Housing Update: Underwater Loans, O'Neil's Plans

Two housing stories are worthy of note this morning - an alarming estimate of homeowners with negative equity and former Treasury Secretary Paul O'Neil's quite sensible plan to fix the housing market. First, the stunning data on underwater homeowners.
From CNN/Money comes this report indicating that almost 20 percent of all borrowers owe more on their house than it is worth. Recall that about one-third of all U.S. homes have no mortgage (a novel concept, no?), so this figure would be about a third lower if measured across all residential real estate.

At least 7.5 million Americans owe more on their mortgages than their homes are currently worth, according to a real estate research firm's report released Friday.

In other words: If they sold their homes today, they'd have to bring a check to the closing. Ouch.

Another 2.1 million people stand right on the brink, according to the report by First American CoreLogic. Their homes are worth less than 5% more than the mortgages they're paying on them.
...

Home values in Nevada and some other states rose particularly high during the real estate bubble - and are now plummeting. So even those who put 20% down when they bought their home don't stand a chance.

In many bubble markets, home prices got so high that the only way that many buyers could get a loan was by using what Fleming called "affordability products." These included adjustable rate mortgages with rates that were set artificially low for a few years, until resetting much higher, as well as mortgages that required little or no down payments.

These loans left buyers with little equity to begin with, and when prices dipped, they quickly found themselves underwater.
 

Ahhh... Memories...

When home prices were soaring, the mortgage industry created "affordability products" so the boom wouldn't have to end - all with the blessing of economists and policy makers because we had entered a new era where "risk" was being distributed with the help of financial innovation in mortgage securitization and insurance derivatives.

Back to the present...

The views of former Treasury Secretary Paul O'Neil on how he might go about fixing the housing market mess were the subject of this report at National Realty News the other day.

The plan is simple and straightforward, albeit quite painful, with absolutely no chance of garnering any support from any elected official.

Former treasury secretary, Paul O’Neill said that congress should scrap plans for a new economic stimulus package and instead simply require mortgage lenders to only make loans for people with a 20% or higher down payment.

On Tuesday, O’Neill addressed reports and indicated that he was not surprised that neither presidential candidate supported his position.
...

According to a published reports O’Neill also said, "Unfortunately we've gotten to a point where people that want to run for president don't think they can tell the truth and still get elected. I'm hopeful whichever person gets elected, they'll be better than what they've said. An awful lot of presidential campaigns now are pandering to the lowest common denominator. They promise people everything."

As you might recall, O'Neil had a difficult time during his short tenure in Washington. His penchant for speaking his mind made for numerous political gaffes and, along with Christie Todd Whitman, hastened an early exit from the Bush Administration.

Comments

[SAF:]

First being underwater is only a problem if you have to sell the property. If you can make the payments you still have a place to live and a nice tax deduction. Over time you will no longer be below water. So while many people might be underwater now this in and of itself isn't an issue for the vast majority of home owners.

O'Neill's idea of requiring 20% down would further dampen the ailing housing market. This is a de-stimulus package. It isn't a terrible idea if phased in over time but in one dose will kick us into a deeper recession.

2008 Nov 02 07:42 AM

[Rhett:]

True, SAF, if you pay off an "underwater" house, it will no longer be
underwater. But what does that prove?

2008 Nov 02 09:29 AM

[home buyer:]

At a time of declining INCOMES, at a time when 60% of Americans cannot meet a surprise $1,000 bill a 20% requirement for the purchase of a home is living in the land of Oz. The further decline in home values with this requirement will put nearly everyone underwater and completely stall the housing market for such an extended period of time as to finally put us all in a depression. The ONLY SOLUTION TO THE HOUSING PROBLEM is
the creation of HIGHER INCOMES.

2008 Nov 02 10:04 AM

[jadziasman:]

The housing bubble was completely avoidable.

It rose out of the ashes of the Nasdaq bubble when the Fed reduced interest rates in hopes a producing a "soft landing" which did indeed occur during 2002 - 2003. Mortgage interest rates were artificially low in 2003 - especially for the newer mortgage products.

Home mortgage interest rates have been affordable for the past 8 years. Mortgage rates declined to present levels in June 2001. Providing the additional stimulus of ARM's and piggyback loans caused prices in overheated markets like California, Nevada and Florida to reach unsustainable levels by 2005. Sub-prime loans were the coup de grace.

Requiring a reasonable down payment represents a return to sanity. The down payment source must be either equity in the current home or drawn from real assets that the borrower possesses. Use of piggyback loans should not be permitted to bypass the private mortgage insurance (PMI) requirement.

It may be too late to save the real assets state and federal government - parts of which are already being sold off to hopefully the highest bidders, but there's still time to protect individual wealth and requiring real equity in homes, automobiles and businesses is a great starting point.

2008 Nov 02 10:16 AM

[OnW:]

When I bought my home 50 years ago, it cost $20,000, and required a 15% down payment. At the time I earned $7,500 and had to save/save/save for several years. I did the same for my first car, TV, etc. And all my friends had to do the same. Was thrift in the 1950s a terrible hardship? Not compared with the depression years, or the war years.

2008 Nov 02 11:21 AM

[Tom Lindmark:]

O'Neill's plan is clearly extreme but to the extent he's trying to get across the point that there is no free lunch and American's need to be more cautious, I applaud him.

I would like to see the methodology that was employed in determining the number of homeowners that are underwater. I don't doubt the number is sizeable but I also think there is a fair amount of guesswork in arriving at the figure. Do you know how it was calculated?

2008 Nov 02 11:30 AM

[Ridgeway:]

O'Neil is not that far of point. Having skin in the game is not unreasonable when it comes to making an investment - I do still believe that a house is an investment. (Investing on margin typically requires roughly 50% in.) 20% down, along with other considerations, seems to me to be a good underwriting practice, something lenders and underwriters have gotten away from during the housing boom. And actually a situation has added to the severity of the current housing crises.

I do not disagree with the reference one out of three houses are owned free and clear, but where did this stat come from?

2008 Nov 02 01:00 PM

[Stephen T. S.:]

O'Neill's proposal is an extremely bad idea at the present time because were it implemented the result would be worsening the severe recession or mild depression we have just started to experience. The current economic decline the U.S. is experiencing won't stop getting worse until housing prices stop declining which I don't expect to occur until 2010 at the earliest. I predict that what will utiimately stop the decline in housing prices is when the U.S. Government and banks share the cost of significantly reducing what borrowers owe on their mortgages which unfortunately will result in over a trillion dollars of added U.S. Government debt and over a trillion dollars of additional losses for banks. The entire world is in for a very rough economic ride in the next 3-7 years and possibly longer. First we will continue experiencing across-the-board deflation which will include a continuing decline in the price of everything including gold that will last approximately two years. Subsequently, here in the U.S. we will experience a relatively high level of inflation (approximately 5% yearly which will last for over 5 years.

2008 Nov 02 05:36 PM

[SAF:]

An underwater house is underwater on paper only. If you can make your payments and live your life it is a mere annoyance. It has no impact unless you are forced to sell.

The point is that just because a house is underwater does not mean it adds to the current financial problems.


On Nov 02 09:29 AM Rhett wrote:

> True, SAF, if you pay off an "underwater" house, it will no longer
> be
> underwater. But what does that prove?

2008 Nov 02 07:58 PM

[axelrod608:]

O'neill's plan wouldn't work without stringent controls. The only reason we have the current mess is that mortgage brokers, lenders and closing agents have skirted the rules.

ALL lenders REQUIRE PMI - private mortgage insurance - on ALL loans with less than 20% down. The only reason we're in this mess is that the folks who were supposed to ensure the loans were insured didn't. They packaged 20% high interest loans with 80% low interest loans and LIED to the lenders about the source of the 20%.

The system wouldn't have had losses if the REQUIRED insurance was in place.

And clearly, the system doesn't work as long as the mortgage brokers and closing agents falsify the documents regarding the downpayment.

FIX THE SYSTEM FIRST. Then start talking about adjustments to the system.

2008 Nov 02 09:52 PM

[Econ 101:]

Housing prices and underwater owners already have a savior on the horizon. The $700 BILLION bailout given to the friends of Paulson (FoP) will take 12 to 18 months to work thru the economy and produce the biggest inflationary era ever experienced. It will make the Germany of the 1930s and France of 1789 look like deflation. It will be worse because it wont be confined to one country.

The next step will be politicians telling everyone the solution is a single world currency. That will be needed because the dollar, the pound, the enro and even the Swiss Frank are going to be destroyed.

Learn to grow your own veggies!

2008 Nov 03 01:55 AM

[derryl:]

I agree with SAF. We make bad deals, we pay the price and stick it out. But this does not include the subprimes who can't make the payments once the teaser rate expires. And a lot of underwater people might just decide it isn't worth it and walk away from their mortgage and their credit rating rather than be saddled with $200k more debt than asset.

axelrod is right. Commercial banks and private mortgage insurers risking their own money would NEVER have made subprime loans. They would have obeyed the rules that banks who want to stay in business live by. Fannie and Freddie, with implicit or explicit unlimited taxpayer backing, made subprimes possible. Fannie and Freddie bought the mortgages, created CMOs and sold the baggage into the open market, supported by AAA fantasy ratings.

Because of federal policy to increase home ownership among people who could not afford houses, bankers and brokers might legitimately fear discrimination charges (or bad publicity) for denying mortgages to "the poor". Plus there was lots of up-front money to be made all round charging fees. They had a risk if they didn't do it and a benefit if they did do it, so they went for it.

I maintain it was government housing policy backed by government mortgage insurers and inflamed by artificially low Fed interest rates that caused the problem. For bankers and brokers and resellers of mtg debt it looked like a no lose proposition. Actually for them it was no lose: they already got paid all their fees.

But without government backing they never would have got into the game in the first place for fear of insolvency once the subprimes started defaulting. Would you lend someone $600k to buy a bungalow? Would you lend ANY money to a stranger with no income record? Neither would private banks, not unless the deal was guaranteed at no risk to themselves.

O'Neill's plan should have been implemented in 2001 to "prevent" the bubble. It's too late to prevent what has already happened.

The problem now is that there is a national stock of thousands or millions of houses that are not affordable to the people who are living in them. Even at current prices that are much less than the outstanding mortgages I doubt there are that many homebuyers waiting on the sidelines with 20% down to clear this stock anytime soon. And I think prices would have to go a lot further down before investors got interested at sufficient scale.

If you foreclose on all the defaults and dump the houses on the market, the market will massively overcorrect on the downside. You might see houses selling for $80-100k. If you put a floor on the price you could see thousands of houses sitting empty and vandalized for years.

Then there's the question of who owns the mortgages. They were packaged and sold all over the planet. The banks and mortgage companies who wrote the loans still administer them (and earn fees), but they have no idea who now owns the debt. How do you sell off assets at a fraction of face value when you can't find the owner to get permission?

I'd say the best bet is to try to keep as many people as possible in their houses. But someone has made the point that any plan to help distressed homeowners, given the scale of the problem, will be way too complicated to get passed or to administer if it does get passed. And bloggers have pointed out clever but easy ways to scam any homeowner bailout plan: just become "distressed" and you get free money too.

I guess it's easy to see the problems. Solutions are harder.

2008 Nov 03 02:57 AM

[WY Broker:]

How quickly people forget. IN the 80's, even 91, MANY people had to go to closing with a check, or sell short. And we had a bit of a boom time in between on real estate. There is nothing wrong with being backwards on your real estate investment, it is a fact of life making an error in judgement. But I guess we are not allowed that any more?

2008 Nov 03 08:16 PM