I have been dismayed about the latest actions out of Washington and Wall Street. The banks are now pushing all manner of mortgage mods and foreclosure abatements. These are little more than “extend & pretend” measures, designed to put off the day of reckoning. They are not only ineffective, they are counter-productive. They reward the reckless and punish the responsible, and create a moral hazard. Worse yet, they penalize middle America for the sake of giant Wall Street banks.
It may sound counter-intuitive, but the best thing for the nation (but not necessarily the banks) is to allow the foreclosure process to proceed unimpeded. We need more, not less foreclosures.
How did we get to this bizarre place in history? A brief recap of our story so far:
It started with the ultra-low rates of 2001-04. It was aided and abetted by an abdication of traditional lending standards, at first by non-bank lenders, but eventually, by nearly all. The Lend-to-Sell-to-Securitizer NonBanks pushed lending standards ever lower to the point of non-existence. This increased the pool of potential mortgage buyers, credit worthiness be damned.
The net result of all this was a credit bubble. I estimate that making mortgage requirements disappear brought between 10 and 20 million marginal new home buyers into the real estate market during the 2,000s decade. This drove prices to unsustainable levels, leading to a huge boom and eventual bust cycle in housing.
Prices have fallen about 30% nationally from the 2005-06 housing peak. As the artificial demand created by free money and an accompanying gold rush mentality disappeared, the housing market collapsed.
Despite this, even down 30% or so, prices still remain elevated by historical metrics. The net result has been 5 million foreclosures and counting. One in four “Home-owers” are underwater — meaning, they owe more on their mortgages than their houses are worth. There are another 3-5 million likely foreclosures coming over the next 5+ years.
The net results of the credit bubble are as follows:
1) An enormous number of families living in homes they cannot afford.
2) Bank balance sheets laden with current bad loans and lots of potential future defaulting loans.
3) Real Estate Sales, despite being propped up with historic low mortgage rates and tax purchase credits, are continuing to slide.
4) A weak overall economy with a very slow, soft recovery.
Whether a function of populist politics or bad economics, the proposals so far appear to address items one and three. But upon closer examination, they do nothing of the kind. In fact, they are actually gaming the system to help issue two — the bad loans the banks are carrying.
Even worse, they are making issue #4 — the economy — increasingly problematic.
We should allow the real estate market to experience a healthy price normalization process. Even though home prices have fallen dramatically, they have yet to reach their historical means relative to income or the cost of renting. This is to say nothing of the usual careening past the median towards under-valuation that typically follows a massive mis-allocation of capital.
We own a home, and have a vacation property. Rooting for falling prices is “talking against my own book.”
Why is it so beneficial to allow foreclosures to proceed unimpeded? Consider the following benefits of foreclosure:
• Increasing Economic Activity: The areas of the country with the greatest foreclosure rates have seen the biggest increase in real estate activity. Look at California and Florida — they have seen enormous upticks in sales versus the lower foreclosure states.
The process moves real estate holdings from weak hands to stronger ones. When someone purchases a home they actually can afford, they end up spending quite a bit of money on additional goods and services. They do renovations, hire contractors, make durable goods purchases, buy cars. They do lawn work, plant gardens, paint and repair. They even hire baby sitters, go out to diner and movies, they spend money in the local community.
The people who are hanging on by their fingernails, however, do almost none of these things. They pay a vastly disproportionate amount of their incomes to service their mortgages. This is not productive economic activity.
• Helping Families: Foreclosures, wrenching thought hey may be, move over-stretched families into housing they can afford. They avoid a steady stream of all manner of excess fees. The banks squeeze whatever they can from delinquent homeowners, who end up futilely tossing $1000s of dollars down the drain.
Worse, the HAMP programs have been totally ineffective in keeping families in their homes. The vast majority ultimately default anyway. More fees paid, more debt accrued, for nothing. The last thing these families need is a banking fee orgy, before they ultimate lose the house anyway.
The HAMP programs have been an enormous taxpayer subsidized boondoggle for the banks, however.
• Punishing the Prudent: The boom and bust saw irresponsible and reckless behavior by lenders and home buyers alike. They overused leverage, disregarded risk, ignored history. Having the taxpayers subsidize this behavior presents a moral hazard.
Worse than that, it punishes the people who behaved prudent and responsibly. Those who refused to buy a home they could not afford, chose not to over-extend themselves, and have been saving for a down payment are the net losers in this.
By working so feverishly to artificially reduce foreclosures and prop up home prices, we punish the first time home buyer, the newlyweds, the savers who want to buy a house they can actually afford.
The net result of all these programs and subsidies for recklessness is that we prevent home prices from normalizing. The people who are punished the most are the group that was not reckless, speculative or foolish.
• Rewarding Bad Banks: Despite the helping families rhetoric, it is not what these mods are about. The various foreclosure abatements, mortgage mods and capital write-downs are little more than a game of kick the can down the road. All of these programs are part of a broad “Extend & Pretend” mind set. They are an extension of the FASB 157 rule changes that allows banks to hide their bad loans.
The entire set of proposals canbe described as “Whats good for the banks is good for America.” Only they are not. The various foreclosure programs are essentially a way the banks don’t have to take their write offs now. Avoid the hangover, have another shot of tequila, push the pain of into the future, regardless of economic cost.
Were the banks required to report their mortgages accurately and/or write them down, they would be revealed as insolvent.
Now we get to the ugly Truth: The mortgage mods and foreclosure abatement programs are really all about propping up insolvent banking institutions on the taxpayer dollar and at the expense of the middle class. These programs are another losing round of helping Wall Street at the expense of Main Street. It is the worst kind of trickle down economics.
Herbert Spencer wrote, “The ultimate result of shielding men from the effects of folly is to fill the world with fools.” We have done precisely that.
It is time to stop punishing prudence
FT, March 24 2010 18
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Bank Launches Big Plan to Cut Mortgage Debt
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The Housing Crisis and the Resentment Zone
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