with the bank eating the loss.

There are many reasons why this is a terrible idea, but parts of it do have merit. First of all, it would be difficult to keep EVERY homeowner who is underwater from asking for a reappraisal and a lowering of their principal owed. Banks would be overwhelmed, and finding the current true market value of a home is impossible except in a sale situation. Appraisers were, en masse, one of the cause of the bubble by their poor appraising and bad use of discretion in looking at housing value, not just prices.

One option that might work is the idea of a short sale auction with a preapproval amount for the current underwater homeowner. I’d say it would be important to limit these short sale auctions to homeowners who are already 90 days late on their mortgage, but have the income necessary to pay some sort of mortgage. Why 90 days late? It would keep homeowners who can afford their mortgage payment, but don’t want to, from taking advantage of a rewriting of the terms of the loan. 90 days late gives a homeowner a terrible hit on their FICO score, so those with clean reports will likely not run into default just to try to get a lower monthly payment.

The first step would be to verify what the homeowner really can afford, taking into account a fixed rate mortgage, outstanding debt elsewhere, and their income levels. Once a realistic figure, no more than 3X their annual income, is decided upon, the bank can then offer the homeowner a price that they can keep their home for. Let’s say that a homeowner who is underwater with a terrible loan package makes $50,000 per year, but their mortgage was based on a $250,000 home (5x income). The bank, after looking over every aspect of their debt and income, sets the new recalculation value at $150,000 maximum.

Then the home goes to auction. The current homeowner is allowed to bid up to $150,000 on their own home, preapproved for a mortgage rewriting. If anyone else bids over $150,000, the homeowner loses their home, and the bank makes a short sale. If no one else does, the homeowner keeps their home, gets a new mortgage, and the bank takes a loss.

I don’t like this option, but it is a possibility because it is no different than any other short sale or auction, it just allows the chance that the current homedebtor can stay in their house, saving the bank significant money in rehabilitation or tax liens or other costs.

Chicago, IL
By A.B. Dada
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With IndyMac’s not unforeseen bankruptcy and temporary closing of its doors and ATM machines, there’s been a little fear by not just depositors for where their money is, and if they’ll get it back. There’s a larger question that the old media has so far ignored: what about payrolls?

FDIC insurance covers $100,000 per account, more if there are multiple owners on an account or if there are beneficiaries. That number could easily be surpassed by corporate payroll accounts. If an average worker gets paid a gross amount of $4400 per month, or $1100 per week, just 91 employees are needed for that account to breach the $100,000 insured mark. Do any employers with more than 91 average-wage employees bank at IndyMac? If so, those employees could be in for a surprise.

The FDIC offers something called pass-through insurance: if an account has moneys deposited that are owned by more than one individual, the insurance is raised to cover $100,000 per individual. The problem with this situation is that payroll accounts are NOT considered pass-through worthy accounts: the employees do not have a right to the money in the account. Insurance is set at $100,000 unless there are multiple owners on the account.

One area that might be covered by FDIC insurance per employee is the program that allows employees to be paid via a debit/ATM card, or a payroll card. In such a case, the employer puts money into an account, and each employee is given an ATM card to access their payroll check, allowing them to withdraw up to the amount they’re being paid. The FDIC has “sort of” clarified that these accounts are insured up to $100,000 per employee. This is still a bit up in the air, though, and hopefully the IndyMac situation will give more clarity to what happens in these situations.

Whatever the case is, it is clear that your money is not safe, in any bank, without proper reserves to back up situations where people are demanding more of their money than usual. Expect to see more banks fail, even solvent ones, if they do not have the liquidity to produce cash on demand.