Mar232012

Another ignorant and misguided appeal for principal reduction

Principal reduction is on everyone’s mind these days. The political left embraces this method of looting the public coffers to buy votes. In their world view, principal reduction is a populist handout to noble loan owners who are victims of circumstance. In my opinion, that’s bullshit.

Today’s featured article caught my attention because the headline speaks a basic truth: The housing crisis is crushing responsible homeowners. However, when I read the article, I was shocked to find the reporter cited all the wrong reasons and came to exactly the wrong conclusion. The reporter concludes falling prices hurts responsible homeowners, and therefore we should grant them principal reduction. In truth, the housing crisis is crushing responsible homeowners because the government and federal reserve are stealing their interest payments and tax dollars to bail out irresponsible banks and loan owners. The solution the reporter advocates crushes responsible homeowners even more be rewarding loan owners and getting everyone else to pay for it.

Before we begin, we need to make a clear distinction often lost when discussing principal reduction. Loan owners are not home owners. Yes, their names may be on title, but if they don’t have any equity, so they don’t own anything. The various proposals for principal reduction only apply to loan owners. No homeowner — someone with equity — is going to receive a penny of principal reduction. In fact, true homeowners — those on title with no loan encumbrance — couldn’t receive principal reduction because they don’t have a loan. Principal reduction is only going to benefit title holders with no equity. It is being paid for by renters (who by definition have no equity) and home owners who really do have equity.

Further, how did loan owners come to find themselves in need of principal reduction? If they borrowed responsibly, used fixed-rate financing, and they can afford the payments, then they don’t need principal reduction. Why would they? Nobody was reducing their principal when prices were going up, so why do we need to do it now that prices are lower? Is it because some are unemployed and need temporary assistance? Those people have already received loan modifications to get them past the economic slowdown. They don’t need principal reduction.

By and large, the people who feel they need principal reduction overborrowed, many through rampant HELOC abuse. Most people overborrowed to get property they could not afford because they saw real estate as an investment. After all, if they were only concerned about providing shelter, they would have recognized the savings from renting and chosen not to buy. The government has no business bailing out real estate speculators and investors. I find it shameful that real estate speculators are what now pass for responsible homeowners.

The Housing Crisis Is Crushing Responsible Homeowners

By Jordan Weissmann — Mar 22 2012, 10:28 AM ET

The GOP says that bailing out underwater homeowners rewards people who borrowed irresponsibly. But most of the homes entering foreclosure today were bought with prime mortgages.

Those two statements are not in conflict. I don’t agree with the GOP on much, but on this point, they are correct. Bailing out loan owners is rewarding those who borrowed irresponsibly. What this report fails to recognize is that prime borrowers using prime mortgages borrowed irresponsibly. The housing bust was never a subprime problem.

This much, everybody knows: Subprime mortgages were at the heart of the U.S. housing crisis.

Bullshit! Presenting a lie as irrefutable truth is really outrageous. It’s not the Borrowers; It’s the Loans. The same bad loans were given to prime borrowers that were given to subprime. Perhaps everybody doesn’t know that, but they should.

Blanks blithely lent money to reckless borrowers who didn’t stand a chance of ever paying down the debt on their new homes. They defaulted, and dragged down the economy with them. That was our original sin, the reason for the country’s fallen state today.

That much is true, but limiting this guilt to subprime borrowers is an outrageous lie. They are all guilty, prime and subprime alike. As Tanta from Calculated Risk noted back in 2007: We’re All Subprime Now.

As a result, when people bring up the idea of allowing Fannie Mae and Freddie Mac to write down the principal on homeowners’ mortgages — in other words, forgive some of their debt — as a way of boosting the economy, it tends to be met with incredulity from conservatives. Whatever happened to personal responsibility!? they ask. Here’s a piqued example from Senator Bob Corker, a Republican from Tennessee:

Reducing the principal on home loans for borrowers who put no money down amounts to a massive wealth transfer from places like Tennessee, where most homeowners have borrowed responsibly, to places like California and New York, where exotic mortgages were widely used to finance a speculative housing boom. It is absolutely egregious….

I’m always taken aback when I agree with the extreme right because I so rarely do, but Bob Corker is correct. Principal reduction at taxpayer expense is a massive transfer of wealth from the responsible to the irresponsible, and it is absolutely egregious.

Here’s what Corker and his GOP colleagues are missing though. Today, the foreclosure crisis isn’t just hurting borrowers who took out subprime mortgages. Those debtors have already been through the ringer. Now, it’s responsible borrowers who took out plain vanilla mortgages who are suffering.

No, what this reporter is missing is that prime borrowers were just as irresponsible as the subprime borrowers who were foreclosed on. Further, he fails to recognize these same prime borrowers have already defaulted and they are squatting in their homes making no payments for the last few years. And now he wants to forgive their sins, give them free money, and let them stay in their houses. Screw that.

Yesterday, researchers from the Federal Reserve Bank of New York published the graph below. It shows that, midway through the Great Recession, the majority of homeowners in foreclosure had taken out prime mortgages. In fact, about two thirds of foreclosure starts since 2010 have involved borrowers who took out 30-year fixed-rate amortizing mortgages. In other words, they took out what was supposed to be the safest, most responsible loan they could.

The recession, increasing unemployment, and falling prices hit everyone. However, much of the reason for the change in mix is that lenders simply ran out of subprime borrowers to foreclose on. Many of these borrowers gave up quickly as they have few resources to survive a financial setback. Once the subprime borrowers were wiped out, all that remained were prime borrowers to foreclose on.

Before 2010, only 40 percent of homes entering foreclosure were attached to 30-year fixed-rate mortgages. The borrowers who are falling behind today also have higher credit scores and had been making payments on their houses longer than those who defaulted early in the crisis.

Share_of_Foreclosures.jpg

The Fed’s explanation: The recession happened. In 2006, people defaulted because they bought too much house. In 2012, they’re defaulting because the entire housing market tanked, the home which they made a 20 percent down payment is underwater, and they’ve lost their job. The Fed says:

“The shift in the composition of new foreclosures from borrowers with nonprime mortgages to those with prime mortgages reflects the fact that falling house prices and rising unemployment tend to impact all borrowers in a local housing market, not just nonprime borrowers. As a result, traditionally safe borrowers began falling behind on their payments as they felt the severe effects of the housing bust and high unemployment.”

To this I reply: so what? When the Titanic sunk, it drowned rich and poor alike. The entire discussion of who was hurt and why is irrelevant. Principal forgiveness is the worst policy option and foreclosure Is a superior form of principal reduction. None of the arguments raised justifies stealing money from me to give it to a loan owner.

To review: When we talk about helping homeowners,

No, we’re talking about helping irresponsible loan owners…

we’re talking about helping a lot of people who made reasonable decisions,

No, we’re talking about bailing out speculators who overborrowed or do not need principal reduction…

who did exactly what economists and politicians had been urging them to do for decades,

Yes, they were clueless sheeple, but that entitles them to nothing…

and have now been victimized by circumstances. Is that so “egregious”?

Yes, it is egregious. The reporter is proposing state-sanctioned theft, the direct transfer of wealth from one group to another with no justification. How can anyone be in favor of that?

Perhaps prime borrowers deserve a break? Who deserves the aid more than they do?