Individual's debt basis for bailout

By DAVID MOON, Moon Capital Management, LLC
March 1, 2009

Dave Ramsey is an idiot.

Ramsey, a wildly successful author and media personality, has been perpetuating either a disservice or outright fraud by encouraging people to pay off their debts.

How can you get government help on your mortgage if you don’t have one?

I used to think Mr. Ramsey’s strategy made sense – and it still does, until I start thinking about Washington’s new Homeowner Affordability and Stability Plan. Then I realize that people with modest or (heavens!) no mortgages are left in the cold when it comes to getting some of the money the federal government will soon be borrowing on the taxpayer’s behalf.

Don’t misunderstand me. I am not disparaging all social programs or minimizing the need to help individuals in need.

But consider this. Government programs typically reallocate resources on the basis of an individual’s income. We are about to start redistributing wealth on the basis of an individual’s debt.

One part of the mortgage bailout plan allows individuals who are current on their loans to refinance their loans and take advantage of lower rates, even though those borrowers don’t have enough equity in their loans to qualify for a new mortgage.

This is supposed to be the least controversial part of the plan. It is also the least logical.

In the last two years we have learned that the best predictor of whether or not a person will default on a mortgage is the amount of equity they have in the loan. When people don’t have skin in the game, it is much easier for them to walk away from the game, regardless of their income.

If a person doesn’t lose any money by defaulting on a mortgage, what difference does it make that his payment is only 31% of his monthly income?

A homeowner who stands to lose tens of thousands of dollars by defaulting on a loan tends to find adequate sources of income to make those payments.

A second part of this plan spends $75 billion to help three to four million at-risk homeowners stay in their homes. These are people who are in danger of having their houses foreclosed. The program would offer a combination of government subsidized interest rates, lower rates from the lender, bonuses for making timely monthly payments and, when a borrower has no other options, a “judicial modification” of the mortgage.

“Judicial modification” is a fancy way of saying a judge rewrites the contract.

Mortgages as large as $417,000 are eligible for restructuring under this part of the plan.

For $75 billion, however, we could just send all three million at-risk homeowners $25,000. The average balance on even subprime mortgages in the U.S. is $180,000. A $25,000 principal payment would make a pretty good dent on most home loans.

But that would be a simple reduction in debt. Why would someone want to do something like that? It might accidentally create some equity in a house. It might even provide a financial incentive to fulfill a contractual obligation.

That sounds like something that silly Dave Ramsey might suggest.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

Add me to your commentary distribution list.

MCM website