Obama's Housing Plan: Legislating Conflicting Goals

Obama has announced a new plan to help renters (oops, 'homeowners') who cannot afford their mortgages.

There are two types of people who aren't paying their mortgage bills, and it is not simple to separate them. There are those whose incomes are insufficient to make the monthly payment. Then there are current homeowners who are merely underwater, and do not want to pay (mortgages are limited liability, so they can walk away and not owe anything). So the government has some rule, and 30% of people with such mortgages get to basically write down their old mortgages to a new level that make them able and/or willing to pay.

There are two problems with this:

First, it directly lowers the value of the bank's assets. We are simultaneously trying to shore up banks. That the government is legislating this implies that banks will have to write down their assets more than they would have otherwise. So it is directly inconsistent with the Treasury's other objective, to strengthen banks.

Second, it generates huge moral hazard. Say 4 million mortgage owners take advantage of this as targeted. Those who were not targeted will look at what their neighbor did, on a house bought at the same time, and try to figure out how they too can write down their mortgage obligation. A good number will successfully navigate the lame top-down criteria applied, because any cookie-cutter criteria in Washington creates a very simple target to game.

This process will put more pressure on housing, because it creates zombie properties as owners figure out if they can get this done, and it creates a new wave of defaults. Thus, previously people who, while underwater on the property or in trouble because of standard vagaries of chance, might have otherwise paid their mortgage. But to do so in this environment is to be a sucker. Many will find this unethical, but many won't. This creates the second wave of mortgage defaults, the opportunists. I imagine there will be incentives on the demand and supply side to play this game.

The most melancholy of human reflections, perhaps, is that on the whole, it is a question whether the benevolence of mankind does more good or harm. - Walter Bagehot

Comments

[deflation r...:]

It is comforting to know that there are other reasonable people in this world. Thank you for the well written article.

Feb 19 06:38 AM

[atlasman:]

I am beginning to think the administration's true goal is to push the banks and mortgage providers towards nationalization. Fannie Mae/Freddie MAC was just step one. This will allow give them complete control over the industry.

Feb 19 06:45 AM

[Ice:]

What I find missing in the all these discussion is why are those mortgages non-recourse/ limited liability.
Why do we give home owner a premium free put on their house prices. Especially why do we give these puts to second homes and investment real estate.

For me components of coherent plan should be

- starting today no more non recourse loans.
- people who pay more than x% of income to mortgage can extend the mortgage to 60yrs but the loan will not be non recourse anymore.

More is necessary but I think step 1 is to deal with the non recourse aspect since this fueled the home price even more than cheap money.

Feb 19 06:59 AM

[axelrod608:]

The piddling little being applied to the mortgage crisis - the major factor in the national economic downward spiral - will be ineffective. If the federales don't do something radical in that area, the downward spiral will persist.

Reducing mortgage payments by a few percentage points of income will not stimulate spending. All the current programs are a product of inside-the-box thinking.

Have the government pay off mortgages in full as foreclosures happen, taking a lien of up-to the amount it costs to pay it off. The lenders are made whole - no loss to write off and have plenty of money to lend again.

Let the people stay in the house. They would be barred from taking out any equity loans on the property. With no mortgage payment, they will start spending again. Some payment plan should be started if they are still in the house after a period of time. Those payments would go directly to pay down the cost of the program.

When the home sells, the government gets the net up to the amount they bought the mortgage for.

This is the ONLY way to stem the tide of foreclosures. There are millions of ARM's out there that will be resetting well into 2012. They will be a continuing source of new foreclosures wel into 2013 unless "foreclosure" is eliminated. And the only way to make the financial sector whole is to pay off those mortgages.

Eliminate foreclosures or they will persist for another five years, and all the other related problems will stay with us as well.

Feb 19 10:03 AM

[WayneS:]

This "crisis" is identical to the "inconvenience" of the eighties. Over 400 of the 675 homes in my subdivison were foreclosed. Over half of these were where the owners walked out and bought a home twice as big for half of what they were paying for their original home. This is the snowball effect we need to watch out for.

Feb 19 10:33 AM

[Trane250:]

Let me get this straight: You stop paying your mortgage either because you don't have the money or you just don't feel like paying; Uncle Sam then buys your mortgage from the bank or whoever holds it using funds borrowed from China or printed up; then you get to live rent free in the house; then you start spending money that you would normally use to pay the mortgage on products imported from China; then China takes their surplus and buys US Treasurys so that the US government can continue to buy up deadbeats' mortgages, etc., etc. Just brilliant, like voodoo economics.


On Feb 19 10:03 AM axelrod608 wrote:

> The piddling little being applied to the mortgage crisis - the major
> factor in the national economic downward spiral - will be ineffective.
> If the federales don't do something radical in that area, the downward
> spiral will persist.
>
> Reducing mortgage payments by a few percentage points of income will
> not stimulate spending. All the current programs are a product of
> inside-the-box thinking.
>
> Have the government pay off mortgages in full as foreclosures happen,
> taking a lien of up-to the amount it costs to pay it off. The lenders
> are made whole - no loss to write off and have plenty of money to
> lend again.
>
> Let the people stay in the house. They would be barred from taking
> out any equity loans on the property. With no mortgage payment, they
> will start spending again. Some payment plan should be started if
> they are still in the house after a period of time. Those payments
> would go directly to pay down the cost of the program.
>
> When the home sells, the government gets the net up to the amount
> they bought the mortgage for.
>
> This is the ONLY way to stem the tide of foreclosures. There are
> millions of ARM's out there that will be resetting well into 2012.
> They will be a continuing source of new foreclosures wel into 2013
> unless "foreclosure" is eliminated. And the only way to make the
> financial sector whole is to pay off those mortgages.
>
> Eliminate foreclosures or they will persist for another five years,
> and all the other related problems will stay with us as well. <br/>
>

Feb 19 10:34 AM

[Berninvestor:]

Thank you once again Eric Falkenstein. Your articles always seem to make so much sense. I've added you to my watchlist. We need more sensible articles like yours.

Feb 19 10:53 AM

[mallarde:]

Any chance we could at least filter out those who lied about their income on their loan applications? Couldn't the government do a minimal audit of these documents and match them to their tax returns?

The idea of my giving thousands of my own dollars to help those people live in their house turns my stomach.

Feb 19 01:39 PM

[Can'tSpotAB...:]

Saving the Housing Market By Speeding Up Foreclosures

www.time.com/time/busi...

The housing plan needs to be shelved. Yes it is unfortunate that people attempted to live beyond their means, but I do think those that did live within their means should pay for the mistakes of those that did not. Normalcy will NOT return to ANY market until the bad debt is forced into the open and defaulted. It won't be painless I can assure you, but it will give us a place to begin rebuilding our economic system on a solid base.

Feb 19 04:16 PM

[Blackeyebart:]

"First, it directly lowers the value of the bank's assets."

Does it really? These are mortgages that people won't or can't pay. Mortgages that are not protected by sufficient property value. The value of the bank's asset should be based on the amount it can extract from the mortgage, discounted for time.

In some cases, I suspect, the value that they will negotiate with the "homeowner" will be more that they would have got by any other means. Mortgagee sale is not noted for maximising value.

Feb 19 09:35 PM

[Mad Hedge F...:]

Here is a novel plan put forth by a hedge fund in Florida, Derivatives Bridge, LLC. Securities backing performing mortgages worth 100% are being sold for 20% because there is no market for these securities. Have the government buy these securities for 60%, rescuing the banks, and then sell them back to the original homeowner. The homeowner then is able to refinance his home, see his mortgage principal drop by 40%, restoring his net worth, and purchasing power. The cost to the taxpayer is zero. This is already possible in some countries like Denmark. If someone offered me a deal like this I’d take it in a heartbeat, even if I had to clean out the sofa cushions and raid my kids’ piggy banks. They say necessity is the mother of invention.

Feb 26 08:22 AM