JAMES ROBERT DEAL, ATTORNEY
PO Box 2370, Lynnwood, Washington 98036-0370
Telephone (425) 771-1110, fax (425) 776-8081
James@JamesRobertDeal.com
October 15, 2008
Henry Paulson
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, D.C. 20220
Also sent by fax to: 202-622-0073
Dear Henry,
I write to identify a policy change that would add trillions of dollars of liquidity to the housing market overnight. It would stimulate home sales, stabilize home prices, and reduce the number of home foreclosures.
My suggestion is to make existing home mortgages assumable. To do this Congress should amend the Garn-St. Germain Act to suspend enforcement of due-on-sale clauses in residential mortgages until liquidity is restored to the system.
The Garn Act included a non-binding provision that encouraged lenders to allow assumptions at compromise rates, but this provision, because it was not mandatory, has never been enforced. It says:
(3) In the exercise of its option under a due-on-sale clause, a lender is encouraged to permit an assumption of a real property loan at the existing contract rate or at a rate which is at or below the average between the contract and market rates, and nothing in this section shall be interpreted to prohibit any such assumption.
Relying on this paragraph, perhaps the appropriate agency could make the change I suggest by regulatory action instead of statutory change.
As it is currently written, the standard FNMA/FHLMC Paragraph 18 due-on-sale clause does not actually require a seller to pay off a loan at the time of sale. It only gives the lender the option of calling the loan due should the seller sell without the lender’s consent. Should a seller sell without lender consent, and should the lender call the loan due, the buyer and seller have 30 days to pay off the lender. If the loan is not paid, the lender can foreclose, which typically takes another 180 days.
If enforcement of due-on-sale clauses were to be suspended, then sellers would be able to pass on their mortgages to their buyers. Buyers would not have to go through the now very difficult process of qualifying for new loans. More homes would become saleable. Home values would tend to stabilize. Fewer homes would be “under water.” Instead of sellers simply abandoning their homes, more would be able to sell them. The number of foreclosures would drop. More renters could become home owners.
Although this simple change would not add new money to the system, it would keep existing money in the system, and make that money available to buyers, thus adding effective liquidity to the system as a whole.
I would assume that many banks have already decided as a matter of internal policy that due-on-sale clauses will not be enforced as long as mortgage payments are paid. Banks do not need more REO properties. However, buyers and sellers do not know this. And they should know this. Sellers and buyers should be encouraged to do assumption transactions and wrap-around deed of trust transactions. The real estate agents I talk with all assume that due-on-sale clauses are still enforceable. They are very cautious about suggesting that sellers and buyers “go around” due-on-sale clauses. They do not want to be liable if the bank forecloses.
Before the Garn Act was passed states had their own laws regarding due-on-sale clauses, generally judge-made laws. Some state courts took the position that a due-on-sale clause was in effect a restraint on alienation, a prohibition against selling and buying, and declared due-on-sale clauses void, at least for residential transactions.
The Garn Act relied on the Commerce Clause to preempt state laws regarding due-on-sale clauses and federalize the issue. This preemption was a good thing at the time because lenders were operating more and more across state lines. The laws needed to be uniform. Further, the cost of money had risen, and banks needed to recycle their loans to earn more money.
However, at this time in our history, the inability of sellers to allow buyers to assume their existing loans means that buyers must get new financing, and that can be difficult. Strict enforcement of due-on-sale clauses, now more than ever before, really does act as a restraint on alienation.
I would suggest that enforcement of due-on-sale clauses be relaxed for an initial one year trial period so that buyers can assume existing mortgages or do wrap-around deed of trust transactions. I would suggest that buyers be required to meet reasonable requirements for assumptions if there is to be a release of liability for sellers, minimal approval requirements for assumptions without release of liability for sellers, and perhaps no requirements at all for wrap-around deed of trust transactions, in which sellers would not be released from liability, as was the general situation before passage of the Garn Act. Any purchase is better than a stagnant real estate market and foreclosures.
Wrap-around deed of trust transactions with no release of liability to the seller should be allowed with no bank review as an available option for two reasons: First, banks are already overwhelmed with dealing with loans in default and short sale transactions, and second, such wrap-around transactions can be closed in a matter of weeks instead of months. If a seller will remain secondarily liable on a loan, he can be counted on to do his own review of his buyer’s credit worthiness.
I would suggest that relaxation of enforcement of due-on-sale clauses apply not only where buyers are buying homes they will occupy, but also where investors are buying homes which will be rentals or which will be improved and resold. Yes, non-owner-occupied investors will go around snapping up homes, but that would not be a bad thing. Sellers will be able to sell their homes and perhaps buy other homes. Foreclosures may be avoided. Banks will not lose money. Further, investors are more likely to have the cash necessary to buy out the equity of owner-occupied sellers.
Best of all, my suggestion does not involve the outlay of any federal money.
My second suggestion has to do with co-signers. More buyers could qualify to buy homes if they could assemble a group of non-occupant co-signers. It is my understanding that FHA will allow an occupant-borrower to strengthen his loan application by bringing in non-occupant co-buyers but that Fannie Mae and Freddie Mac will not.
I would suggest that an owner-occupied home buyer be allowed to solicit his relatives and friends to be co-signers and that each be allowed to obligate himself for $1,000 or $20,000 or some other fixed maximum amount of money. I would suggest that this obligation be considered non-dischargeable in bankruptcy. These co-signers should not be required to go on title as co-buyers, as is currently required. Co-signers would voluntarily assume responsibility to supervise their buyer, make sure he is employed, maybe even hire him, and make sure he is paying his mortgage.
With more parties obligated, lenders would have more confidence that a borrower would pay his mortgage. It would be an American version of a Grameen Bank loan where an entire village co-signs for a borrower and guarantees payment.
I would suggest that if an occupant-buyer secures sufficient co-signer guarantees, he should be allowed to purchase a home on a zero-down basis.
Third, I would suggest that the almighty credit scoring system be relaxed, particularly when a borrower can assemble a credible group of cosigners.
Finally, I would suggest that the entire system of qualifying borrowers be reviewed so that those capable of repayment can get loans. There are many arbitrary loan qualification requirements which prevent people who are capable of making their mortgage payments from getting loans.
I was glad to read that Fannie Mae and Freddie Mac have temporarily suspended foreclosures. That was a good move. The situation should be held in stasis until the next administration takes office.
Henry, you are doing a great job, and I wish you the best.
I believe these might prove to be useful ideas, so I am sending copies to others.
Sincerely,
James Robert Deal
Copies sent to:
Wall Street Journal
Alan Murray, sent by e-mail to: a.murray@wsj.com
Almar Latour, sent by e-mail to: a.latour@wsj.com
Dave Pettit, sent by e-mail to: d.pettit@wsj.com
Daniel Bernard, sent by e-mail to: d.bernard@wsj.com
New York Times
Sent by e-mail to: oped@nytimes.com
Sent by e-mail to: editorial@nytimes.com
Sent by e-mail to:
executive-editor@nytimes.com
Sent by e-mail to:
managing-editor@nytimes.com
Seattle Post-Intelligencer
Mark Trahant, sent by e-mail to: MarkTrahant@seattlepi.com
President George Bush
Sent by fax to: 202-456-2461
Representative Nancy Pelosi
Senator Robert Byrd
Sent by fax to: 202-228-0002
Senator John McCain
Sent by fax to: 202-228-2862
Senator Barak Obama
Sent by fax to: 202-228-1404
Copyright © 2008 James Robert Deal.