An Idea to Help Homeowners but not Screw up Markets

There is a lot of banter about saving families from their own worst instincts of buying a house they couldn't afford.  Even Top Gun "Maverick" John McCain has joined Hillary and Obama in coming up with a solution that meddles in mortgage markets.   Ever wonder why mortgages are 6% when credit card debt is 18%?  You can walk from ALL of your credit card debt but not your mortgage.  So the market prices in the excessively easy bankruptcy by jacking up rates. 

I think housing is only halfway down - it needs to fall again as much as it has to hit historical levels.  About 1mm homes (of 110m nationwide) went into foreclosure in 2007.  At current rates  another 2mm will go this year.  As prices drop again, another 5.5mm homes are at risk.  This will quickly become a huge problem. 

Walter Brusse runs a wonderfully carmudgeonly blog on Amazon.  He has come up with a fascinating alternative approach, to create a Rescue Foreclosed People agency to help responsible families out while keeping markets sound.  I lay out his thoughts (with a little editorializing) below the fold.  Worth a look. 

The Rescue Foreclosed People agency (RFP) is for households in the last stage of foreclosure who have maintained their homes (an incentive).  This means they must be the primary people living in the homes - this does not help speculators and landlords.  It protects people who are honest, hard-working, and strive to join the American Dream of home-owning. 

The RFP will go to the mortgage holder, and, using data on how much foreclosed homes sell for in that area, offer the mortgage holder that amount of money. Since the mortgage holder will only get that amount in any case, and they can save the cost of foreclosure, it is in their interest to take the money.

Then, the RFP will offer to rent the home to the foreclosed family for the cost of the money to the RFP (plus 1% for expenses).  The RFP should be able to borrow at lowish rates.  And no principal is built into the payment.  This will enable the foreclosed family to stay in the home with a rent payment substantially lower than their previous mortgage payment. But, they will no longer be owners with the long-term benefits of equity building. This will satisfy neighbors who perhaps scrimped to make THEIR payments and who would resent a free ride for others. Equally, the neighbors’ homes are less likely to lose excessive value due to vacant homes in the neighborhood that are boarded up.

The cost of this new agency will be low, since the renters will be paying the cost for the RFP funding. If it eventually helped 4m homes at $500k average, it would be managing $2T of property, a huge pool of capital.  But it would borrow that money and charge 'rent' of 1% above carrying cost.  Hence it would not really cost us anywhere near $2T ("us" = the taxpayers, not the hypothetical guy-behind-the-tree). The real costs would be due to (a) management (b) defaults - some of those people whom we help will not be able to continue renting (c) political interference to try to help various aggrieved constituent groups.

Since the homes that were to be foreclosed will not go on the market, they won’t be exacerbating the excessive-homes-for-sale problem. The RFP should thus prevent some of the final 5.5m future foreclosures, since it should help prevent firesale prices in some neighborhoods. 

Eventually, perhaps in ten years or so, when housing prices have bottomed out and are beginning to recover, the agency will be able to start selling these homes and close up shop.

The other benefit is that it doesn't put more power into the Fed.  The very institution which caused the credit debacle is being (potentially) given new powers to manage more institutions.  Wrong!  Help the people, not the bankers.

Comments

[sibley]

yelnik,

This may be the least worst option. the other reasonable option starts the same way; with current lenders forced to write off now fictitious value. but in this one the "owners" refi with a govt. agency low interest rate mortgage on the reduced value, (if the borrowers qualify).

Upfront costs are about the same for both plans. the differences are that taxpayers become lenders, not real estate owners and property managers. (that is the biggest problem with the RFP scheme). It does provide these homeowners with the opportunity to get the equity/profit that eventually will come. While this may be rewarding bad behavior, it is doubtful if any of these people will consider this a positive experience that they want to repeat.

The potential advantages are (1) homeowners have the incentive to keep up and improve the home-renters do not, and (2) the govt. is less involved-no long term ownership-property management- or down the road selling issues. (You can bet that when these houses are resold under RFP-they will not get top dollar.) These mortgages could also be written with a partial profit recapture provision, where the govt. gets say 20% of any resale profit, or these borrowers could be excluded from the tax exemption on home sale profit.

Also- your point regarding rates on secured (mortgage) and unsecured (credit card) debt is essentially correct. You can walk away from credit card debt with less repercussions than mortgage debt, where you lose your house but, thanks to the credit card industry, personal bankruptcy is no longer easy, and credit card debt is now not wiped in most personal bankruptcies.

[Margaret]

The difficulty w/the plan is a possible lack of the price discovery function of the market. The plan suggests that "The RFP will go to the mortgage holder, and, using data on how much foreclosed homes sell for in that area, offer the mortgage holder that amount of money." And further "since the homes that were to be foreclosed will not go on the market, they won’t be exacerbating the excessive-homes-for-sale problem."

How will the RFP get the "data on how much foreclosed homes sell" if we aim to eliminate foreclosures? Wouldn't it be nice if we could just sweep all the problems under the carpet and ask "crisis, what crisis? And maybe our local banker could just take the price of every house out of thin air, without bothering to see what the market would pay? I am sure such banker would definitely keep the numbers consistent with his balance sheet needs...Can you see how that gets more and more absurd?

Markets are supposed to be self-correcting, and if they overshoot in one direction they need to overshoot in the other direction to put supply and demand in balance again. Government will not be able to replace markets, ever. All the government can do is scare away any potential buyers with the threat of administractive intervention. And let's remember, capital can vote with its own feet - and flee somewhere else where free markets prevail,and not where government intervention takes over.

When we created telecom overcapacity in 1999-2000, did anybody suggest that the government should buy all the cable glut then to save some companies, jobs, stockholders or individuals affected? I am sure telecom lobbyist did, but that certainly did not create the sort of public support we see today for government involvement in the housing market (which is puzzling because the public doesn't seem to understand that by bailing ourselves out with regard to our housing values we are simultaneously burdening ourselves via expanded public debt, resulting higher taxes and inflation - in other words there is still no such thing as a free lunch in economics as Milton Friedman once noted).

Homes are commodities just like anything else and are subject to to the laws of supply and demand. The ones who really get helped (temporarily) by delaying or disabling the price discovery via market action are real estate developers and banks, which can delay posting colossal losses on their books. All these so called "rescue" plans are simply a bailout plan for the banks at the cost of the taxpayers. Besides, such proposals do nothing to help the market clear a gargantuan supply of homes. Market problems get solved only through market action - supply demand and price. One place we should definitely look is the price of money. If money gets too cheap things do tend to get expensive. When money is expensive, things get cheap. Central bankers are supposed to know that and act accordingly.