Mortgage Refinancing Is Not the Solution 25 comments
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US government policy is attempting to build a floor under housing, principally through programs to refinance homes and keep people in their homes. However, a fundamental tenet of problem solving is to have solutions that solve the underlying problems at their root cause level. The current government programs do not meet that condition.
The fundamental problem is reduced demand for housing, which in turn is based on reduced expectation of profit from buying a new home, reduced capacity to pay, and reduced ability to finance. Here are the major elements which must be dealt with in finding an effective solution to the housing problem.
- Elimination of speculative buyers. In the first half of this decade, we had many unprofessional and professional buyers which simply no longer exist. You had the persons of modest means making down payments on future housing with the hope of doubling or tripling their money in a few months. You had Calpers, the California pension organization, speculating hundreds of millions in raw land purchases. History will probably attach significant responsibility to Alan Greenspan for stimulating this speculative boom through the Fed monetary policies. In summary, an unsound, but important source of buying has disappeared. The elimination of speculative buying will inevitability drive housing prices down to “normal” levels, as opposed to the previous high, speculative levels. There has been substantial adjustment in housing prices, but we are not yet near the bottom for housing prices.
- Elimination of Unqualified Borrowers. First we had the Liar Loans, where loans were made to purchasers that simply did not have the means to buy. Then we had the adjustable rate loans, where the buyer could pay for the first year or two, but had no real ability to pay when the rate was reset to a much higher interest rate.
- Elimination of Low Down Payments. Loans were made to buyers with nothing down, 5% down or 10% down. Historically this is imprudent lending and today most banks have gone back to much more conservative lending practices, in part because of their losses coming from the previous credit excesses. Today, 20% down seems more like the norm for loans that qualify for Freddie Mac and Fannie Mae. Furthermore, jumbo loans which exceed government stipulated limits have become virtually non financeable. As is usual, we are over correcting in response to previous excesses, but some correction was essential to sound lending practices.
- The Rise of Underwater Debtors Who Walk. Virtually any home purchased since 2004 is now worth less than the mortgage owed on the house. A small, but increasing number of people are going to abandon their homes on the logic that why should they spend decades paying for a home where they are not building their equity in it.
- The Rise on Unemployed Who Cannot Pay Their Mortgage. A person without income cannot pay his mortgage, even with refinancing. There are millions of Americans falling into this category. An even larger number are likely to be those who lose their relatively high paying job, which provided the income to pay their mortgage, and finally get another job but which pays much less. If you go from a $27 per hour auto worker job to a $7 per hour job at McDonald’s, probably no amount of refinancing is going to make the numbers work for a person or family with a 75% drop in their income.
- The creation of even bigger problems at the government mortgage banks such as Fannie Mae and Freddie Mac. There is something almost cynical about saying the former management of Fannie Mae and Freddie Mac were inept and we replaced them, but then we turn around and continue the same poor lending practices that got them in their horrible financial condition. Both of these banks have negative net worth and are problems just waiting to explode again, this time bigger and with more dire consequences for the nation and this time much more seriously affecting US Treasury ability to handle this debt.
In summary, there are profound problems which the US government plan does not deal with. The practical effect of the government stimulus plan on mortgages is that it will not achieve the desired effect and it will help only a very small percentage of the people who need help. A floor for housing will involve prices much lower than today, and credit standards pretty much as they are today (not as they were two years ago). This means there will be staggering financial problems for the banks holding the existing paper for mortgages that are not going to recover their financed value in the coming years.
It could well be that our policy makers know all of the above full well, and feel that this is all they can do. They may feel that speaking the truth will cause despair. My experience as a problem solver and as banker and industrialist is that speaking the truth provides the basis to ultimately find effective solutions.
Stock position: None.
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This article has 25 comments:
point 6 seems to reinforce the fact that much of the cause of this problem was Fannie/Freddie, CRA act/HUD, The FED and the regulators. The goverment would like to see the holes in the bubble sealed up and the bubble continue to inflate. I cannot see how there attempt to artificially set a floor on house prices can possibly work. The money they are borrowing, and then shreddding, on attempting to fix everything is fighting a 54 trillion dollar debt contraction.
We know about all these problems already, what are your proposed solutions? I see no analysis here, just history and summary.
To quote your own words, "a fundamental tenet of problem solving is to have solutions". I couldn't agree more, but how's that working out for you??
You, sir, are wasting my bandwidth.
you can stop reading after that...
Perhaps rather than spending tax dollars in the vain attempt to slow/stop the decline in home prices, the government should be devising policy that expedites the home price declines.
Imagine how many home sales we would have if home ownership was cheaper than renting? It would also result in a lot of homebuilding if land prices were low enough, especially in urban areas.
Of course we would also have to resolve the bysantine regulatory structure around real estate development. And we'd have to break the strangle-hold that local governments have on real estate development.
Yeah, it's a mess and once again government is not the solution to our problems - government IS the problem.
Government-subsidized programs to restructure mortgages enrage me and the other 90% of borrowers who pay their mortgages on time and live within their means. Many buyers paid too much and borrowed too much for their houses. That is how bubbles happen. I do not accept the argument that the creditworthy should subsidize those in risk of default top prevent further market price declines. The hard truth is that price declines are economically necessary and socially desirable. Moreover, the Federal government cannot stop the deflation that is occurring in housing through massive subsidies to the unlucky. Under the Obama plan, the ants will subsidize the grasshoppers, and house prices will continue to decline anyway until the market reaches equilibrium.
What can government usefully do?
First, face reality and stop trying to prop up housing prices. The government should recognize that borrowers who are significantly “under water” and/or have mortgages that they cannot afford should let their houses go into foreclosure. In foreclosure, the buyers who overpaid will lose whatever equity they may have put into their current house, and lenders who foolishly lent them the money will take a loss on the mortgage. That is as it should be. I am not responsible for fixing bad business deals between my neighbor and his bank. And the government should not try to manipulate the market price of houses in favor of those who own houses now, against the interest of aspiring house-buyers.
Second, many of those who are now “under water” have stable incomes and would be willing to buy a different, now-cheaper house if they could get financing. The best way for government to help these individuals is to take steps to insure that mortgage defaults arising from the current housing debacle should not by themselves disqualify future mortgage seekers. Wipe the slate clean, so to speak. These prospective buyers, having been chastened once by the housing debt trap, will likely be excellent credit risks in the future. If such buyers want to turn around and purchase the house they just defaulted on, so be it. But they should have to compete fairly with every other prospective buyer who does not have a government subsidy.
Third, bankruptcy courts should have a role in restructuring mortgages. Some who have defaulted or could default might be able to stay in their current houses if mortgage terms were re-written. (I honestly doubt that many will qualify, especially in the housing markets that inflated the most and now have fallen the hardest.) Allowing bankruptcy courts to reset mortgage terms is the fairest way to deal with the myriad individual circumstances involved. The courts are the best hope for a sorting out the deserving from the un-deserving, the hopeless from the curable. However, there would have to be a huge ramp-up of the bankruptcy courts to deal with the case load. Happily, there are large numbers of unemployed, knowledgeable real estate and finance professionals who could be appointed as special masters to deal with the millions of cases that could be heard.
Fourth, stop any plans to revive the housing construction industry at taxpayer expense. We can’t build our way out of a housing glut. These folks contributed mightily to the current housing problem. Once prices have fallen to equilibrium levels, their industry will revive on its own, hopefully a bit wiser than before.
Are you sure that is true?
That does not sound like the Obama that we have come to know!
The longer they hide the more uncertainty there is. And as we all know, the market hates uncertainty.
Obama could have focused on making the banks go open kimono but instead he wasted his time with the $780 trillion sausage named porkulus...uh...i mean stimulus...
On Mar 01 06:31 PM D_Virginia wrote:
> ...and?
>
> We know about all these problems already, what are your proposed
> solutions? I see no analysis here, just history and summary.
>
> To quote your own words, "a fundamental tenet of problem solving
> is to have solutions". I couldn't agree more, but how's that working
> out for you??
>
> You, sir, are wasting my bandwidth.
If you can't meet these terms you would have to sell.
What would be the downside for the USA if we did this?
USAffordableHome.com
An effective public/private partnership....The Affordable Home Account
On Mar 01 07:33 PM Stark Naked wrote:
> Just rehash on the old stuff. I have read this analysis in one form
> or another from everybody and their mother who writes about the housing
> crisis. Do you have a solution! If you dont then get out of the way
> and let them try!
If rational (underwater) defaults accelerate like they have been(pretty much the focus of the Obama plan) that will shrink the prime buyer market a huge amount as these are people willing to forego home ownership by letting their credit rating take the hit.
As can be seen from some auctions in Florida and California, even those that bought at auction properties well under 50% of the assessed value are having trouble finding renters. The rental market is sagging badly as well, so revenue properties are a pipe dream.
The "rush" in by some strong buyers in the last 2 months is an illusion—a head fake. They, too, are increasingly caught in having bought too high with no secondary market due to unemployment and a diminished rental base. Once taxes are taken into consideration only buyers with stamina and cash to burn can ride this out.
Rehabilitating the market over the next few years will require that many of those currently underwater or foreclosed come back in. Until that happens, the negative growth on the demand side and the oversupply will keep prices down for a very long time. In the Great Depression house prices stayed down near a bottom for almost 19 years.
>> "I like Cramer's idea of 4%, 40 years, at current value, to EVERYONE.
If you can't meet these terms you would have to sell.
What would be the downside for the USA if we did this? " >>
The downside ? Simple. Financial institutions that hold mortgages and mortgage backed securities need EARNINGS to recover. Cutting their interest rate to 4% for 40 years cuts their EARNINGS long term Cramer's plan would prolong the financial crisis indefinitely.
The only practical solution is to END foreclosures, a prospect that infuriates me and most Americans who have been financially responsible. In effect, the only feasible solution is so politically incorrect it can't possibly get enough popular support to be adopted.
What are we left with ? More muddling while housing prices inch their way down to eventual fair value. It will take years. SNAFU
Prices are falling because they are unsustainable at those levels.
This economy will only stablise when prices are sustainable - there is no other outcome - think about it.
The problem he is trying to solve should have been addressed years ago. It is no longer just a market problem, but a social problem as well. Foreclosures lead to disintegration of families and rises in crime. He violates his own principles by looking at this merely as a problem in the housing market.
Here is the story of a friend who bought a New home in Tracy, CA in January, 2004.
The cost of the home at that time was 350K. I paid 20% down. My neighbors also bought the same model at the same time with a 3% down payment.
They refinanced into a 3/1 Arm cash out with a low teaser rate in November, 2005 for 500K because the value of the home had gone up. I did not do any such thing and just continued to pay my mortgage.
They quickly spent the money on buying a BMW, an exotic chandelier, granite countertops, stainless steel appliances and other high priced furniture in their home and went on a Vacation to Hawaii and then on a Cruise the Bahamas. In between they had time to party out in glitzy Vegas.
In 2008 their first re-set took their payment way above what they could afford and they are behind on their payments. The current value of the home is back to what it was valued in 2004 - 350K.
Now, per some of the advocates of foreclosure prevention, a principal write down (from 500K to 350K) is going to be handed out to my neighbor by the government using my tax dollars, so that he can continue to pay the same monthly payment as me after having run through 150K of Tax payer money! Thus forcing me to pay for my neighbor's luxuries?
Both of us have teenaged kids. I did not indulge in any of the splurges that my neighbor indulged in. I drive around in my old Ford Taurus, saved money equal to 8 months of living expenses just in case I lose my job and put away some more in a CD so that it could help pay for my kids college tuition fees!
THIS IS THE BEST THING FOR EVERYONE. ITHINK EVERYONE COULD AFFORD TO STAY IN THEIR HOMES AT THIS RATE
On Mar 01 11:05 PM sf94127 wrote:
> I like Cramer's idea of 4%, 40 years, at current value, to EVERYONE.
>
> If you can't meet these terms you would have to sell.
>
> What would be the downside for the USA if we did this?