On Rescuing Homeowners Undergoing Foreclosure 15 comments
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I think that anyone who is talking about foreclosure/homeowner rescue needs to refer to the graphic below (granted it's a few months old, but I doubt the numbers have changed to an extent where it impacts my general thesis, in fact they would probably just strengthen my argument) depicting the default rate for various types of mortgages.
click to enlarge
Graphic courtesy of the WSJ
Notice how the prime fixed rate mortgages have barely moved, and it's the subprime and prime exotic mortgages that are showing a surge in the number of defaults?
In other words the problem is the origination of loans to people who either couldn't afford it, or were on terms that weren't sustainable/affordable at super low teaser rates. Not to mention the fact that 25-33% of all houses bought during the boom were purchased by speculators, who (in many cases) are now stuck with homes they either can't sell or rent out profitably.
Considering the factors that are driving foreclosures, how (pray tell) can you legislate, modify, etc., the problem away without giving out a straight up subsidy to enable people to afford things that are beyond their means?
Simple: you can't.
That's why all efforts to halt foreclosures to date have been largely ineffective at worst and are only delaying the inevitable at best, because they ignore the realities around sustainability and affordability that are the root cause of the problem. The goal(s) of people who want to help those facing foreclosure shouldn't be to help them stay in homes they can't afford, it should be to mitigate the impact of the situation, and help them get into a sustainable housing situation.
Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.
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This article has 15 comments:
One that actually has a plan rather then wanting to persecute people...
I for one hope somebody will listen to you.
Virgil
www.KeepAmericaAtWork....
McCain is wrong, Obama is wrong and Bush is wrong on the entire situation. There are good reasons why some people just should not own homes.
They live week to week, paycheck to paycheck, save nothing and the slightest bump in the road, a furlough at work, a layoff, an illness, a surprise repair expense on the house or car, a child in trouble or some other fact of life hits them between the eyes and all of the sudden they can't pay their mortgage. Once they are behind they never catch up because they do not understand why someone isn't there to help them.
There are some people in life who should just rent because it is all they are capable of managing. Some can't even manage that and we see them on the street with their cardboard boxes. It is not my responsibility to bail them out because they made poor life choices and refused to sacrifice anything in order to get what they want or work hard to keep it. I see people every day who make more money than I do yet have so little to show for it. They spend as thought the flow of income will never be interrupted even for a moment.
Given the stat that 45% of homes under foreclosure are unoccupied makes me think that far more people in trouble are speculators than owners. I'm renting a second home in FL right now for thirty cents on the dollar of what it would cost me to buy and the price is falling 20% a year on it.
True, but look at the ratios that are considered acceptable.
Even the hallowed FDIC program has folks at 34% on the front end.
It's simply not feasible to be paying such a large percentage of your GROSS earnings (forget about net) just to OWN a home.
Just as it's not acceptable for people to be spending such a large percentage of their income just to OWN a car (not to mention insure, fuel and maintain it).
The people I work with on a daily basis have never written a monthly budget before. And it's a bit of an "ouchy" when they see, in black and white, what they've been doing to themselves.
Believe it or not, people are beginning to see the insanity of living in this culture, living the life of a slave to their (disposable) possessions.
But you don't get this wake-up call if you get a package in the mail to modify your mortgage before you even default.
I'm all for keeping people in their homes, but most of us do need the wake-up call of a default/foreclosure threat to finally pay attention.
If we "bail everyone out," while ignoring the behavior modification that's needed, nothing is really going to change.
--- On Mon, 3/24/08, <@yahoo.com> wrote:
From: <@yahoo.com>
Subject: Housing Crisis -- "Protect our Property Values" Plan
To: senator@shelby.senate....
Date: Monday, March 24, 2008, 8:39 PM
For those of us who played by the conventional rules for buying a home – saved money for the appropriate down payment and borrowed an amount that did not exceed our salaries’ ability to service – we look at the current housing crisis and wonder how foolish we were as lax lending standards permitted unqualified borrowers to ultimately devalue our primary asset and as irresponsible lending practices by regulators and bankers fueled the bubble without regard to the disaster they were creating.
Right now politicians are sitting around either talking about ways to save the irresponsible borrowers or devising plans to bail out the banks that recklessly inflated this bubble.
Our politicians are pandering to the foolhardy and mindless instead of searching for solutions that seek the following outcomes:
(1) preserve the home values of responsible investors (by far the vast majority of homeowners in this country);
(2) recover tax dollars from those responsible for the inevitable bailout currently underway; and
(3) construct the right regulatory framework so that future profligacy will be avoided
Painful as it is to say, to protect responsible borrowers’ primary asset, politicians must bail out reckless borrowers. In the absence of this assistance the responsible parties will continue to suffer as their property values unjustly fall as the supply of homes from defaulting sub-prime borrowers floods the market.
Politicians must collect taxes from the irresponsible parties. To do that they need to design a special federal real estate tax (SFRET) whereby “qualified” sub-prime borrowers (i.e., those who can continue paying their mortgages at their current rates) will be permitted to keep their homes and maintain their mortgage payments but accumulate tax liability payable within 20 years or when the property is sold or transferred, for example, to family members. The SFRET payable will be a percentage of the borrowed funds and will grow each year but be capped at 50% of the funds borrowed and be payable within 20 years. (After 20 years SFRET homeowners can still own their SFRET properties but will have to refinance and pay taxes due.) The longer those SFRET home owners hold their homes the greater the percentage they will pay. Thus there is an incentive for SFRET homeowners to get their financial house in order quickly, sell their SFRET properties and purchase properties unfettered by SFRET tax liabilities.
(In the immediate term the SFRET solution will stifle the over-supply of homes on the market -- because SFRET owners will keep their homes instead of defaulting on their mortgage obligations -- which will restrain further downward pricing pressure on home values. SFRET property owners will have to wait till their properties appreciate enough to repay their loans and pay their SFRET taxes. In the intermediate term as home values start to move up in value SFRET property owners will undoubtedly try to sell their properties tempering another potential real estate bubble from developing. In the long run when property values have appreciated to the point where SFRET properties can be sold and SFRET taxes repaid in full without any risk to the financial system, property values will reflect the current demand and supply conditions for real estate.)
The treasury coincident with the introduction of the SFRET program should float SFRET bonds based on the present value of future SFRET receipts. Wall Street firms who helped fuel this bubble and who are now enjoying the current Federal Reserve bail out should be obligated to purchase these bonds which will carry an interest rate 100 basis below current treasury bond rates.
As with any program that holds accountable the responsible parties, borrowers who are right now counting the days, weeks, and months before they face their inevitable default and bankruptcy will still find this SFRET program unfair even though it bails them out of bankruptcy, permits them to retain their homes and gives them the opportunity to enjoy the appreciation of their home in the long run. Essentially, those that find the SFRET unfair are looking for a free-ride – a bailout without consequences. Those that find the SFRET solution unfair have two choices, declare bankruptcy or sell their homes quickly to get out from their growing SFRET liability.
This is not much better than the current 'save them all' type plan. What User 273364 wants is for the gub'mint to tax all homeowners in order to make sure that the value of his home doesn't fall below what he bought it for.
Newsflash for User 273364: There is no guarantee that your home will maintain its value. If you bought when prices were 'bubbled' to unrealistically high levels then you alone should bear the loss in value, even if you played by all the rules, made a good downpayment, and were able to afford the payments on that high price.
Why should the value of your home be 'guaranteed' to never fall below what you paid? I don't recall you asking my opinion when you bought the place, why should I pay tax on my home to support the price of yours?
Do you plan on sending me 'my cut' of your gains when you sell at a higher price later on? No? Why not? If you want me to pay for propping it up now shouldn't I get some of the booty when you sell?
What next? Do you want the gub'mint to tax all investors so that they can guarantee the value of your 401(k) investments? the value of your car? Your art collection?
You agreed to buy at the price you paid. You are the one who should bear the costs of falling values in your market, not everyone else. That's life. You make your choices and you bear the consequences that result, whether good or bad.
Trying to legislate away your loss via the gub'mint is no better than hiring someone to rob your neighbors at gunpoint on your behalf.
Also its not right to preserve the bloated prices of housing. Few could afford them--- housing prices need to come down.
I'm trying to avoid a deep recession. I'm merely saying that consumer spending is a function of life-cycle wealth (Modigliani). If home values have declined, total wealth has declined and spending will recede causing a steeper recession. My plan merely attacks the current supply/demand equation -- i.e., supply far outrunning demand. Over the long run, my plan does not lead to inflated home values; in the long term, home values will be exactly where they'd be without the SFRET. The difference, however, is that under the SFRET plan the cost of this bail out is born by those who needed the SFRET to avoid bankruptcy. In the short and intermediate terms home values will not plummet and consumer spending will remain at reasonable levels staving off a deep recession.
Call it a lucky hunch, but anyone who is saying that home values should plummet and the economy should go into a deep recession, is most likely not a homeowner nor gainfully employed outside of government or academia.
i'm comfortable with the real estate purchases I made and the cushion i have to withstand it. But, undoubtedly, my spending habits will change if the value of my property declines and that has a direct affect on GDP.
Call me old fashioned, but my spending habits are not influenced by the value of my home and never have been. My home is just that, a dwelling which protects me from the elements.
My income comfortably covers the costs of ownership now, but for nearly 5 years between good jobs I scraped by on a very modest income. Even though my mortgage payments exceeded 40% of my gross income during those years, I never missed a payment. I simply figured out how to get by on less. That's exactly what every other American consumer needs to do now.
Trying to 'sustain' the economy by further borrowing or taxation schemes (read that as a transfer of wealth from those who have to those who don't, ie. theft) will only serve to make the eventual correction that much worse.
If more borrowing is needed to 'sustain' the economy, how much further into debt do we need to go before we stop? Americans already owe over $14 Trillion in personal debt. How much is too much?
If more taxing is needed, how far will it go before the productive people decide that it just doesn't pay to be productive any more and they join the non-productive group for the 'freebies' that others worked to produce? This isn't sustainable over the long run either. Why do you think the Social Security ponzi scheme keeps needing more and more funding?
No, your plan is not plausible in the long run. 'Sustaining' currenly levels of consumption merely serves to direct money into production that is not meeting basic necessities as it would if consumption were to fall so that people had to chose between "must haves" and "nice to haves".
The way to restore health and vigor to our economy is for everyone to live well within their means and save as much as they can. This way only businesses which meet essential needs are supported and grow.
Others who supply the "nice to have" items will be forced to cut back on production to meet the demand levels that current levels of income can sustain (and not levels available via borrowing to spend).
In this manner the limited resources available to the economy as a whole will be directed to those successful businesses providing the most needed products and services while the public as a whole builds a base of savings which can be used to expand and improve methods of production without incurring endless debt.
Unfortunately, don't agree, and the data doesn't support, that people spend based on their current level of income, but rather spend based on their life cycle wealth. For example, a young lawyer might spend above his means b/c he believes that within 7-9 yrs he's going to make partner and make a lot of money in the future. Similarly, an investor may look at the value of his/her stock portfolio and say i'm going to buy that new BMW. When the value declines or employment prospects change for the worse, spending slows (and so does the economy).
Read, among his other works, Modigliani's 1985 nobel prize speech
Life Cycle, Individual Thrift and the Wealth of Nations
nobelprize.org/nobel_p...
Bottom line is people do spend based on their life cycle wealth and that includes the perceived value of all their assets which for most Americans includes their home.
When home values decline, people cut back on spending. While I don't disagree that income levels must catch up with home values, the health of our economy depends, to a great extent, on consumer spending. When people stop spending, companies cut back on capital projects, jobs are lost, and the economy slows.
I don't see how that's a good thing.
The SFRET plan gives individuals a chance to keep their homes without filing for bankruptcy. BUT it also holds them accountable to repay the government for the handout they're inevitably being given. Property values will definitely go up (to the pre-bubble levels) in the short or intermediate term, but they should level off and move up a little. In the long run (call it 10-15 years), property values will increase. In the interim, GDP can remain strong.
As my Mother used to say:
If those same people jumped off a bridge would you follow them?
Those who are foolish enough to spend beyond their means as a result of some theoretical "wealth factor" should suffer the consequences, good or bad and not expect the gub'mint to 'save' them when the doo-doo hits the fan.
Your claim boils down to a) people are going to overspend during the good times anyway; and so b) the gub'mint should 'help' them get by the eventual bad times they will face as a result of a).
I respectfully disagree. While they have every right to spend more than they earn to the extent someone will give them credit, they have no right to burden everyone else when the wheels come off, regardless of how 'wealthy' they FEEL at any point in time.
(I could retire today because I FEEL wealthy, but when the money runs out and my stomach starts growling I'm gonna FEEL a bit different when I'm sorting through a dumpster looking for a meal.)
If people mismanage their financial affairs they should suffer the consequences. Period. Eventually they'll figure out how to live within their means and avoid those kind of problems or at least limit them to risks they can handle.
As for a recession, I live within my earnings and manage to save a bit. If the economy slows down I can still find the things I need to buy. Why should I care if the latest game-box manufacturer goes under because its market was bouyed by massive consumer borrowing? I don't need one of those gadgets to get by. The things I do need like food, clothing, and utilities will continue to be produced and delivered no matter how bad the economy gets.
As for the people who lost their jobs making game-boxes, why is a job making those good if the only way people can afford them is to borrow? Let them find a job delivering food, clothes, or utilities that everyone needs to get by. Become productive by supplying NEEDS and not desires.
The recession doesn't have much impact on my spending patterns except maybe to change which stores I frequent.
As you point out, many people do not live in this manner and instead choose to spend beyond their means for whatever reason. Over the long run this is destructive to the economy and wasteful of resources.
Mr. Modigliani's speech and works support the Keynesian view of economic theory which, in my opinion, is fatally flawed in practice. Any theoretical framework which puts consumption as the primary focus regardless of income or savings is bound to create problems. Keynesians have been running the show for decades and look where it has led us ... global banking meltdown and debt beyond comprehension.
See any good Austrian Economics book for an extensive analysis why that is the case. I can recommend "Human Action" by Ludwig Von Mises if you can stay the course and work through it. "Economics in One Lesson" by Henry Hazlitt is a good basics book.
The fact that Mr. Modigliani was awarded the Nobel prize fails to inspire. After all, Al Gore got the Peace Prize for being a tree hugger, like that makes any sense at all.
Well, let me get radical here: The banks created the money out of thin air (screwing me via inflation BTW since I have no bank loans) and loaned it out for mortgages. What could they possibly lose if the home owner defaulted? Thin-air?
Some guy kept his home via this argument in some state. It would serve the fractional reserve bankers fine to have the tables turned on them, IMO.