Why Bailing Out Homeowners Will Not Fix the Housing Market
This Sunday, the New York Times asked a panel of economists, "When Will the Recession Be Over?" A few panelists offered hopeful words, 'Perhaps later this year... if there are no more surprises.' The eternally pessimistic Nuriel Roubini suggested three years... or more. One sage observer offered the wisdom of bubbles past: You don't reach the bottom until people stop asking.
We are having a hard time accepting that recovery will take time. Leveraging, or getting into debt, is a lot of fun. For twenty years or so, as interest rates declined and lending standards loosened, America went on a debt-funded spending spree. Across the country, as housing prices rose and the home-equity lending came into vogue, Americans used their access to money to live beyond their current incomes, creating an illusion of prosperity and growth.
Deleveraging, on the other hand, is not fun. It ultimately requires reducing debt. Actually getting rid of it. For American households--whose real incomes have been flat for a decade or more--it means returning to the standard of living that they could afford before the borrowing spree started, adjusted further downward to allow them to pay off the debts they accumulated during the boom years.
So far, our public policy responses to the housing collapse and banking crisis have largely amounted to various strategies for shifting the debt burden around. In the name of stability, the TARP program socializes the losses from our financial sector. Now, in a similar vein, we are proposing to tackle the problem of home foreclosures. But unlike the TARP program that puts the bank losses on the broad shoulders of the Federal government, the strategies to boost the housing market will shift the losses experienced by current homeowner onto the next generation of homebuyers.
Consider this. In 1981, the median home price was $62,000, and the annual cost of funding the purchase of that home at the then-current 16.6% mortgage rates, and with a 20% down payment, was $8,900 per year. $8,900 was 47% of the median family income at the time of $19,000, indicating that the median priced home was not affordable for most families.
As interest rates declined through the 1980s and 90s, home prices escalated as affordability increased. By 1998, the cost of carrying an 80% mortgage on a $128,400, median priced home dipped to $8,228, or just 21% of the 1998 median family income.
By 2007, median home prices increased a further 70% to $217,800. 30-year mortgage rates only dip another 1% or so, but home priced increases were aided by the advent of all sorts of "creative" mortgages, that continued to reduce buyer monthly payments.
For more than two decades, the growth in home prices was made possible by the long-term decline in mortgage interest rates, and at the late stage of the bubble by interest only, variable rate, and teaser-rate mortgages. Despite all hopes for a revival of the real estate market, and particularly a new period of growth in home prices, this is not likely to happen.
Current Federal strategies to re-stimulate the housing market to address the foreclosure problem are ill-advised. Over the past several months, the Federal Reserve has initiated efforts to push long-term mortgage rates down toward 4.5% by purchasing mortgage-backed securities. In addition, the newly enacted stimulus package included an $8,000 first-time homebuyers tax credit.
The problem with these efforts is that they will not fix the fundamental problem, but instead will simply push the problem--the loss of home equity--onto the next generation of homebuyers.
Consider this example. Take the median US home that was worth $220,000 during the years 2005 to 2007, but which might be worth $180,000 today, reflecting a loss in value of nearly 20%. This reduced home price, with a market-rate, 6% mortgage and 80% down, would cost the new owner around $10,500 annually. However, with a 4.5% mortgage rate and the $8,000 tax credit, this new owner can afford to pay $215,000, and still owe only $10,500 annually.
This is the same game that we have watched for the better part of two decades. The buyer--who has been taught to focus on the monthly payment as the measure of "affordability"--is willing to pay the higher price for a home because of the availability of low-cost financing. The seller is happy, because they receive close to the 2005-2007 price of their home. For two decades, this logic worked, because interest rates were continuing to drop and home prices were continuing to rise.
But the situation today is different, creating two very real problems. First, these policies constitute deliberate inducements to entice homebuyers to pay over-market prices for homes, as a matter of public policy. It is reasonable to expect that once the Federal actions that induced the purchase are ceased--the artificially low mortgage rates and the tax credit--the market price of the home the buyer purchased for $215,000 in the example above will fall back to its current value of $180,000.
Therefore, the impact of these policies will be to benefit--or "bail out"--the current homeowners who are facing substantial losses, by passing those losses on to the new homebuyers.
Second, and equally important, new homebuyers should be on notice that the "great deals" that they might see in the real estate market today are only great in comparison to prices at the high point of the real estate bubble. The implied suggestion is that once the current mess is behind us, home prices will continue to rise once again. But that is not likely to be the case.
There are two simple reasons for this. First, tightened rules governing mortgage banking will end the lending practices that artificially lowered the carrying costs of purchasing a home and supported the run-up in home prices. Traditional conforming mortgages with real down payments and more conservative underwriting standards will once again tie home affordability to household incomes and long-term mortgage costs.
Second, long-term mortgage rates are more likely to rise than fall, once the Federal Reserve Bank curtails its market intervention to suppress mortgage rates, and particularly if Congressional action allows judicial rewriting of mortgage contracts, which will undermine the security of--and therefore increase the cost of--mortgage loans.
Many will argue that since we have chosen to bail out the banks, it is only fair that we bail out homeowners. That is a fair argument, and one that Hank Paulson and Ben Bernanke and Congress should have considered before we began our long walk down this path.
But Federal actions to artificially boost home values will not socialize the losses in home values, but instead will literally pass one family's loss on to the next. Like the TARP program, the fundamental problem is that the losses are real, and try as we might to shift them around to avoid the pain, they will not go away.
Streamlined Modification Program: The New Homeowner Bailout From ...
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These are the words I have been wanting to say ever since we got into this mess.
4. I still can't afford to buy a house because the irresponsibility of people like my neighbor has caused the balance of my investment account to be cut in half, while the value of the dollars I've saved have been reduced even further. This is in addition to the fact that prices of house are still over inflated because the government won't let the market fully correct itself.
5. If I lose this job, and miss one rent payment, I get to be evicted. This seems to make sense. If I'm 10 days late on a rent payment of $1,800, I'm homeless. But my neighbor gets to be almost a year and half late on a $5,000 a month payment, and not only has a place to live, but gets the government and taxpayers to give him a high six figure valued asset.
My view isn't about punishing my neighbor for bad decisions. My point is that it is not right to punish others for being responsible and making good decisions. There will be no trickle-down effect. This is a plan designed to help a few at the expense of many. There are some burdens for which I'm willing to pay the price. Buying my spoiled, self-entitled neighbor a 3 bedroom, 3 bath house in Newport Beach is not one of them.
In other words, my neighbor gets to live in a luxury home for less than what I pay to live in an apartment one street over, and I, along with the rest of the country get to pay for part of his mortgage. I'm not sure if I mentioned that he and his wife have a nanny to whom they pay more than $2,500 per month (and have for almost 2 years), just had a second child, and also leased a new Lexus (with a co-signer).
What does this economic stimulus package do for me? Since I'm one of those people who choose not to buy a house they couldn't afford, and therefore should be punished. Or a better question, perhaps, would be what doesn't this economic stimulus package do for me.
1. I will eventually get between an extra $8 and $13 per paycheck, assuming I still have a job that provides me with a paycheck. Wow, that 4 bucks a week should really put food on the table.
2. I get to see the continuation of the greatest economic collapse since the great Depression.
3. I get to pay my neighbor's mortgage (Once again, assuming that I still have a job that provides a paycheck from which taxes will be deducted). (cont.)
I was one of the millions of optimistic Americans looking forward to the bright, energetic ideas that President Obama would be bringing to the White House. Instead, I see a housing plan that is anything but bright and energetic, and will only cause more economic hardship. I fully supported the President's economic stimulus plan, until I read the details of the package.
This housing bailout plan is the biggest fraud perpetrated on the American people since President Bush’s administration told us that Iraq has WMDs and we had to go to war. For example, I would like to talk about my neighbor (who is also a friend). He bought his house in late 2006 on a "No Doc" loan for close to $900,000 with no money down. I, on the other hand, did the sensible thing a rented since I knew I couldn't afford a $5,000 a month mortgage payment. He is currently 14 months behind on his first mortgage, 16 months behind on his second mortgage, 2 years behind on his property taxes, and 19 months behind on his HOA dues. Under the Obama plan, however, he could potential keep his house at one-third of the original payment on the first mortgage, have his second mortgage wiped clean, and still not pay the HOA. (cont.)
I wonder how many Obama supporters financed their campaign contribution through their house debt? Bailouts are a coming; that's some change you can believe.
Buy a house and pay no taxes for a year. That is what the government is saying with the most generous tax credits in history for first time buyers of new homes. Buyers in California with incomes under $75,000 can cash in on $18,000 in tax credits ($10k in state, $8k in federal) that were slipped into the stimulus program. This is on top of incredibly generous financing, free upgrades, and no fee loans offered by desperate sellers. The package also raised the FHA loan limit from $625,000 back up to $725,000, crucial in the high cost markets of California, New York, and Florida. The only catch is that you have to stay in the house for three years to reap the full benefit. Flippers need not apply.
sOLVE HOUSING CRISIS
NATIONAL, STATE, or CITY HOUSE and LAND LOTTERY
SUPPORTS THE TAX BASE OF LOCAL COMMUNITIES
GENERATES WEALTH FOR WINNERS
KEEPS BANK FROM LOSING MONEY ON FORECLOSED PROPERTIES
employs construction workers
Say a city has 1000 foreclosed homes
The city can make arrangements with the banks that own a foreclosed property to enter the property into the raffle instead of auctioning them off at the court steps
For example purposes lets say each home is worth $150,000.00
Now the city sets an average payment for the foreclosed properties to be say $55,000.00
That brings a total of $55 million dollars to the all the banks of the 1000 foreclosed properties(banks receive this)
Now the city rasises through a Raffle $150,000 for each home and lets say they sell 3,000 tickets for each home at $50.00
Once all tickets are sold the amount raised on 1000 homes through lotto $150,000,000.00
You raffle off the property
The winners receive home outright.
CONTINUED
CONTINUED......
City pays $55,000.00 to the bank for the property
for this example lets say out of the money raised the gov't gives the winner $25,000.00 for remodeling or any other way the winner chooses to use it.
The city is left with a $70,000.00 profit on each property
on 1000 homes that equals $70,000,000.00
The city also benefit by being able to collect property taxes again. plus sales taxes if winners spend money on material things or businesses either remodeling the home or furniture sales. The winner has a new home with full equity.
all these numbers can be suited to individual gov’t preferences and purchase price of individual properties. You can raise as much money as you want on each home by selling more tickets. if it was a foreclosed house that was $224,000 to purchase from bank then raise $324,000.00 by selling 6480 tickets for $50.00 or 12960 tickets for $25.00 dollars.
CONTINUED.......
Each home can be purchased by the local gov’t(in IOU form) and sold off in a lottery system. You can target a specific profit margin you want on each home by tickets offered for it.
So neighborhood benefits with better property values as homes are occupied and remodeled for more wealth.
Winner receives new home with no mortgage. so winner also wins wealth with the paid off home.
City makes profit on home. City receives property taxes. City takes care of homes sitting around doing nothing or causing eye sores.
Creates jobs for housing repairs.
1000 Number of foreclosed properties raffled off
$150.000.00 Price set for each of these properties
$150,00,000.00 total amount raised through raffle
$55,000,000.00 Amount paid to banks who own those 1000 properties ($55,000.00 for each property)
$25,000,000.00 Amount given to winners of the raffles ($25,000.00 for each winner)
$70,000,000.00 Amount city profits ($70,000.00 profit amount on each property)
CONTINUED..........
Or create a national house raffle bank
have all the banks that have foreclosed properties to send those defaulted homes to the National raffle bank. The government then puts the homes up for raffle in the same mode as written above. Sell Stock in this bank. It will only generate a profit. Use the profits to pay small dividends and to pay for expenses which can be quite small if technology is used. It can be an online bank. Use the rest of the profits to pay on the national debt and pay the towns each individual home is located in also some of the profit. The banks will be freed to loan again with the monies they have received. It virtually keeps them from losing money on loan defaults. You still will create wealth to the winners of the properties which will give lots of people some capital to work with. The banks get the monies they would have otherwise lost out on. Also with this system we can save the consumer who defaulted on the loan credit woes cause as a deal since the home is raffled off we don't place a foreclosure on their credit which will then keep them from filing bankruptcy. It can be a long term solution or just a short term one until we get out of this depression. If the gov't can take a home with imminent domain laws then why can't this be done?
Citing the 16.5% interest rates of 1981 is more than a little disingenuous. Historically mortgage rates have hovered in the 8-10% range. The early 80's were an anomaly, with interest rates at all levels out of control. I remember CD rates over 20%. No, that's not a typo.
End of last year we got an offer for up to $200k in the low 2% range. That's not a typo, either, and historically also out of control.
This post seems to be well written in explaining facts, figures and why things are they way they are with the housing market, but it's only in the last two paragraphs that the author says that we shouldn't bail out homeowners because, if I understand it correctly, "but instead will literally pass one family's loss on to the next. ", it will impact people that have as of yet to buy houses? OK, I don't think that people that have not bought houses currently are clamoring to buy one now. I think the argument should be, will it benefit the country as a whole, if millions of people are not forced into foreclosure. From my perspective, giving money to the zombie banks is like throwing money into a black hole, where it's never to be seen again. We might get more bang for the taxpayers buck if we could use this money to keep people in their homes.
Keeping people in their overpriced homes raising the price of housing.
What programs are being discussed to pay people's rents. Homeowners and the real estate lobby have the political power to keep housing way overpriced
But this is no good for our country.
Right, right, right. Please, helping home owners won't do a thing for the economy! No no! No, our money is best spent continually propping up banks and corporate interests.
Yeah, they're going to go spend.
Or better yet they're going to lend, placing home owners further in debt.
Great logic!
Too bad, with everyone losing their jobs, no one has ground to borrow anyway, so the money getting funneled into the banks is dead-ending there.
Economists are so smart!!
I agree with your (hopefully) sarcastic remarks about propping up the banks. Our country is only 200 years old and when the settlers arrived here, AIG was only a glimmer in a skimmer's eye. I don't know why some institutions are deemed "too big to fail." If they are too big to fail, why did they fail?
One claim AIG has that it should be rescued, "They guarantee 401K's" Ha Ha Ha Ha Ha Ha Ha Ha
"If they are too big to fail, why did they fail?"
Because the original phrase is "too big to be allowed to fail", and the people in the various media who are lazy with language have mangled it into something that doesn't say what it means or mean what it says.
I am trying to buy one of those toxic assets that Fannie owns to increase my farm acreage. They want $350,000 for ten acres & a tear down house. In a few more months the house will fall down on its own due to neglect. I did my research and want to offer $205,000 for the place (over $20,000 per acre). I can't even get the real estate agent to write the bid. He wants me to offer over $300,000. He is crazy. He says Fannie will not accept anything less than $350,000. I guess if you have access to unlimited amounts of tax payers money, you don't have to live in the current reality.
We are also trying to buy a fannie mae owned property that has a 700 sq foot addition that hasn't even been touched yet (no pipes, heat, electricity, drywall...). The selling realtor told fannie mae they could get 315,00 for the house (even though fully completed, larger houses in the area are selling for way less) so even though fannie mae owns it for 238,000, they were unwilling to accept our offer of 245,000. LAME. Now that they are gov. owned, they can do whatever they want without fear of failure. So annoying!
Get a new agent. Ours will put any number on the paper we tell him to. Yes, he is so desperate for the business that he will go for even the lowest bids.
In any case, if you are bidding $205k, chances are the property is worth less than that.
You are analyzing the problem from the point of sales of homes, and efforts by the fed to prop up market pricing.
The more important and achievable goal is to stem foreclosures.
Home owners are basically in 2 camps.
First, the guy who bought a $500,000 house , 20% down, fixed rate. His payments haven't changed. But his house is $300K not $500k. He still makes his payments however. so stay put and wait for the market to rebound.
Second, guy that bought a house and got a loan that had a teaser rate or was otherwise adjustable and now can't make his payments, and the house value has declined to less than what he owes on it. On one hand, there is the argument to let him suffer the consequences. But that could mean the bank getting back a property that it has to sell, with all the costs of foreclosure and reselling and the guy still won't be able to buy another house, because he has no equity and now has bad credit, plus the feds could be on the hook if it was federally insured mortgage. The bank will basically dump the property to move it, further depressing the market.
This is where the feds should be pushing to get banks to rewrite loans. Make the loans at 4% for example, fixed, stretch terms to 40 years, try to make the payments affordable. Then guy 2 is in guy 1's position.
Your plan would probably help, but the problem will remain that your first guy didn't buy a $500,000 house, he bought a $300,000 house for $500,000. If he's waiting for the market to rebound that much, he might as well wait on a re-inflation of the Dutch tulip bubble.
Of course, if the US keeps printing money the value of the dollar may drop enough that the price of that house may go back up to $500,000, but that $500,000 will only buy what $300,000 buys today.
I agree completely.
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