A Nation of Mortgage Slaves

A recent op-ed in the WSJ echoed many of my same sentiments around the current housing market with respect to foreclosures, and the need to encourage sustainable financial situations as opposed to homeownership at all costs:

(From the WSJ): "Preventing foreclosures has become a top priority of politicians, economists and regulators. In fact, allowing foreclosures to happen has merit as a free-market solution to the crisis.

If the intent is to help homeowners, then foreclosure is undoubtedly the best solution. Household balance sheets have been destroyed by taking on too much debt via the purchase of inflated assets. With so little savings, a household with negative equity almost implies negative net worth. Walking away from the mortgage immediately repairs the balance sheet.

Credit may be damaged, but homeowners can rebuild it. And by renting something they can afford, instead of the McMansion they cannot, homeowners are most likely to have some money left over each month that they can save toward a down payment on a house they can eventually afford.

If the intent is to help the credit markets, then foreclosure is undoubtedly the best solution. The securitization model has proven to be flawed. Slicing loans horizontally into tranches created asset classes that have conflicting interests in a dissolution strategy of the same underlying asset. The holder of a senior tranche would be agreeable to modification, since his position is secured; the holder of a junior tranche would essentially be wiped out. The lower tranches are worthless but are still legally an encumbrance, hindering any type of sale or work-out effort.

Consider a property that sold for $500,000 at the peak, financed with a $400,000 first lien and an $80,000 second lien, which is now worth $300,000. The second lien is worthless, but the lien will remain as a cloud which complicates any modification effort by the senior lien holder. There is no incentive for the junior lien holder to voluntarily agree to a modification. Foreclosure would be the best and finite action. It wipes the slate clean."

Understandably there are a lot of emotions wrapped up in home ownership both at the political and every day citizen level, which makes it difficult to sell the idea that some people are better off letting go of their homes and becoming renters. However I think these people need to ask themselves: do they want people to own homes for the sake of owning them, or do they want people to be in healthy and sustainable financial situations?

Nothing comes out of helping someone stay in a home they can't afford, especially when all you're doing is both delaying the inevitable and magnifying the financial impact of the inevitable foreclosure. At the end of the day it's not "renter vs. homeowner" that defines a stable financial situation, it's income vs. liabilities and savings. Better to be a renter that saves 10% of his/her income, than a homeowner who can't make ends meet.

Activists, politicians, and various other policy makers will be able to create more long-term home owners by helping people get into healthy financial situations, than they will by focusing their energies on stopping foreclosures.

You can read more here.

Sources:

The WSJ: "Why Be a Nation of Mortgage Slaves?" -- Ramsey Su, January 31, 2009.

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.

Comments

[Dan Walker:]

Spot on analysis and since it extends beyond McMansions, absolutely guaranteed to be ignored by this year's crop of village idiots in DC. (Both sides of the aisle).

If, as seems inevitable, the move to drive mortgage rates to ~<4% succeeds, anyone who cannot afford that payment has no business owning a house.

Feb 03 08:42 AM

[User 105228:]

Credit may be damaged?!? Credit will be damage and with new stricter lending rules you can forget about saving towards a down payment on a house you could eventually afford because it is highly unlikely you will ever again qualify for a home equity loan with a forclosure on your credit history.

Feb 03 09:29 AM

[Jubilee Year:]

This is a very shallow analysis. Real estate values are the bedrock of much of our banking system. The ever-accelerating deflation in home values is the primary driver of most of our financial troubles, as banks hoard capital to stay solvent.

Of course, it is obvious from an individual point of view, you should walk from your upside-down home. But what happens when everybody is upside-down? We are rapidly approaching that very situation, as home values are already at pre-bubble prices (Spring 2004), and rapidly falling.

Someone please answer this question: What happens when everyone is upside-down? This is no idle question. We are already approaching the 50% mark, which is way past the tipping point.

The solution is actually quite obvious: After we nationalize the banks, we can begin the recovery by writing off mortgage debt and gving away the huge bank-owned housing stock in lotteries (or somesuch process).

Unfortunately, our leaders probably won't come to this sane solution until there are widespread homeless camps and the squatter problem has swelled out of control. No one, least of all the author of this article, seems to get the basic problem: they cannot sell these homes. A normal recovery is beyond us, it is not possible at this point. Leading to the ridiculous idea being floated by some that excess housing should be destroyed.

Feb 03 11:00 AM

[Markham Lee_:]

To clarify my original point I'm only talking about people who can't afford their mortgages not people who are upside down, because there are undoubtedly home owners who have positive equity but can't make payments and there are people with negative equity who can make payments.

I've always felt that a home is (first and foremost) the place where you live not an investment, so if you can afford your home you should just stay put and not risk the financial damage that will come from walking away.

However people who can't afford their homes in the first place are highly unlikely to benefit from any sort of loan modification, and any efforts to resist foreclosure will just delay the inevitable.

The point of the article was to inject some realism into the conversation around preventing foreclosures, as there is really little point in wasting resources to try to keep someone in a house they can't afford.

Thanks you for reading.


Markham Lee

Feb 03 01:36 PM

[subguy:]

As a member of the proletariat, I like the” produce the note” option for people in foreclosure. This way people can stay in their homes until the senior, junior and baby tranches can be sorted out in whatever CDO and CDS the poor suckers note resides. They just need to hire a few more accountants. That might help bolster the economy as a bonus.

Feb 03 06:25 PM

[John Preston:]

First of all......income in households in default will be shown....in some future academic study, by some lame, but famous economist, to have eroded substantially or, been wiped out....

100% of the homeowners I counsel currently have experienced this....

As jobs get worse, incomes will decline further...and our "housing correction"....which this never was....will get worse...

this was an income/jobs correction...the problem never was the house...

Feb 04 08:10 AM

[notsosmart:]

teach people that the house is the roof over your head & not an atm machine.teach people to pay off the mortgage as fast as possible & save thousands in interest. teach people to pay off the credit cards every month. teach them to pay cash for their cars &maintain them. you dont need granite counter to live(surprise-italso radiates radon).i paid my3 0yr mort,. in 20 yrs.paid cash for my then new 1991 caprice,paid cash for my 1998 rav4.all my cards arepaid every month. living from hand to mouth & over your head is not a good life. many finding out the hard way now,sadly.

Feb 04 12:08 PM

[tahoe1780:]

Right on! The root of the "housing crisis" is the inability to pay. Higher energy costs, outsourcing of middleclass jobs, stagnant wage increases.


On Feb 04 08:10 AM John Preston wrote:

> First of all......income in households in default will be shown....in
> some future academic study, by some lame, but famous economist, to
> have eroded substantially or, been wiped out....
>
> 100% of the homeowners I counsel currently have experienced this....
>
>
> As jobs get worse, incomes will decline further...and our "housing
> correction"....which this never was....will get worse...
>
> this was an income/jobs correction...the problem never was the house...

Feb 04 12:14 PM

[derryl:]

Jubilee Year wrote,
"No one, least of all the author of this article, seems to get the basic problem: they cannot sell these homes. A normal recovery is beyond us, it is not possible at this point. Leading to the ridiculous idea being floated by some that excess housing should be destroyed."

I disagree. The basic problem in not 'they cannot sell these homes'. It is 'they cannot sell these homes at these prices'. I read in another post of foreclosures selling for $32k in Florida. Not everyone is broke. Depressed real estate assets are bargains for investors looking for rental revenue. Goods clear when prices drop to levels that demand will pay.

Yes, foreclosures deleverage the banking system, but those assets are worthless to the banks anyway because they are non-performing. It is a simple legislative matter to relax banks' asset-to-capital ratio so you don't have to declare them insolvent when writing down their asset side. The Fed is making sure bank liquidity is not an issue so by relaxing asset:capital ratios banks will be neither insolvent or illiquid. This can be done without spending any taxpayer money.

Many many people bought way more house than they could afford. This is a problem. There is too high a proportion of McMansions. Those houses will need to be sold at less than cost. They will have to be sold at the price of a much smaller 'affordable' house, so whoever buys them as foreclosures is going to get more house than they pay for. But when they rent out these houses the new owners are going to have to charge 'affordable' rents, so as a financial asset the houses are not worth as much as their size and luxury would lead you to believe.

If GM stupidly builds 2 million $60k Cadillacs per year instead of 6 million $20k Chevys, they will have to sell their Cadillacs at Chevy prices in order to get rid of them. There is not enough of a market for luxury cars and houses. Somebody made the mistake of building them and now somebody has to take the loss.

The beneficiaries are people who get Caddies for Chevy prices. These will be people who have cash or intact credit. It was a mistake to think poor people could afford to have Cadillacs parked outside their McMansions. Maybe banks should relax their policy of not relending to bankrupts, and let the people whose houses are foreclosed have a shot at buying them back in the foreclosure sale at much reduced prices. If they still can't qualify at firesale prices then you're not doing them a favor by chaining their financial future to a mortgage payment they can't support.

Feb 04 02:45 PM

[User 351348:]

You're kidding me right? I went to your website and am offended by it. So we cancel all this debt that people signed up for using their OWN signatures while I did not and they get all debt wiped away and what the hell do I get? I don't get a huge house I never took out an overblown mortgage for. I don't get any credit card debt wiped away since I have no debt...I don't get anything for free. You are pissing me off.


On Feb 03 11:00 AM Jubilee Year wrote:

> This is a very shallow analysis. Real estate values are the bedrock
> of much of our banking system. The ever-accelerating deflation in
> home values is the primary driver of most of our financial troubles,
> as banks hoard capital to stay solvent.
>
> Of course, it is obvious from an individual point of view, you should
> walk from your upside-down home. But what happens when everybody
> is upside-down? We are rapidly approaching that very situation, as
> home values are already at pre-bubble prices (Spring 2004), and rapidly
> falling.
>
> Someone please answer this question: What happens when everyone is
> upside-down? This is no idle question. We are already approaching
> the 50% mark, which is way past the tipping point.
>
> The solution is actually quite obvious: After we nationalize the
> banks, we can begin the recovery by writing off mortgage debt and
> gving away the huge bank-owned housing stock in lotteries (or somesuch
> process).
>
> Unfortunately, our leaders probably won't come to this sane solution
> until there are widespread homeless camps and the squatter problem
> has swelled out of control. No one, least of all the author of this
> article, seems to get the basic problem: they cannot sell these homes.
> A normal recovery is beyond us, it is not possible at this point.
> Leading to the ridiculous idea being floated by some that excess
> housing should be destroyed.

Feb 05 06:31 AM

[pacificapat...:]

Bankruptcy courts need to be given power to alter (read: reduce) these home values that never were.
A lot of people can be kept in their houses this way and some neighborhoods may not empty out and become ghost towns.
Since the banking/mortgage industry was largely responsible for this mess, they can take the hit, and when THEY fail, we can nationalize them.
You'll never see that in the WSJ's pages.

Feb 05 11:05 AM

[john1:]

Just more unpatriotic negativity from liberals who hate freedom, and the troops.

Feb 05 03:22 PM

[rufusmcbufus:]

Ooooooh...I'm sooooooo scared. As if "credit rating" will mean anything after this is all over. There is a HUGE overemphasis on the "you gotta have a good credit rating" mantra. Face it, it's a dying meme. When 30% of the population sits in a "bad credit" category you'd better believe an enterprising someone will figure out a way to service them. Credit fearmongers beware...rufus is on to you and will make you look stupid.
-rufusmcbufus


On Feb 03 09:29 AM User 105228 wrote:

> Credit may be damaged?!? Credit will be damage and with new stricter
> lending rules you can forget about saving towards a down payment
> on a house you could eventually afford because it is highly unlikely
> you will ever again qualify for a home equity loan with a forclosure
> on your credit history.

Feb 05 05:46 PM

[FP:]

If banks can afford more foreclosures before closing doors let it be but the problem is that more people indirectly will be layed off & rates will go very very high making cheap houses unaffordable not to mentioned losses in 401Ks.

I believe this is good news for the ones that never bought & never will buy any houses because they will go always be poor and above all very jealous of others.

Feb 05 11:34 PM

[Jubilee Year:]

User351348 said, "So we cancel all this debt that people signed up for ... and what the hell do I get? ...I don't get anything for free. You are pissing me off."

The problem is, no matter how much we disapprove of the debt-drunk behavior and systems that got us here, here we are, in the starting stages of a debt-deflation Depression.

At the minimum, you would get an economy that works again. Surely that is worth something.

Feb 06 12:52 PM