You Want to Save the Housing Market? Don't Fight Foreclosures

One of my readers pointed me towards a Time Magazine article that argues in favor of speeding up foreclosures, as it's the only way to truly stabilize the housing market.

(From Time Magazine): "Slowing foreclosure rates by cutting the monthly interest rates of homeowners who could not otherwise afford their mortgages may actually string out the amount of time it takes for housing prices to reach a nadir and swing up again. A homeowner with a $300,000 mortgage on a house which is worth only $200,000 will keep that house off the market if at all possible, to avoid having to come up with $100,000 to subsidize a sale. That house sits in limbo while the government makes the monthly mortgage payment low enough to keep it in the hands of its owner. Excess home inventory growth is artificially arrested because residences which would normally be for sale are kept off the market.

It seems especially cruel to push foreclosures because no one wants people to lose their homes. But, at some point, the system must take into account the fact that many of these people cannot afford their houses. The irony of allowing current owners to stay where they are is that they will never really "own" a home. They will remain in houses where they are very unlikely to be able to pay off the principle. These residences will not be released into a market where prices continue to drop very rapidly because there are no government programs to keep the housing prices at or near current levels as people are pushed out of work. If enough people lose homes, some of them will at least have the opportunity to buy property that they can afford, property which has reached its economically "correct" level through the forces of the market and not through a system that manages prices."

This relates to something I said earlier in the week, with respect to the mortgage rescue, loan modification programs, government policy, etc, needing to differentiate between those who are just in situations they could never afford vs. people in affordable situations who have just fallen on hard times due to loss of income, medical expenses, divorce, etc. The reason for this is that if we are indeed going to put taxpayer money towards helping homeowners, let's focus on the cream of the crop, i.e. the people who just need temporary help to get back into a sustainable housing situation.

It doesn't make sense to artificially enable someone to stay in a home they can't afford, because chances are all you're doing is both delaying the inevitable for that person as well as the future stabilization of the housing market. In my view the cost of delay tactics is far greater than the cost of the short-term pain caused by allowing certain things to run their course.

Finally I think that people need to accept some harsh truths about the housing market:

Market Correction: the housing market is going through a very needed price correction after a period of inflation caused by over speculation, irresponsible lending and irresponsible borrowing. The only way for the housing market to stabilize is for it to give up those gains. Now this is a hard pill for many to swallow, but trying to artificially prevent reality will only make things worse.

The only way to fix housing is to allow the market correction to run is course.

Affordability : outside of those who are struggling due to income loss, many of the people facing foreclosure as those who used exotic loans to spend above their means. For evidence of this look at mortgage default rates and note how the default rate for prime, fixed rate mortgages only shows a slight increase, while the default rates for exotic mortgages is skyrocketing. The only way to help someone stay in a home they can't afford is to directly subsidize their mortgage until its paid off. Call me crazy but I don't think that's sound public policy or a good use of taxpayer dollars.

The focus shouldn’t be to help these people stay in their homes it should be put them into a housing situation they can truly afford, whether that's a rental situation or helping them buy a cheaper house.

Long-term price outlook: driven by largely by speculators many homebuilders built condos and single family houses that were traded between speculators like shares of stock, the problem is that there was never really demand from an actual future resident for these homes. As a result prices will continue to be driven down until all of these excess housing units can be absorbed by the market.

Needless to say the inventory issue is likely to negatively impact housing prices well into the next decade if not into the 2020s, and many people may never see the prices of their homes recover.

Moving forward I think this nation needs to decide if we're going to accept the housing market as it actually is, or try to artificially force it to behave as we'd like it to be. The longer we deny the former the greater the pain, and the longer it's going to take for the market to recover.

Final thought: how is living in a home you can't afford (especially if you're in a negative equity situation) any different from renting, when you need a government subsidy to make the mortgage? In fact doesn't that make you a modern day serf since you're basically just a renter that is enslaved to the home they live in, because you can't afford to leave the home if you want/need to.

I think we also need to rethink what ownership actually means, because once you can't afford the home on your own and/or can't afford to leave you don't own the home the home owns you.

You can read the article in full here.

Sources:

Time Magazine: "Saving the Housing Market by Speeding Up Foreclosures" -- Douglas A. McIntyre, February 18, 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

[Can'tSpotAB...:]

Exactly! Bravo!

Feb 22 10:32 AM

[ArnoldCountry:]

I find your aritcle factual... but missing one very important glaring point. Our government and mainstream media cannot tell us the truth. If Obama were to come on the television today and state that the government was not going to do anything, foreclosures are a necessary correction and all of these folks underwater would be better off walking from their houses and become renters, the financial markets would completely collapse in a month.

It reminds me of Jack Nicholson in a Few Good Men... you can't handle the truth!

Truth is, they are trying to contain a disaster and try to bring consumers back to buying homes, using credit and buying goods to stave off a collapse.

In my practice, I tell consumers each day that are in an underwater house that they are struggling to pay for of which their lenders offer little to no assistance... what are you fighting for? You can make a home anywhere, home is about people and families, not brick and mortar. If you are hurting watch out for your family first, if you have to walk from the house and rent for cheaper because it is in your families best interest, just do it. The credit hit will be for a few years and when you recover you will be able to buy a similar home in the future for about half what you owe on your current place.

However, you will never hear that kind of advice coming from our government or mainstream media. Instead you hear about personal responsibility. Dont shame these folks, their personal responsibility is to provide for their families, the rest can be cast aside.

Feb 22 11:36 AM

[VennData:]

...But the problem is that the banks lose so much more on foreclosures that the banks take the worst-case scenario hit, their assets are written down to zero and not only do We the People own it, the banks don't restart lending sooner, rather than later.

The small fix $300B on a $15T mortgage market will stem the tide on a few hundred thousand marginal foreclosures. The majority of people will still be foreclosed on that can't afford it. This plan will leave the banks better off, and the housing market will eventually find equilibrium no matter what. This plan makes it less painful at the margin, that's all.

Wailing about people who we are subsidizing to live in McMansions simply isn't what's happening, but it will get people riled up and keep, advertisers coming to Rush,Fox, and CNBC.

Feb 22 11:36 AM

[Lok Sang Ho:]

2 points. One, I agree that those who "bought" homes they could not afford should face foreclosures, while those who face temporary difficulty should be offered assistance.

Two, I had argued for allowing home prices above the median price to settle to their "equilibrium values" naturally but for price support through a buy-back program by the Federal Government at a snap-shot market price as of some date. There are 3 arguments for this. a) prices below the median prices have less "bubble" content but are continuing to fall in part because of excess supply and in part because of fear; b) the proposed price support program will not cost the government much because the government will buy back only from existing homeowners, can rent them out in the interim, and can re-sell them later at a price at or above the acquisition price; c) the price support will help preserve the equity of homeowners in general during this trying hour and will ease credit conditions, thus lending support to economic recovery. See my earlier articles published in Seeking Alpha.

Feb 22 11:40 AM

[gump59:]

to start with, you have split it into two scenarios: those that "can't afford the home" and those that are in a temporary situation.

That is called oversimplification. How do you determine who can't afford their home? do you *really* mean those that can't afford the loan(s) for their home? is it really that their home is too expensive *or* that their loan is too expensive? Have you even considered that there are a good number of people out there that could afford their homes if they were to get mortgages with no arms and at current market rates but can't because they are 20-60% underwater?

Beyond that, we already are subsidizing the "responsible" home owners. Last time I checked, interest payments are tax deductible on the homes for all homeowners. If people are that much against subisidizing others to achieve or maintain home ownership, then those same people should stop deducting *their* interest payments in their taxes. All those renters out there, including the ones recently removed from their homes, will appreciate it when they stop being hypocrites.

Feb 22 12:03 PM

[Jon Smirl:]

I think there are two major groups of home owners, those that put down a lot of cash, and those who put down little to nothing.

People who put down little to nothing and are crying about being underwater need a quick and efficient foreclosure. If you have nothing down on the house you're just a renter. If you can't make your rent payment you get evicted. The government doesn't do cram downs on landlords when the renter can't pay, why should they do a cram down on a bank when a renter equivalent can't pay? The government evicts renters that can't pay. You have nothing invested in the house so you have nothing to lose except the fact that you are living in something that you can't pay for, go move into something that you can afford. You've probably made money from the process by living rent free during the foreclosure.

The people that need help are the ones that invested their own money in a large down payment. If you've lost your entire down payment and you're about to be foreclosed, then you've really been hurt. Temporary help to people in this class is a good thing. Because of the down payment this class is committed to the property. You can be sure that this class didn't lie to much about their ability to pay. After all, if they couldn't pay they were going to lose their down payment.

My favorite proposal helps both groups. Temporarily allow the tax deduction of 200% of interest paid. Congress could implement this tomorrow. The costs of it are known exactly from IRS data. It can be repealed or reduced at anytime. The greatest benefit from this automatically falls on to the people paying the high interest rate who recently bought their home. People who have 20 year old mortgages are mostly paying principle, not interest.

The key to this solution is that you have to pay the interest to get the double deduction. This will increase the payment flow to the banks and get them out of their mess. It will also sort of committed owners from renter equivalents. If you still can't hang on to your house with a 200% interest deduction, they you truly can't afford it.

Feb 22 12:47 PM

[gump59:]

"those that put down a lot of cash, and those who put down little to nothing. "

what is a lot? 20%? hardest hit areas are down much more than 20%. If you define responsibility by the amount placed in down payment, then plenty of the responsible are still left out.


"You've probably made money from the process by living rent free during the foreclosure"

that assumes that the lender does not pursue a deficiency judgement. It also assumes that your "renter" has not liquidated savings, 401k, credit cards, etc, at the request of the "landlord"

Feb 22 01:21 PM

[Jon Smirl:]

Anyone at 20% or more has a lot invested in their house. On more expensive homes even 10% is a lot. $5,000 down on a $800,000 house is not a lot.

Get a clue, if you " liquidated savings, 401k, credit cards, etc," to make payments on a thirty year mortgage you can't afford the property. Do yourself a favor and take a quick foreclosure; you'll be better off in the long run. Get out, save your cash, and buy something affordable.

Feb 22 03:23 PM

[gump59:]

I agree, people should have taken that route. But they trusted their lender when they shouldn't have on more than one occasion. They don't necessarily have a 30 year mortgage. Many were only offered arms and balloons but corrupt and greedy brokers. Some were told they had 30 year fixed when they were really given something else. The primary point I am hoping to get out there is you can't boil it down to two groups.

If it was that simple of an issue it would have been fixed already. The reason it hasn't really been addressed is nobody wants to go near it with a 10' pole.

Feb 22 07:58 PM

[gump59:]

Lets take this a little further: $800,000 house you mentioned, now instead of $5k down, place 20% down, $160,000. $640k loan. But the loan was an ARM. Shame on both the lender and the buyer, whatever. buyer can afford the initial rate at 5.5% but when it resets up a few points, can't. House dropped 30% in value, now worth $560k. Guess what? you can't get a refi and you aren't eligible for the obama plan based on the existing details (see the 105% loan/eqity). Even though if you were refinanced to a 30 year you could afford it. You are now at the mercy of the lender.

Now, replace that a little bit with a less responsible borrower. two loans, little or no money down. balloon and/or ARM involved. House lost 30% or more in value. If you could replace both those loans with market rate 30 year loans, the house would be affordable for the borrower. But nobody will refi them since you are so far underwater. Same with Obama plan. You are now at the mercy of the lenders even though you could technically afford the house if you had market rate loans.

Ah, but this isn't as convenient to the black/white world that does not have any shades of grey now is it?

Feb 22 08:14 PM

[Shame:]

Did I miss something in all this valuation chit chat? Didn't the bank who have done all this bad lending already write down the value of their assets? Isn't that why taxpayers have rushed to help artificially inflate their balance sheets? So why haven't those banks been forced to lower the valuation of the mortgages so that borrowers' balance sheets will now be properly readjusted? And aren't these the same banks who, now flush with cash that costs them nothing and Fed rates at zero, are raising their rates on consumer credit for credit cards -- against balances that were outstanding prior to the banks' collapse? Seems the banks know exactly what they're doing: taking money. From consumers and from taxpayers. It is not borrowers "at or below the margin" who need to be foreclosed upon more quickly. It's the banks. Shame on them.

Feb 23 01:02 PM

[nobull:]

Thanks. What Ive been saying - stop mucking around trying to "fix" an overpriced asset.

Feb 23 01:25 PM

[wunderhof:]

The real estate market dysphoria now common across the US
started with home prices artificially inflated by too many buyers
with too much credit. The market will react to another proposed
artificial property price boost by failing again at some time in
the future. Until the last, final, painful correction plays out.
Uncertainty of the effect of the next government program will
make every attempt at government intervention fail. If you
believe that the real estate market will stabilize by abating
foreclosure, then you must prevent ALL foreclosures. If you
exclude some foreclosure from abatement, then those foreclosures
will depress the values of the neighboring rescued properties.
Stay out of the market and provide sustenance to the
unfortunates.

Feb 23 04:11 PM

[EEB:]

Nearly all of the suggestions for stabilizing the housing market call for actions to increase demand. Many of these suggestions require extremely complicated analyses of individual mortgages. Just think about designing the system and procedures that would be needed to distinguish between those who bought too much house and those who just fell on hard times. Loan modification schemes require way too much work. The banks and the government don't have enough workers to do all that would be required in anything like a timely manner.

If the government should try to stabilize the housing market (I think that it should, but that's an even more complicated debate.), then systematic but simple ideas need to be applied, and soon. First, take some action on supply. There are way too many vacant homes and too many on the market. The government could easily buy and hold homes to reduce supply. This would put some people back to work buying and maintaining these properties. When the market stabilizes, government owned homes can slowly be put back on the market. Second, if action on the demand side is required, then just force down mortgage rates a bit more with some sort of subsidy. At least everyone gets a shot at the subsidy and we don't have to try the impossible by evaluating every single bad mortgage in America. At least these two things would also help those who bought within their means during the last decade.

Feb 23 10:02 PM

[ReallyFucke...:]

What amazes me is that through the whold discussion of the housing crisis the word "renter" is never used. Ironically there are 100,000,000 renters many of whom are ready to buy those houses once they return to appropriate (and realistic) prices.

Hurting renters is actually bad for homeowners and even lower income individuals. See more on this here:

watchingmarcitz.com/20.../

Feb 24 01:56 AM

[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 08:21 AM