Economist Luigi Zingales has come up with a better way to help financially troubled homeowners than the Obama administration’s floundering loan modification plan.
Zingales proposes that homeowners who are more than 20 percent underwater on their mortgages would have the right to reset the value of the loan to the house's current value — in exchange for giving half of the future upside to the bank, reports Yahoo! Tech Ticker.
Zingales' proposal is akin to the debt restructuring that bankrupt corporations go through. Essentially, it’s a debt-for-equity swap that reduces monthly payments and the actual principal owed.
From the bank's perspective, this plan would have the same drawback as today's mortgage modifications: It would force an immediate writeoff.
But, if homeowners were given the option the banks wouldn't have any choice.
Zingales’ plan would have the added benefit of causing banks to reveal the health of their balance sheets and the value of their loans, figures that are now unavailable.
A study by the Federal Reserve Bank of Boston found that mortgage lenders don’t try to rework most home loans held by borrowers facing foreclosure because doing so would probably mean losing money.
The Boston Fed’s findings suggest the Obama administration’s major effort to solve the foreclosure crisis by giving the lending industry $75 billion to rewrite delinquent loans to more affordable levels is not likely to work.
The study’s co-author, Boston Fed senior economist Paul Willen, said the government would be better off giving the money directly to struggling borrowers to help them with their payments, rather than to lenders.
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