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.
