1. Thomas J. Costagliola July 23, 2010 4:36 pm

   Yehuda,

   Maybe it is just me, but it seems that the obvious way to modify a mortgage is to leave the principal alone, stretch out the payback period and lower the interest rate. This will keep the creditor whole, just less profitable. Does this make sense to you? Additionally, homeowners need deflation protection and creditors need inflation protection. We cannot have a functional society if only one class is protected. Since the early 1980’s we have generally been in a bull market for bonds; creditors have had the upper hand and have generally received handsome returns above inflation. The extreme advantage that they accumulated over time has caused their own ruination in the last few years. Creditors drowned homeowners who are the geese that lay the golden eggs. Interestingly, from 1946 to 1980 we were generally in a bear market for bonds. Debtors’ extreme accumulated advantage, rampant inflation, in the 1970’s led to the end of debtors’ advantage.

   In the last few years we have been in a serious bear market for big ticket assets. The market is going to extremes. I look forward to a reversal, which as you pointed out in an earlier post is the one thing we can always count on about markets; we just never know when. “Markets go to extremes and then reverse.” Hopefully all yield curves will flatten without inverting. We need low inflation, low interest rates and easy money. Is this just Utopian thinking?

   Historically bankruptcy courts lowered interest rates which realistically determine the debtors’ true cost. Since the late 1970’s creditors have successfully lobbied Congress to do away with protection for debtors. Deregulation has led to excesses and imprudence by creditors and to the creditors’ demise. Usury Laws are the oldest recorded laws; Hammurabi’s code was in large part a set of usury laws. We need a revival of usury laws with clear adjustments for inflation and deflation.

   I look forward to your response.

   Thomas

2. Yehuda July 23, 2010 7:25 pm

   Hi Thomas,

   “the obvious way to modify a mortgage is to leave the principal alone, stretch out the payback period and lower the interest rate. This will keep the creditor whole, just less profitable. Does this make sense to you?”

   This does make alot of sense and it could work. But, I have one quibble with it. It doesn’t necessarily provide a potential profit to the homeowner upon sale of the house. It surely helps the creditor avoid writedowns and reduces ongoing expenses to the homeowner. But, it doesn’t generate profits per se for the homeowner.

   My belief, is that our society as currently arranged, for good or bad, does not work if there is no profit for both the buyer and seller. Capitalism is not a zero-sum game, as some would claim. In fact, everyone can and should win. This is, of course, why capitalism requires some degree of constant inflation.

   I believe the crux of the real estate problem is that people are “underwater” on their homes and they can’t make a profit if they sell. Every day a new loss is created. This creates a continued negative feedback loop which shuts down the system.

   With your suggestion, if you keep the principal the same, there is no guarantee that the homeowner can then sell the house at a profit. So it wouldn’t necessarily solve the issue. There would still be uncertainty with regards to profits and the system would remain deadlocked, in theory.

   I believe that would should happen is a writedown of principal to a level that is equal to or less than the value of the house. That provides an immediate profit for the homeowner if they decide to sell the house. The resumption of profit will eliminate any profit uncertainty and get the game started again. In time it would awaken “animal spirits” (a Keynes term), fueling further profits and the inevitable positive feedback loop.

   With my suggestion, banks would obviously suffer a short-term loss, but they would easily make up these losses manifold in the next boom. There’s no sense in not taking losses, if doing so opens up new opportunities for profit. Every good investor understands that principle.

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