The NYT on Foreclosure: Can We Talk About Sex?

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Friday, 04 March 2011 04:50

Actually, I meant to say "the housing bubble," but in top policy circles it might be easier to get a discussion going on sex. The NYT's lead editorial defends the Obama administration's housing programs based on the fact that house prices are falling again. This is really confused thinking.

First, we should expect house prices to fall. Nationwide house prices have to fall by about 15 percent to return to their long-term trend level. No one has produced any remotely plausible explanation as to why we should expect house prices to diverge from a 100-year long trend, so this decline is consistent with the market returning to normal.

Why, as a matter of policy, would we want to try to prop up housing prices, even assuming that we could? Should the federal government be running an unaffordable housing program? 

House prices had been supported through the second half of 2009 and the first half of 2010 by the first-time buyers tax credit. This pulled purchases forward and now house prices are back on the path to correcting. Given the still near record housing vacancy rates, there is no reason to expect this decline to stop soon regardless of what we do on foreclosures. 

If we could talk about the housing bubble, there is an argument that the government could take steps to support house prices in markets where the bubble appears to have deflated. In former bubble markets like Las Vegas and Phoenix, it might make sense for the government to target loan money and other support in order to prevent prices from falling too far below the trend level. However, this would require distinguishing between markets where the bubble is still deflating from the ones where it has deflated. The price to rent ratio gives us an obvious to tool to make that assessment, but no one seems to want to have that discussion.

Returning to the question at hand, the Republicans are absolutely right, the Obama administration foreclosure programs have been a disaster. There are both policy and political obstacles that make effective programs a virtual impossibility.

On the policy side, the key problem is that the Obama administration never wanted to force the banks to do anything. This invites efforts at cherry picking. They want to have the government subsidize them to make modifications that it might have been in their interest to make in any case. This means the program is giving money to banks, not homeowners.

There is also the problem that servicers are not in the mortgage modification business. Servicers collect monthly payments, they assess fines and send out threatening letters when the payments are late. They move forward with foreclosures when the payments are repeatedly late. They don't have experience working with owners to do modifications.

Asking servicers to do modifications is like asking the police to be social workers. It might be nice if a beat cop could pull aside a troubled kid and give him some counseling, come by and check on his school work, and help him with his family problems, but that is not what cops do. It is the same story with servicers and putting a few thousand dollars on the table will not change this fact.

On the political side, it looks absolutely horrible for the government to be paying the mortgage of people who have fallen behind. Every person who has fallen behind on their mortgage has a neighbor who is working overtime or taken a second job, scrimped on basic expenses, and taken other extraordinary measures to keep current on their mortgage. Of course the Obama administration policy is not actually giving large amounts of money to defaulting homeowners, but the right has been effective in building this perception.

It is also worth noting that we would have a disaster if the government actually did offer large amounts of money to defaulting homeowners. This would give everyone incentive to default on underwater mortgages and have the government and/or lenders pick up the tab. While many of the people helped this way may be very deserving, many of the biggest gainers would be relatively well off people who bought expensive houses at bubble-inflated prices or opted to take large amounts of money out of their home when the bubble sent the price through the roof.

Some of the losers in this story would be the banks that pushed and packaged fraudulent loans. However the bulk of losses would be incurred by public and private pension funds, who bought mortgage backed securities (MBS) in good faith, and individuals who hold MBS in their retirement funds. 

There are policies that the Obama administration could pursue that provide benefits to troubled homeowners at no cost to taxpayers and with none of the policy and political risks noted here. For example, it could push to allow cramdown in bankruptcy. This means that judges could re-write mortgage contracts when a homeowner declare bankruptcy. It could also push for right to rent laws. This would allow homeowners to stay in their home as renters paying the market rents for a substantial period of time (e.g. 5 years) following foreclosure.

Both of these policies would increase the bargaining power of homeowners relative to lenders, leaving them in a better situation to keep their home and, in the case of right to rent, put them in a much better housing situation in the event that they can't keep their home. Neither policy requires any new government bureaucracy or creates any serious moral hazard problems.

Both cramdown and right to rent would require action by Congress, which may prove impossible, but at least the Obama administration would be pushing for sound policy. As it stands, the Obama administration programs are largely worthless. If the President wants to put on his fiscal austerity hat and cut out government waste, he's got some good targets here.