Monday, June 2, 2008

Housing Policy Incoherence: The Mortgage Forgiveness Debt Relief Act

Previous posts in this series have developed a framework for which borrowers should be helped with their mortgage problems, who should help them, and why they should be helped. This post applies the framework to The Mortgage Forgiveness Debt Relief Act.

Briefly, the Act provides relief to taxpayers whose mortgages are foreclosed or modified during the 2007, 2008, and 2009 tax years. Prior to the Act, mortgage debt that was forgiven or cancelled pursuant to a modification or foreclosure was considered income and was taxed as such if the taxpayer was solvent. The Act waives that requirement (for more details, here is the official IRS description).

Who Should Be Helped? Here is how the Act lines up against our criteria:

  • Modest Housing v. Luxury Housing. The Act does not distinguish between high end and low end housing; up to $2,000,0000 in indebtedness can be qualified.
  • Long Term Owner v. Short Term Owner. The Act does not focus on length of ownership.
  • Owner Occupied v. Investor/Speculator. The Act only applies to principal residences, so investors and speculators will not benefit.
  • Limited opportunity for recovery versus good future prospects. The Act does not address a borrower's future prospects.
  • Loan funds used for necessities/productive purposes versus loan proceeds used for frivolous purposes. The Act is limited to mortgages used to purchase or rehabilitate primary residences (or the refinance of such debt), so cash out refinances and home equity loans not used for rehabs are excluded.
  • Limited Capacity and/or Duped versus Knowledgable/Complicit. The Act does not address this dimension, so, for example, a borrower who committed fraud to obtain the mortgage can benefit from the Act.
  • Unable to make contractual payments versus able to make payments. The Act does not test for ability to pay. In fact, forgiveness of income is only taxable for solvent taxpayers, so the only beneficiaries of the Act are borrowers with the ability to pay (or who have assets which could be liquididated to pay).
  • No housing alternatives versus those with housing alternatives. The Act does not look at this criteria.
Who Should Help? The Act in essence is a direct taxpayer subsidy of the borrowers who take advantage of the Act, in that taxes that otherwise would paid will not be paid.

Why Help? For taxpayers where the forgiveness arises out of a foreclosure, the motivation to help is altruistic (the home is already foreclosed on, so the negative neighborhood and economic impact arising out of the foreclosure will still occur). Forgiveness arising out of modification is both altruistic and may help neighborhoods and the economy by avoiding another foreclosure.

Conclusion. No doubt the Act will help many worthy borrowers avoid insolvency and it will help facilitate modifications. On the other hand, it is perfectly plausible that the Act will provide six figure subsidies from taxpayers to borrowers with $1,000,000+ homes who committed fraud to get their mortgages and who have the ability to pay both their mortgages and the taxes. The striking aspects of the Act are that it only benefits solvent borrowers, and that the benefit comes directly from taxpayers. Possibly taxes never collected are a more palatable subsidy than direct assistance.