Foreclosing Foreclosures: Mitigating the Housing Crisis
Signs of distress abound in the U.S. economy. Gross domestic product (GDP) growth has slowed abruptly over the last six months – the growth figure for July-September 2007 was 4.9 percent; the equivalent figure for October-December of the same year was 0.6 percent. Inflation for basic consumer goods is about 10 percent over the last year. Some parts of the country are seeing a price of $4 a gallon or higher for gasoline. The capital markets have lost upward of 10 percent of their value since the beginning of the year.
At the vortex of the nation's economic slowdown (we'll be able to say "contraction" when we get the GDP growth figure for the first quarter of 2008 and "recession" when we get the GDP growth figure for the second quarter) is the spreading subprime housing crisis. The value of the American home in the 20 largest metro areas in the nation showed price declines fell by over nine percent in 2007, the largest annual decrease since the early 1970s. Housing permits in December 2007 were 34.4 percent below the level of December 2006, and the number of housing starts was 38.8 percent lower – the largest declines since January and February 1991, respectively.
Most menacing, however, is the rapidly increasing rate of foreclosures and the projection of up to three million more foreclosures over the next couple of years. The corrosive effect of foreclosures is not just a matter of devastated personal finances (the vast majority of all American families' equity is based on the value of the homes they own), but of vandalism, arson, even drug trafficking in vacant homes, leading to a further downward spiraling of neighborhood home values and still more foreclosures.
How can this cycle be stopped before millions of American families lose their homes? If the federal government is going to be part of the solution, political reality – regardless of economic exigency – will require the following of any plan:
• It cannot involve "massive government intervention," or it risks the threat of veto by President Bush
• It must pay for itself or include offsetting tax hikes or spending cuts to comply with the pay-as-you-go
(PAYGO) constraints Congress has imposed on itself
• It cannot involve a bailout of either financial institutions or investors who have lent to homeowners or to
homeowners who have borrowed, except perhaps in "predatory" cases, since "bailout" is a dirty word,
connoting taxpayer exploitation
One might also add that simplicity and a catchy name would be helpful for any such plan.
A proposal floated by House Financial Services Committee Chair Barney Frank (D-MA) manages to meet all of the above criteria – except for the last. Still, the "FHA Housing Stabilization and Homeownership Retention Act of 2008" (FHAHSAHRA), avoids all political and legislative minefields and could forestall over half of the foreclosures otherwise projected to occur over the next 18 months.
Here's how it works: The Frank bill would permit the Federal Housing Administration HA to provide up to $300 billion in loan guarantees that would help to refinance at-risk borrowers into viable mortgages. Existing lenders or mortgage holders would avoid the 40 cents-on-the-dollar-plus losses they could otherwise expect, in exchange for the accepting an auction-determined write-down of principal likely in the realm of 30-35 cents-on-the-dollar and will have no further credit exposure to the borrower, if the restructured loan is one the borrower can reasonably be expected to pay.
Both borrowers and lenders would pay a premium to the government in return for the FHA loan guarantee. These payments would bring the aggregate cost of the program down to negligible amounts – $10 billion over five years in the worst case, a profit for the government in the best. The Frank plan could potentially refinance between one and two million loans (and help these families stay in their homes), protect neighborhoods, and help stabilize the housing market.
Because the government outlay (or "intervention") is minimal, the plan is likely to find favor with the Bush administration. And because the premiums will come close to covering government costs, the plan is expected to be practically PAYGO compliant without need for more than minimal offset provisions. Finally, no one could fairly characterize the plan as a bailout for anyone. Lenders would suffer the losses of substantial write-downs, and borrowers would pay penalties on any profits from reselling.
The stakes to the economy and to American families are high and the timing tight. But the guess here is that Congress will act swiftly upon its return from its Easter recess, and the administration will not interpose ideological objections to the plan. By mid-May, the Frank plan could be signed and take effect, and the battle against the true source of the nation's current economic woes will be joined.
All fine except for your final paragraph which should read:
"Congress will act swiftly upon its return from its Easter recess, and the administration will not interpose ideological objections to the plan until some congressman from Oklahoma attaches a rider to the bill outlawing abortion and calling Iran 'a bunch of lilly livered cowards who don't have the guts to take the fight to us in Iraq.'"
March 25, 2008 5:43 PM | Reply | Permalink
This is an interesting proposal. I guess I have three main problems with it though:
1. I would prefer not to have the government meddle with contracts freely signed between two consenting parties. The purpose of government should be to enforce contracts, not rearrange them when one side finds it expedient to do so. For instance, there are only limited exceptions in the law for when a court may change the terms of a contract, and these exceptions usually revolve around some instance of fraud.
2. One problem with this housing fiasco, honestly, is the mortgage interest deduction. Owning a home gets a special place in the tax code, and this deduction can distort economic decision-making towards would-be home owners. Yes we value home ownership but it's not always a blessing, as we currently see. So I would advocate eliminating the mortgage interest deduction from the tax code.
3. More importantly, however, is that bailing out anyone for anything only addresses the symptom, and not the real problem: people living beyond their means. The time-honored tradition for buying a home is that the buyer puts 10% down and then has a mortgage payment constituting no more than 25% of take-home pay. We have lost sight of this tradition with these exotic financing arrangements that have appeared as of late. I don't know what the solution is, or even if there is a solution; but we should not jump to simple-minded ones that make us feel good but don't resolve the underlying problem. For instance, banning "interest-only mortgages" (a terrible financial product, IMO) won't solve the problem because people will still demand to live beyond their means, and banks will come up with some other creative way to satisfy their desires.
March 25, 2008 5:55 PM | Reply | Permalink
I would prefer not to have the government meddle with contracts freely signed between two consenting parties.
I don't know the details of the Frank legislative proposal, but Chasin has presented it as a voluntary program. What's wrong with that?
March 25, 2008 8:05 PM | Reply | Permalink
I am troubled here (unlike the recent Stearns bailout) and have serious doubts about whether or not the Frank bill will do long-term good for the economy and stabilize home prices rather than being nothing more than a politically expedient short term solution.
Many people in my office and neighborhood have complained that there is no benefit for them for getting a mortgage they could afford, and maintaining their savings rates despite pressure to spend.
I would only support this legislation if there was a hard look, mortgage by mortgage, of the underlying conditions that caused the default of each one. I would prefer that both the lenders who did not price and lend according to well-known risk principals and borrowers who did not buy based on a sound financial plan both bear the brunt of this, up to a point - and here is where the debate should lie:
At what point is the goal of housing market stability more important than letting consumers and lenders alike have the consequences of their financial choices? (Foreclosures and a decline in overall housing values in some areas).
The last time this happened, for example, in Colorado and Alaska in the early '90s, lenders spent a great deal of time (including my own bank) with workout loans and trying to avoid foreclosures for the same reasons. Even for "greedy bankers" it is much better to have a borrower in the home, even if they could only afford 1/2 to 3/4 of the original payment. The regulators also favored these workouts, as it eased pressure on the banks tier-I capital, forced more rapid resolution of each mortgage, and kept as many people as possible in their homes - a visible public policy plus.
As there are some indications that some markets (Texas, and North Carolina) are more stable than others (California, Florida) and for different reasons, I would prefer a cautious approach driven by local decision makers rather than a hasty federal action that may ultimately (though unintentionally) deflate all of our housing values anyway.
March 25, 2008 11:40 PM | Reply | Permalink
"At what point is the goal of housing market stability more important than letting consumers and lenders alike have the consequences of their financial choices? (Foreclosures and a decline in overall housing values in some areas)."
Umm, I don't know what things are like in your neck of the woods, but in mine, that point is now. Or last month. Or last year sometime. My neighborhood is emptying out--partly because of foreclosures, partly because of foreclosure-related problems like copper theft, and partly because people are just walking away in discouragement from properties worth half what they were three years ago. (I know that last thing doesn't make sense, I'm just saying that's what is happening.)
Owners of surrounding houses are not maintaining or improving them, because, like, why would you spend a bunch of money on something that's worth $5000 less with each month that goes by?
I'm no expert on this stuff, but I think it may have been easier to do workout loans in the 90s because at least then everybody knew who owned the paper, which is not the case now.
March 26, 2008 11:40 PM | Reply | Permalink
"I would prefer not to have the government meddle with contracts freely signed between two consenting parties. The purpose of government should be to enforce contracts, not rearrange them when one side finds it expedient to do so."
We need to understand that many of these mortgages were not freely signed contracts: they were predatory and violated most state and federal consumer protction laws (TILA, RESPA, UDAP) and were as such void ab initio and subject to a right of recission. These high-cost deals are loaded with junk and other unearned fees, hidden ballon payments, and rates tied to the LIBOR (how in the world any variable rate deal can be tied to something as obscure as the LIBOR and be considered anything but a contract of adhesion is ludicrous. There is simply no real bargaining and it's a take it or leave it proposition). Many of our clients thought they were getting into a fixed-rate deal only to find their interest rates jump as much as 12% after the "teaser" period. Seniors, who owned their homes outright, were lured into equity stripping scams. And we haven't begun to discuss servicing scams. The exploitation has been naked, brutal, shameless, and widespread.
My experience dealing with these issues leads me to believe that once we have stripped out all the predatory aspects of the loans and set them up with a reasonable--8%--fixed-rate, conforming product, these defaults become reliable, performing loans. Rep. Franks's auction plan is appealing. Hillary's talked about it--and I wish Obama would consider it.
March 27, 2008 11:50 AM | Reply | Permalink
To Erica:
I am looking to purchase my first home and have been doing alot of research on the subject of home buying. One of the main tings I have noticed is how quickly the value of houses inflated in the last 20 years compared to the wages in the same area. The median household income in Oregon is around 45,000 in 2005 up from 41,000 in 1985 while the price of homes have went from 60k -> 120k 1970-1980 and up to 160k in 2000. They have continued to increase to where most average homes on the market today are in th 200-225k range.
My point on this information is individuals and families are only increasing their wages at around the rate of inflation while housing values have spiked up 200-400% or more in some cases. This rapid loss in value is the market stabalizing itself back into true value of property instead of the inflated bubble pushed by these predatory lending practices.
I feel for those who are having their homes devalued or forclosed upon. But I do not believe a bailout should occur. The property value needs to drop to a value that is affordable for the wages available in a given area. At the very most the government intervention should allow people to renegotiate into a fixed rate. If they cannot afford payments on a fixed rate they should unfortunately loose their homes.
March 27, 2008 3:29 PM | Reply | Permalink
The median household income in Oregon is around 45,000 in 2005 up from 41,000 in 1985 . . . .
You seem to be confabulating nominal (house prices) and real (incomes) dollars. According to the U.S. Census Bureau the 1985 median household income for Oregon in current dollars was $21,894 and $44,159 in 2005. You should use one or the other but not mix them.
On top of that there are some pretty significant differences in median household income by county (2004 Washington County $55,933; Wheeler County $29,390) which is why they say real estate value is all about "Location, Location, Location."
March 28, 2008 12:23 AM | Reply | Permalink