Arnold Kling  

The Perpetual Foreclosure Crisis

The Malevolent Invisible Hand... Bernanke Mea Culpa Redux...

This story reports,

The Obama administration, battling a foreclosure crisis that shows no signs of relenting, will step up pressure on mortgage companies to do more to help people remain in their homes, officials said Saturday.

This story was predictable. In fact, I have been predicting it. The attempts to relieve the foreclosure crisis will only serve to prolong it. We need to get more homes occupied by people paying market rents. That is instead of having them occupied by "owners" who are getting bigger and bigger mortgage subsidies and nonetheless are re-defaulting at high rates.

If policy makers had done nothing about the foreclosure crisis, it would be mostly behind us. Instead, it is mostly in front of us.

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COMMENTS (6 to date)
B.B. writes:

My solution from a year ago was to address the foreclosure crisis head on.

First, the government would buy the houses of those with subprime mortgages for the amount of the mortgage. The mortgages would be paid off early.

Second, by paying off the mortgages, the subprime securitization crisis would have been stopped in its tracks, and the banks would be properly capitalized.

Third, the government would rent to the curent occupants at a fair market rent. Those with truly too much housing would have to move to someplace cheaper. We could avoid the waste of neighborhood upheaval and millions of vacant homes and the expensive costs of mass foreclosures.

Fourth, eventually the government would sell the houses it bought.

No doubt this proposal would have been expensive, but it would likely have been cheaper than the TARP plus the fiscal "stimulus" plus the costs of FDIC plus the bailout of Fannie and Freddie, not to mention the upcoming bailout of FHA and Ginnie Mae. Best of all, it would have solved the problem.

tjames writes:

B.B. - your solution to the foreclosure crisis is to repay lenders 100% of their investment, let borrowers who cannot afford rent simply walk away, and have government (aka taxpayers) absorb 100% of the losses. That might prevent the foreclosure crisis - if indeed a 'crisis' is truly what it is - but it might also trade it for a sovereign debt crisis (if it hasn't already). At this point, at least *some* of the pain is being inflicted on lenders, investors, and borrowers.

CJ Smith writes:

@ B.B.:

I've heard this proposition from a number of sources, but I've never heard a reasonable defense of the problems implicit in the proposition. Assume for simplicity's sake that the mortgages can be bought out without pre-payment penalties or objection from the owners or lenders:

1. In many, if not most of the sub-prime mortgages, the market value of the home is less than the buyout value of the mortgage. The proposal would effectively transfer, not the risk of loss, but the ACTUAL loss, from the lender to the government. Why should I, as a taxpayer, support this government bail-out of sub-prime lenders?

2. Assume the response is, "But the government will hold the properties until the market value recovers, thus making money." Can you point to a study demonstrating that, on a present value basis, the hypothethetical future gains will offset the actual loss on purchase and the holding costs (maintenance, depreciation, etc.) of the properties?

3. Assume the response is, "The government can rent the homes to the original owners to cover maintenance costs." If the government can capture a market rental rate, would the owners be able to afford even this rate? Would the government now be a super-landlord? Assuming the government's action significantly depresses market rental rates (as would be likely with a glut of government housing coming onto the market) would the government then step in to support previously profitable landlords who now cannot ask and receive the rents they did before? If the government cuts rental rates to either keep owners in homes, or to entice new renters, should I, as a taxpayer, support what is effectively a rent subsidy by the government, while my rental properties sit empty, because I can not absorb the losses the government does?

"We need to get more homes occupied by people paying market rents. That is instead of having them occupied by "owners" who are getting bigger and bigger mortgage subsidies and nonetheless are re-defaulting at high rates."

First, I assume and hope the "owners" you refer to are foreclosing lenders, because to my knowledge, the number of actual mortgagees being subsidized by the government is almost non-existent.

Second, can you provide a study or other data on re-default rates? My understanding is that, despite the TARP funds that were supposed to go into refinancing options, there is relatively little refinancing or loan modifications going on, much less re-defaulting.

Third, your comment implies that the rental market would somehow alleviate the foreclosure crisis and echo crises. How? Most "owners" of investment properties are already attempting without success to rent their units to stave off foreclosure or to alleviate holding costs. Unfortunately, the housing bubble created a tremendous amount of excess inventory - so much so that I doubt there are are sufficient "renters"
available to meet the supply; even if there are, I suspect the depressive effect on rental rates will be severe, reducing the positive impact of getting homes into renters' hands. So, so we create a rental crisis in addition to the housing crisis, the lending crisis, and the building/development crisis? See my comment point 3 to B.B. above.

Fourth, what is your position on bankruptcy cram-down (the bankruptcy court judicially modifies the loan, either by adjusting the interest rate, amount of payments, and/or duration of loan,or by extinguishing the unsecured portion of the debt, and then modifying the laon terms as stated previously)? Expidited bankruptcy cramdowns would certainly readjust the market quickly, and cause lenders to bear the costs of their poor lending practices.

Fifth, could you comment on the following: If we assume the housing/mortgage crisis is a reset due to irrational exuberance causing overexpansion of the housing market in excess of the actual demand, who should bear the costs of the reset, and in what relative proportions - homeowner/borrower or subprime lenders, CDI investors and insurers?

Ryan Vann writes:

I think CJ has it right; the problem is that there are simply too many homes per capita. What might have been land best used for ag or commercial zoning, was zoned residential. Restructuring such a capital intensive and widescale misallocation is going to require a whole lot of time (even with legal barriers knocked down).

While expedited bankruptcy court might be one way to solve the issue of defaults and upside down mortgage holders, it still wouldn't replace the housing units with more productive buildings. There is no fiscal, or legal trickery that is going to fix this within a politically acceptable timeframe. Thus, there will be plenty of flailing and floundering within the next couple years.

ThomasL writes:

"The attempts to relieve... will only serve to prolong it."

Yes, it's like no one read the Prince.

Nick writes:

"If policy makers had done nothing about the foreclosure crisis, it would be mostly behind us. Instead, it is mostly in front of us."

The next wave of ARM resets would be ahead of us either way.

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