Apr272010

Proposed Subsidies to Housing Market Prices Benefit Only Bankers

The indulgent lives of the Great Housing Bubble were last seen during the Roaring Twenties, another era notable for its sequence of financial bubbles. First came the Florida land boom (from Wikipedia):housing_consumer

The Florida land boom of the 1920s was Florida’s first real estate bubble, which burst in 1925, leaving behind entire new cities and the remains of failed development projects such as Isola di Lolando in north Biscayne Bay. The preceding land boom shaped Florida’s future for decades and created entire new cities out of the Everglades land that remain today. The story includes many parallels to the modern real estate boom, including the forces of outside speculators, easy credit access for buyers, and rapidly-appreciating property values.

That massive bubble was followed by a stock market bust (from Wikipedia):

The Roaring Twenties, the decade that led up to the Crash, was a time of wealth and excess. Despite caution of the dangers of speculation, many believed that the market could sustain high price levels. Shortly before the crash, economist Irving Fisher famously proclaimed, “Stock prices have reached what looks like a permanently high plateau.” However, the optimism and financial gains of the great bull market were shattered on “Black Tuesday”, October 29, 1929, when share prices on the New York Stock Exchange (NYSE) collapsed. Stock prices plummeted on that day, and continued to fall at an unprecedented rate for a full month.

The October 1929 crash came during a period of declining real estate values in the United States (which peaked in 1925) near the beginning of a chain of events that led to the Great Depression, a period of economic decline in the industrialized nations.

It is interesting that they reversed the order; the real estate bubble came first, and the stock market bubble came after. The Great Depression followed the Roaring 20s, just like night follows day or a hangover follows drinking,  the Great Recession follows The Great Housing Bubble. Massive Ponzi schemes and credit binges always end badly.

Foreclosed Dreams

The Obama administration’s remedy for the housing crisis benefits bankers, not homeowners.

By David Moberg

Like millions of other Americans, Alicia and Jorge Hernandez are hanging on to their home by a thread. Six years ago they bought their brick bungalow in a working-class neighborhood on Chicago’s southwest side for $175,000, a bargain compared to homes nearby that sold for $250,000. Jorge, who earned $18 per hour as a roofer, had earnestly avoided debt, but a mortgage broker offered him a fixed interest rate of 5.25 percent on a conventional loan. With a growing family, now including three young children, it seemed like a good deal.

[Kareem Rashed stands outside of a foreclosed home on March 12, 2010 in Bridgeport, Conn. (Photo by Spencer Platt/Getty Images)]

Then the housing bubble burst in 2007. On each block throughout the neighborhood, several families—at first mainly those with sub-prime loans—lost their homes to foreclosure. Housing prices fell sharply. The Hernandez home is now worth $119,000, well below the $146,000 still owed on the mortgage. The construction industry imploded and Jorge, 41, could find only scattered jobs. He now collects about $220 per week in unemployment benefits.

“We are a little bit struggling to make our payments,” says Alicia, 39, her voice breaking as she juggles her two-year-old son. “We’ve cut out what luxuries we could, like cable. Now we have to decide to continue our lifestyle or cut everything and make the mortgage payments.”

The family ran through its savings, then borrowed from relatives as Jorge’s income continued to slide. But unlike many unemployed workers in past recessions, they had no equity in their home as collateral for temporary credit. Early this year, they fell behind on their mortgage by three months.

Alicia looked for an administrative assistant job similar to the one she had after college, but nothing turned up. Then she found a job for $8 per hour at a bulk-mailing subcontractor to the U.S. Census Bureau. But even with that paycheck and Jorge’s unemployment compensation, they owe more than half of their monthly income for the mortgage. “Like many Americans, we were hoping next year would be better,” Alicia says. “We just relied on hope. That was our mistake.”

No, this family did not make a mistake. In fact, they did everything right. This is the very first borrower-in-distress profile I have seen anywhere in the media where the family truly did nothing wrong. The reporter’s search was worth while because it is very difficult to find a borrower-in-distress who didn’t borrow too much using unstable terms, usually to capture appreciation or to get free money to spend. This borrower was a working-class guy providing for his family. If there is any family that I would like to see benefit from the various bailouts, it would be this family. It is the other ninety-nine out of one hundred that irritate me.

The Hernandez family is the new face of the deepening home mortgage foreclosure crisis—a crisis that is increasingly affecting suburban and upper middle-income homeowners as well.

Note the setup here: the reporter advocates a political position in this article, so it was important that people feel like they are saving this family rather than the HELOC abusing squatters I profile here every day.

In the earlier waves, most foreclosures involved speculators or holders of sub-prime loans that were designed to fail, according to the North Carolina-based Center for Responsible Lending, an advocacy and research organization. Its research shows the fault in the sub-prime collapse lay with the loans, not the people who borrowed the money. Many of them could have qualified for a conventional, fixed-rate mortgage and not defaulted.

Although the new wave of foreclosures this year will involve other exotic mortgages (especially interest-only and payment-option adjustable rate mortgages), most recent serious deliquencies and foreclosures involve conventional loans.

Around three-fifths of homeowners seeking loan modifications under President Barack Obama’s Home Affordable Modification Program (HAMP) cite loss of income as the cause of their hardship. At least one-fourth—and by some estimates one-third, heading toward one-half—of all mortgages are currently “under water,” meaning that they are worth more than the market value of the home. Under those conditions, homeowners have strong incentives to walk away, leaving investors holding their costly mortgage and devalued property.

Very good synopsis of the problem. This author did his homework.

The White House tinkers

Responding in late March to these new trends in the housing crisis, the Obama administration rolled out the latest version of HAMP, which offers new provisions to deal with underwater mortgages and unemployment, some of which might help homeowners like the Hernandez family.

But consumer advocates like the Center for Responsible Lending and the Washington-based National Community Reinvestment Coalition (NCRC) are not happy with the Treasury Department’s proposals. “We continue to tinker around the edges of foreclosure prevention,” says NCRC President John Taylor. “We rush to give banks tax breaks, but we dawdle to help homeowners.

The fundamental problem is that the Obama administration and Congress are reluctant to use the legal, political and judicial forces at their disposal to cut through the Gordian knot of special interests that block meaningful reforms. Instead, banks, investors, mortgage service companies, rating agencies and other financial interests that caused the problem are encouraged and bribed (“incentivized”) to modify troubled loans voluntarily.

The fundamental problem is that any reform is a bailout loaded with moral hazard. The lack of progress is a great thing, and the administration should be reluctant to institute some reform that will further hurt the prudent at the expense of the foolish.

Neil Barofsky, the special inspector general for TARP, warns that this scheme “risks helping the few, and for the rest, merely spread[s] out the foreclosure crisis over the course of several years, at significant taxpayer expense and even at the expense of those borrowers” who struggle to pay modified loans but eventually default.

I profiled this guy before. He clearly understands the problem.

Dean Baker, co-director of the Center for Economic and Policy Research, advocates giving defaulting homeowners the option of staying in their homes and renting at market rates for five or more years. Besides keeping people in their homes, the right to rent gives them bargaining leverage with banks to modify loans, since bankers have no interest in being landlords.

I really like Dean Baker’s idea. If lenders knew their payments could get knocked down to rental levels, they would never loan beyond what the cashflow of the property would warrant. I proposed something similar in The Great Housing Bubble. Lenders created more debt than borrowers could service. This is more difficult to accomplish if lenders are limited by a rental equivalence income stream.

Consumer advocates, such as NCRC, National Peoples Action and the Center for Responsible Lending, fought hard for Congress to give bankruptcy courts the power to modify home mortgages—the only major property excluded from the courts’ oversight. But the proposal was defeated in the Senate, which prompted legislation sponsor Sen. Dick Durbin (D-Ill.) to say the banks “own the place.”

Yes, the banks own the Senate. I do happen to agree that bankruptcy judges should not be able to reduce mortgage principal. It would merely encourage borrowers to overextend themselves and petition for relief later. I do like that it would burn the banks though.

With the support of the NCRC, Rep. Brad Miller (D-N.C.) and 26 other congressional Democrats recently proposed that the Treasury use its existing powers to set up an equivalent to the Home Owners Loan Corporation (HOLC), the successful New Deal-era agency. The new HOLC would use the power of eminent domain to buy up large quantities of distressed loans at their current market value, then modify and refinance them.

I only like that idea if the borrowers are kicked to the curb. The programs sounds like a direct government subsidy to be doled out as political largess in poor Democratic districts.

Both homeowners at risk of foreclosure and the government need such powerful tools to get deals done quickly and to shift the costs of resolving the crisis to investors and institutions that were responsible. Such cost-shifting could weaken some banks, but oddly, it could also be the best option available—it’s certainly better than foreclosure—in most cases for banks and investors, as well as for homeowners.

Everyone seems to think foreclosure is a big problem. It’s not. Foreclosure is not the problem; foreclosure is the cure.

Bleeding homeowners

… But many investors or banks hope they can bleed homeowners as long as possible, even though many banks now feel pressure from their growing inventory of distressed loans and the increasing risk of underwater borrowers walking away in strategic default. And they hold out hope for bigger government bailouts, like proposals to pay banks to reduce principal on distressed loans.

Efforts to modify distressed loans started in a modest, ineffective way under former President George W. Bush. The Obama administration has continued to rely on voluntary action by financial interests, and has committed larger amounts of money to support and stabilize home ownership through loan guarantees, purchase of mortgages and mortgage-backed securities, incentives to banks and new homeowners, and its modifying of mortgages through the Making Homes Affordable programs (including HAMP).

An ineffectual solution

… Though homeowner advocates lament the loss of $7 trillion in wealth with the housing crash, much of that was bubble money. Trying to prop up home prices below their historic trends helps no one ultimately, says Baker. …

The efforts to forestall foreclosure need to be stopped, and the foreclosures need to occur unimpeded. Lenders were unconscionably stupid during the housing bubble, and they need to bear the brunt of pain through losses and oppressive regulation or they will repeat their mistakes.

It was obvious to anyone who bothered to care that most borrowers in the bubble era could only afford their homes with Ponzi borrowing; however, lenders did not care. They believed they had no risk. The collateral would appreciate endlessly, the loans were sold to investors, and any other risk could be mitigated with a credit default swap form AIG. With no concern for risk, lenders underwrote really foolish loans.

I am opposed to any effort to save borrowers or lenders. It is sad that families like the one in this article were hurt, but it is not sad that HELOC abusing squatters like today’s owners were hurt. We need neither irresponsible lending nor irresponsible borrowing, and bailouts encourage both.

Stop the bailouts!