Not So Extreme Home Makeover
I just watched a 60 Minutes piece on the housing collapse that was long on scare tactics and short on explanations/solutions. The "expert" who was interviewed stated rather dramatically that we are at best halfway through the mortgage crisis. He pronounced that the Subprime meltdown has simply been the opening act for the forthcoming crumbling of Alt-A and Prime mortgages. It was mentioned that many of these previously thought-to-be sound mortgages are already in foreclosure, even prior to any harmful interest rate resets. Of course, the implication was imagine how bad it will be once the resets occur. All of this was just dumped out there as a fait accompli, with no explanation of why it's happening or how it might be stopped.
Despite 60 Minutes poor reporting, the outcome is not pre-ordained. There are smart policy actions that can stem the tide and avert much of the future pain. But, we need to understand cause and effect.
One school of thought is that if we significantly slow the rate of foreclosures there will be less inventory on the market and prices will stabilize. Sounds reasonable, but it ignores a critical element—why are foreclosures happening in the first place? By not understanding the cause, the effects of our remediation efforts, including the government-sponsored Hope Now initiative, have been less than desirable.
To date, setting aside the issue of over-extended speculators, the preponderance of foreclosures is due to the sharp decline in home values, not problems with interest rates. Many buyers purchased homes with very little or no money down. As such, the precipitous decline in values has led to a situation where buyers must decide if it makes sense to continue funding a substantially depreciating asset. Since many have practically no skin in the game (i.e. material down payment), it is in their economic interest to walk away. That will be true if their mortgage rate remains at the initial teaser level, or even if it is lowered further as part of some forbearance process. If we don't recognize that simple fact, then we're going to be swimming upstream and not doing what's necessary to get the housing market functioning again.
The solution is two-pronged. One part is a foreclosure mitigation program. However, it must have reasonable expectations and be structured in a fashion complementary with the buyer's economic interests. For most, merely fixing the rates at lower levels will not be sufficient. the majority will require a workout with the institution holding the mortgage that includes a meaningful reduction in principal (proportional to the decline in the home's value).
The second component is tax and mortgage rate incentives for purchases of new and existing homes. Again foreclosures create excess inventory which puts downward pressure on prices which leads to more foreclosures which leads to lower prices which...well, you get the point. A very non-virtuous cycle. The bottom line is that incentives will clear excess inventory and help prices to become stable and ultimately rise again. The incentives can take multiple forms—a large tax credit; a reduction/elimination of capital gains when the home is sold; etc.
The first prong addresses supply; the second deals with demand. Together they can return housing to an equilibrium state and put us back on the path to economic expansion.
It should be noted that the ultimate demand-oriented solution is to let the market clear itself. A healthy economy with low unemployment is the first, best way to get housing on track. The suggestions above carry the baggage associated with artificial, temporary demand. They may pull demand forward, rather than actually create new demand. And, they run the risk of reinflating the bubble. For a government that likely does not have the political courage to let the market work on its own, they represent the next best option.
Despite 60 Minutes poor reporting, the outcome is not pre-ordained. There are smart policy actions that can stem the tide and avert much of the future pain. But, we need to understand cause and effect.
One school of thought is that if we significantly slow the rate of foreclosures there will be less inventory on the market and prices will stabilize. Sounds reasonable, but it ignores a critical element—why are foreclosures happening in the first place? By not understanding the cause, the effects of our remediation efforts, including the government-sponsored Hope Now initiative, have been less than desirable.
To date, setting aside the issue of over-extended speculators, the preponderance of foreclosures is due to the sharp decline in home values, not problems with interest rates. Many buyers purchased homes with very little or no money down. As such, the precipitous decline in values has led to a situation where buyers must decide if it makes sense to continue funding a substantially depreciating asset. Since many have practically no skin in the game (i.e. material down payment), it is in their economic interest to walk away. That will be true if their mortgage rate remains at the initial teaser level, or even if it is lowered further as part of some forbearance process. If we don't recognize that simple fact, then we're going to be swimming upstream and not doing what's necessary to get the housing market functioning again.
The solution is two-pronged. One part is a foreclosure mitigation program. However, it must have reasonable expectations and be structured in a fashion complementary with the buyer's economic interests. For most, merely fixing the rates at lower levels will not be sufficient. the majority will require a workout with the institution holding the mortgage that includes a meaningful reduction in principal (proportional to the decline in the home's value).
The second component is tax and mortgage rate incentives for purchases of new and existing homes. Again foreclosures create excess inventory which puts downward pressure on prices which leads to more foreclosures which leads to lower prices which...well, you get the point. A very non-virtuous cycle. The bottom line is that incentives will clear excess inventory and help prices to become stable and ultimately rise again. The incentives can take multiple forms—a large tax credit; a reduction/elimination of capital gains when the home is sold; etc.
The first prong addresses supply; the second deals with demand. Together they can return housing to an equilibrium state and put us back on the path to economic expansion.
It should be noted that the ultimate demand-oriented solution is to let the market clear itself. A healthy economy with low unemployment is the first, best way to get housing on track. The suggestions above carry the baggage associated with artificial, temporary demand. They may pull demand forward, rather than actually create new demand. And, they run the risk of reinflating the bubble. For a government that likely does not have the political courage to let the market work on its own, they represent the next best option.
Comments