"The deal here is that if someone owes $400,000 on a home, which is subsequently sold in foreclosure for $350,000, then they have had $50,000 of debt forgiven. Under currently tax rules, this $50,000 is treated as taxable income."

Good grief! Really, that's taxable income? Astonishing.

Don't worry the former Goldman Sachs CEO is on the case so we can rest assured the little guy will get a fair shake...

The official said Bush will direct former Goldman Sachs CEO and, less importantly, Treasury Secretary Henry Paulson and Housing Secretary Alphonso Jackson to work on an initiative to help troubled mortgage holders get services and products they need to keep them from defaulting on their loans.

(bold added)

http://biz.yahoo.com/ap/070831/bush_housing_slump.html?.v=3

Here is an innovative idea to help homeowners, stop trying to help them.

All the myriad of tax breaks and govt guarantees accomplish is to drive up home prices, undoing the "help" they are intended to deliver. If you add the clientele effect, i.e., not everyone can fully take advantage of all the "help", the situation is even worse.

If buying a home were treated as a serious decision, with no expectation of a govt bail-out, home prices would be much much lower. Also mortgages would be much less risky thereby decreasing the likelihood of a foreclosure.

I realize this might be difficult for some, but newly married 21 year olds with no money, low incomes and high debt due to the ring, the honeymoon and the motorcycle that you know who had to buy, should not be in the market for home...really.

Thank you so much for the clarity. It is unbelievable that fed regulations are being laxed and changed overnight by idiots. There needs to be a discussion of the unprecedented nature of this "changing of the rules." These benchmarks are necessary for any competent analysis of risk level in an investment.
I fear the train is careening into the abyss and the conductor is still punching tickets...

If the feds decide to do this the government should refinance no more than 80% of the home value and let the mortgage holder eat the rest (or face the risks of owning a property in foreclosure).

In that manner the mortgage company at least pays partial penance for its sins.

The forgiveness of debt rules were really not written for this type of case but apply because there is no excpetion in the law. Taxing someone who loses money is not good tax practice or theory (but then this is the IRS code we are talking about).

Save_the,

Taxing someone who loses $ is not good practice. Nothing terribly is wrong bc the debtor would have needed to come up with the $ to repay. Now, the debt is forgiven and he doesn't. Is this a benefit that he enjoyed?

Tim Worstall

Certainly it is taxable income and should be. Otherwise people who understand the game could manipulate it, otherwise there really is no downsize risk in investing in a bubble market.

Speculators got rich during the bubble by constantly extracting equity by either selling, refinancing or just taking out a HELOC. A rational investor in this environment would have a line of credit open to the maximum amount of equity your appraisal will support. (And in appraisals like so many things, you get what you pay for). The instant the market starts to dip you simply start depositing cash using those handy HELOC convenience checks. Boom, instant tax free money and insurance against a drop. After all you have extracted more value than you could by selling (for one thing no 6% sales commission). Now this strategy makes sense for both the honest homeowner who subsequently gets in trouble and ends up in foreclosure and for the fraudulent speculator. As long as long as continued appreciation and the return on the extracted equity exceed the rate on the HELOC you are fine. Or if you choose not to tap the line immediately you are effectively insured against a downturn. (I have a HELOC, most of it unused, it is pretty good insurance all around.)

Generally speaking banks don't bother trying to get deficiency judgements on foreclosures, the assumption being that there are no deep pockets left.

That gets turned on its head if all risks are being shoved onto the lender. If a speculator uses an inflated appraisal to deliberately get a loan for $200,000 more than the true market value, well that's mortgage fraud, if you default and the subsequent sales brings in say $250,000 less than the loan the bank can and would come after you and you will owe that entire amount. If they forgive the loan you have $200,000 in fraudulent gains, the least you can do is pay taxes on it.

What this proposal would do would be to establish an elaborate process of equity extraction and asset hiding that would attempt to keep the MEW right under the level in which a bank would pursue a deficiency judgement. It both rewards and enables reckless strategies based on maximum leverage and essentially legalizes mortgage fraud up to a certain level.

There is a continuing attempt to make all of this about "poor (and stupid) homeowner victims", and all to set up a system to bail out speculators at both ends of the transaction (bubble market and Wall Street). Well I really don't see any reason to reward fraudulent speculators with a 33% premium on what they managed to steal. We need a system that separates out the sheep from the goats from the wolves.

I am not a total fan of Dean's proposal, but at least it doesn't write a blank check for the people who are responsible for this mess in the first place.

S-T-R

A family losing a home in Ohio because of a shuttered plant may deserve a tax break. A guy who took a few hundred thousand in bubble equity out, stashed half and blew the rest on a BMW and two weeks in Vegas? Well not so much.

You could effectively give the lower to moderate income homebuyer the tax break simply by allowing income averaging over say a five year period. This should reduce most of these peoples extra tax exposure to near zero without rewarding people who simply looked at their house and said "You know? I could really use a bigger boat."

It essentially means paying off the current mortgage holder -- who otherwise would be holding bad debt -- with taxpayer money.

Well, we do live in a Conservative Nanny State, don't we?

There is a continuing attempt to make all of this about "poor (and stupid) homeowner victims", and all to set up a system to bail out speculators at both ends of the transaction (bubble market and Wall Street). Well I really don't see any reason to reward fraudulent speculators with a 33% premium on what they managed to steal. We need a system that separates out the sheep from the goats from the wolves.

Well put. But I'd go further than your last part.

We need a system that not only seperates out the wolves. We need a system that takes a pair of pliers, forces them into the mouths of the wolves, and pulls out their fangs one by one.

How long are we going to let the religion called market fundamentalism screw up our country? Regulations are not always a bad thing! And they are surely not a sin!

"most moderate income homeowners will face relatively low tax rates".

Well, the marginal rate on income from $30,650 to 74,200
is 25% (2006 rates) - people with income lower than this would not be buying homes in any bubble market. And if they get significant writeoff on the mortgage they could be pushed up into the next bracket.

Not really trying to nit-pick Dean here, just pointing out that people above the poverty level pay taxes at rates which are not really progressive.

"... It essentially means paying off the current mortgage holder -- who otherwise would be holding bad debt -- with taxpayer money. ..."

Who are those current mortgage holders? I believe they are banks and lending institutions. Why should they not take some lumps?

I should have used the rates for married filing jointly in my comment above - $61,300 to 123,700. Since the median family income falls below this bracket, there will be a lot of homebuyers in the 15% bracket.

Dean, Here's a link to a Blog of an interesting San Diego realtor. In an 8/31 post, "Two year meltdown" he asserts 5 of 26 Oceanside home sales between 8/15-8/23 were 100% financed. WOW!

For a little weekend fun, here's a link to an MSN Moneycenral home affordability calculator.
http://articles.moneycentral.msn.com/Banking/Loan/HomeAffordabilityCalculator.aspx

I entered $150k income, $400 mo. debt, $100k cash downpayment and excellent credit on a 30 yr loan @ 6%.
The maximum affordable house it recommended is $628k. Dropping int. rates a full point to 5% the max. affordable house skyrockets to $641k (sarcasm intended.)
Had more SoCalifornians been reading you along side David Lereah (back in the early days of '03-'04, not '05-'06 when they were caught-up in the frenzy) I suspect our prospective buying pool would much larger & the pain we're about to endure nonexistent.

Have a GREAT weekend.
http://www.bubbleinfo.com/

Bruce,

Speculators don't deserve additional help in the form of tax break. Banks don't seek judicial foreclosure bc there's no equity left in property or borrower. It takes three months or longer than TD sale. The longer it's on banks' book, they need to set aside reserve for non-earning assets.

For mortgage fraud (or agregious shortfall), it's different story. Those go through rounds of internal review b4 referring to supervisory agencies such as local and Federal. They don't get off that easily. Tax break is the last thing the defrauders have to worry about.

What is needed is a lesson from American history when home mortgages were a strict process that took more time to secure. In the 2000's obtaining a home mortgage was little different than applying for a credit card through the mail. The application process and strict requirements should be the norm for something as important and life changing as obtaining a mortgage. The industry trivialized the ritual of mortgages and made obtaining them too easy. For instance, no money down mortgages. It cannot be too important if they were practically giving them away.

Danny L. McDaniel
Lafayette, Indiana

Bruce: not a bad idea, the old income averaging rules had value in smoothing out unusual circumstances.

3% equity? In the old days 20% was considered good practice, excepting VA loans.