A funny thing has happened since I wrote last week about the need for both a broad foreclosure moratorium and for longer-term reforms, including principal reduction, to help homeowners who now owe vastly more than their homes are worth. A conventional wisdom has emerged -- with the White House vocally joining in -- that we must let millions of foreclosures proceed for the good of the economy.
Let's be clear: The housing market is a mess, and that mess won't end without significant pain, but there is no reason for that pain to fall entirely on the shoulders of homeowners.
Secretary of Housing and Urban Development Shaun Donovan has argued that a moratorium on foreclosures "would do far more harm than good" because it would gum up a housing market in which a quarter of the sales are foreclosed homes. But underlying that argument is an assumption that these foreclosures -- or at least the vast majority of them -- are right, proper, and inevitable, even if unfortunate for the families being thrown out into the streets.
Lots of evidence suggests otherwise. It's clear that shady practices, from inflated appraisals to laughable underwriting standards, became standard practice at many lending institutions. For example, former Countrywide honcho Andrew Mozilo recently paid a $67.5 million penalty for, as the New York Times put it , "misrepresenting the company's declining lending standards during 2006 and 2007 and portraying themselves publicly as underwriters of high-quality mortgages even as they learned that the company's loans were becoming increasingly risky."
Economist James K. Galbraith has been less polite, calling the lending industry's behavior "criminal." Writing in The New Republic in July, Galbraith explained:
Appraisers were selected who were willing to inflate the value of the home being sold. This last element was not incidental: surveys showed that practically all appraisers came under pressure to inflate valuations in order to make deals happen. There is no honest reason why a lender would deliberately seek to make an inflated loan.
Mortgages were made with a two-or three-year grace period, with a low, fixed interest rate called a "teaser." These were not real mortgages; they were counterfeits, whose value would collapse when exposed. As with any counterfeit, the profits came early, when the bad paper was first sold. After the grace period, rates would reset, and the lenders knew that the borrowers, who were already stretched by their initial payments, would either refinance or default.
And there are plenty of credible stories of homeowners facing foreclosure due largely or completely to either mistakes or to bank behavior that most reasonable people would find outrageous. In once case, for example, a family lost its home after a chain of events that began with $2,200 in charges that were assessed after they mistakenly underpaid by 14 cents.
Yes, some people got in over their heads because they took needless risks. But millions of homeowners are in trouble due to either shady mortgage industry practices or to a housing crash over which they had no control. The idea that we can stabilize the housing market by tossing all these innocent victims overboard is simply insane. In what parallel universe do millions more distressed homes on the market and millions more families with ruined credit create stability?
We can do better. A moratorium need not last so long that it causes more than a small hiccup in the market. While the banks straighten out their paperwork (remembering, after all, that these pieces of paper represent people's lives), the banking industry and the government should put together a credible program of principal reduction to help homeowners whose home values have crashed due to the wave of misdeeds outlined above. Nobel Prize-winning economist Joseph Stiglitz has called principal reduction the "best option for the country."
Helping people keep their homes will do far more to stabilize communities and the economy than unleashing yet another tide of foreclosures.