David Leonhart is absolutely right. While bailing out U.S. homeowners strikes the right chord politically, it is fraught with all sorts of problems.
There are two separate groups of people who are at risk of foreclosure, and they often get muddled in any discussion of the housing crisis. The first group is made up of people who, for whatever reason, will not be able to make their monthly payments. Some took out mortgages with initial monthly payments that they couldn’t afford. Others took out adjustable-rate mortgages whose monthly payments have ballooned to an unaffordable level. Still others have lost their jobs. …
The second group is quite different. It is made up of people who are at risk of foreclosure not because they won’t be able to keep up with their monthly payments — but because they may decide they don’t want to continue making them. These are the homeowners who are “under water,” which is to say their houses have lost so much value that they’re now worth less than the underlying mortgage. Homeowners with an underwater mortgage face a choice. Many will stay put and keep making their monthly payments … Others, though, are going to look at their home purely in economic terms and see an investment that may never pay off. Some of them will choose to walk away …
The problem with this approach — and it’s the heart of the problem with any big-time homeowner rescue — is probably obvious. As soon as the government announces that it will help everyone at risk of foreclosure, a lot of people are suddenly going to decide they’re at risk of foreclosure.
Homeowners who are under water will have an incentive to think of their homes in cold economic terms and threaten to walk away, while those who can just barely afford their monthly payments will have reason to slide into delinquency. Multiply 19 million mortgages by a couple of hundred thousand dollars, and the government could be left with $4 trillion in obligations.
Yep. Not just struggling homeowners, but people who speculated on Miami or Scottsdale or Las Vegas real estate will now be in for a bailout. Plus, the economy will never correct itself if the government keeps artificially propping up real estate assets.
When I tell friends in Europe or Canada that Americans can simply walk away from mortgages, they are in shock. One key reform has to be to make U.S. mortgages a permanent, binding contract that can’t be walked away from.
October 23rd, 2008 at 10:59 am
Unfortunately, a lot of these “victims” are young, first time homeowners who fell prey to predatory lenders and their unscrupulous lending practices.
Example: In Indiana it was possible to borrow 125% of the (inflated) homes value with little or NO money down. That’s insanity!! Lending laws permitted that.
I bet Europe or Canada never allows that.
Also, “simply walking away from mortgages” is not so simple if you consider the ramifcations of bankruptcy and it long lasting effects on a persons credit. (but if you never had any of your hard earned money down on the house in the first place why not walk away?)
I would love to hear Obama or McCain’s strategy on how to fix that one. I hope they have more than a sound bite up their sleeves.Scary times in America and around the globe.
Question is, are there enough creative people in the positions of power to cultivate innovations that may save this economy? Eventually, even the United States will run out of money.
October 23rd, 2008 at 9:33 pm
Easily solved — no bailouts for second homes. Or third homes. Or fourth..
No bailouts except for places of residency — with proof, of course.
And no walk-aways. If the situation is so undesirable then push for legislation stopping it, like they probably have in Europe and Canada.
It’s far too easy to become indignant over the “bad people.”
October 24th, 2008 at 9:55 am
You can’t “stop” people from walking away from their houses and mortgages. What’s the alternative– jail them for not paying the mortgage? There’s already a pretty significant penalty for doing so, i.e., losing your house, damaging your credit, then either being on the hook for a deficiency suit or a “forgiveness of debt” income tax hit if the lender decides not to sue for the deficiency. Part of the problem is that lots of defaulting and walking-away borrowers either don’t know about these penalties or don’t care.
As for Canada and Europe, I doubt that they have laws to forbid walking away from one’s mortgage. Concepts behind mortgage law are pretty uniform across borders– the lender both gets a promise to pay the borrowed money back and a security in the property. One difference is probably that US mortgage law carries the possibility of the deficiency judgment after foreclosure, while other countries limit enforcement to foreclosing the mortgage. That’s a lesser sanction, though, not a greater one. And there may already be mechanisms in place to renegotiate the terms of a defaulted mortgage in other countries. In the US, until very recently, there was essentially no such renegotiation mechanism in place, and no reason for one, from the lender’s perspective. The vast majority of loans were underwritten such that the lender would get its principal back in the event of default, even if the foreclosure sale didn’t yield up enough money.
We have a recent history of free and easy credit, so people’s perception is probably, so what if their credit rating is damaged? They think they’ll still get credit soon enough. And they probably will, because selling and renting money to each other is by far the largest “industry” in the US. That industry, more than any other, drove the housing bubble.
October 26th, 2008 at 12:42 am
There’s bailouts and there’s bailouts. Helping someone who was suckered into an escalating ARM mortgage or balloon payment to get a long term mortgage with a reasonable interest rate doesn’t hurt anybody. Limiting it to principal residence probably makes sense. With the complex and opaque securatized financial instruments, probably no-one except the federal government can make this happen on a large scale.
Changing bankruptcy laws so judges can allow people to stay in their homes is common decency. I suspect most people won’t walk away from houses if they have reasonable options. Many are painted into a corner by their mortgage holders and just see themselves being bled dry. Even many investors (aka landlords of renters) would like to work out a break-even or small loss. The scam artists are another story, but not our concern.
I don’t have any experience with no-down-payment but I know every time I’ve bought a house I’ve had to come up with thousands of dollars in extra charges, and that every young person/family I know has had to draw on savings and families to buy a first house. When a poor or young person loses a house it’s generally not just the property but their savings and entire net worth, as well as their parents savings.
October 28th, 2008 at 10:09 pm
There are two ways out of the problem of inflated housing values – lowering the value of homes or raise incomes. If we focus on the latter, housing prices will recover some of their value soon enough. How to accomplish this? Expanding tax credits for dependents, higher minimum wages and expanded student aid are a start.
In some ways, however, we have not learned our lesson. The Fed is lending out money at next to nothing. This is the wrong way to get housing prices to recover,
November 11th, 2008 at 10:31 pm
The government can never “fix” housing because all of its efforts to make housing more affordable through subsidies, tax breaks, and bailouts have the effect of driving up housing prices. The only way you can have both afforable housing and higher prices is to engage in a process of ever increasing subsidies. This, of course, is unsustainable.
There may be no better case of why redistribution of wealth and socialism don’t work than our home grown housing mess. Over a trillion dollars has already been diverted to propping up homeowners and the lenders, including Fannie Mae, who foolishly lent them the money with no down payment. Yet our economy continues to tank. It shouldn’t be surprising: an economy based on homeownership and housing inflation is not a real economy.