Home prices rose steadily and dramatically over the last several years. For the first time in history, the increase in home prices outpaced the increase in inflation. This rapid rise was fueled by low interest rates and an artificially expanded consumer pool as a result of government policies like the Community Reinvestment Act and quota requirements that Fannie Mae and Freddie Mac engage in a certain percentage of subprime loans. As a result, the appreciation in home values also coincided with a dramatic expansion in the number of homeowners.
Many new homeowners benefited from new financial products to qualify for mortgages. Some of these products are referred to as ‘sub-prime’ loans. These loans allowed millions of consumers—who traditionally would only be able to rent—to purchase homes. However, with the regulatory structure that mandated that GSA’s like Fannie Mae increase their volume of these loans also resulted in many consumers purchasing homes that they could not afford. Now that home prices have fallen and unemployment rates have risen, some homeowners have fallen into trouble—and this has sparked something of a panic.
It is a tragedy when someone loses their home. However, it is imperative that government retain some perspective when addressing the issue of foreclosure. Over 68% of households are homeowners—a record. 35% own their home outright—meaning no mortgage payments. And even after a rough 2008, the vast majority of homeowners including a majority of those who acquired a home with a subprime product remain current on their mortgage. The FDIC estimates that one in two hundred homes will be foreclosed upon. That equates to roughly one half of one percent of all homeowners who will face foreclosure. The vast majority of homeowners will keep their home.
And not all homeowners who are facing foreclosure do so for the same reasons. Some homeowners utilized equity loans to finance investment properties and are now facing difficulty repaying both loans. Other homeowners who got loans based on “low doc” or “no-doc” loans would likely be unable to afford their home in any economic environment. Still others may face foreclosure as a result of job loss or other strictly economic reasons. And recent government action has created another category of homeowner facing foreclosure proceedings—those who stopped paying their mortgage in order to qualify for government mandated loan modifications.
So, when considering policies that help the one half of one percent of homeowners who will be affected by foreclosure, it is imperative that government not do so at the expense of those consumers who are current in their mortgage or do so in a way that will make it harder for consumers to purchase homes in the future.
The sad but harsh reality of the housing market is that the stratospheric and artificial rise in home prices just wasn’t sustainable and that foreclosures are a natural result of the market correcting to align housing prices with the actual value of the home.
So, the solution to our housing crisis lies in recognizing the reality of the current state of the housing market. Banks holding notes that exceed the current or expected near term value of a home will need to accept that it isn’t realistic that they will ever recoup the entirety of that loan amount and write down the principal amount to a level that consumers are willing and able to pay. Consumers who owe more than their house is currently worth will need to meet the banks in the middle and negotiate an amount that may exceed the current value of their home but is within range of expected near term growth.. The housing market realignment is inevitable and no amount of wishful thinking will make it otherwise. So, if either of the parties refuses to negotiate or is unable to accept such a compromise, then the result will be foreclosure
Like all recessions, the effects of the housing realignment will be painful but unavoidable in a capitalist economy. And current attempts by the government to prevent inherent losses will likely serve only to prolong the pain, increase losses and inflict long term damage to consumers’ ability to buy a home. By pumping money into banks and promising to buy up bad debt, the government decreases the banks’ incentive to modify loans and make them performing loans. By mandating principle write downs on all loans the government removes the negotiating flexibility of banks and consumers alike to address each situation specifically and incentivizes more homeowners to enter foreclosure. All of these increase the cost of mortgages for all other consumers. The so called “cram down” provisions will cause an increase in interest rates for all loans and make it more difficult for first time buyers as well as homeowners seeking to refinance their existing loan. But using taxpayer money to fund the write-down of principal or buy up these loans would mean that homeowners in good standing are paying not only their own mortgage but are also being asked to pay for others as well. Given the number of foreclosures that are a result of some speculating investment strategy gone badly and the fact that all foreclosures are basically treated equally in forced write down mandates, this is inherently unfair and just plain wrong.
While the current economic environment will cause pain as our economy realigns and resets, we have been here before. The US economy has been through recessions and depressions only to come out stronger in the long run. But in order to do this again, we must preserve the system that has enabled this growth. While there are certainly opportunities and areas where oversight and transparency requirements need to be addressed, socializing our economy is not the solution. As we have seen time and time again, government is not suited to running a business or managing the economy. After all, if not for certain regulations, we’d not be in the current state of crisis. Give the business and consumers alike the freedom to negotiate a better deal and we’ll be back on track soon enough.