Mortgage - Housing - Debt Bubble

More Foreclosures, Please . . .

By Barry Ritholtz - March 25th, 2010, 7:15AM

The latest actions from Washington as well as Wall Street banks include all manner of mortgage mods, foreclosure abatements, and other extend & pretend measures. These are not only ineffective, they are counter=productive. From a moral hazard perspective, the reward the reckless and punish the responsible. Worse still, they are yet another example of penalizing middle America for the sake of Wall Street banks.
Our story so far:
It started with the ultra-low rates of 2001-04. It was aided and abetted by an abdication of traditional lending standards, mostly by non-bank lenders. These Lend-to-Sell-to-Securitizers pushed lending standards ever lower to increase the pool of potential mortgage buyers — credit worthiness be damned.
The net result of all this was a credit bubble. My estimates of the changes to mortgage requirements was that somewhere between 10 and 20 million marginal new home buyers came into the real estate market during the past decade. This drove prices to unsustainable levels, and created a huge boom and bust cycle in housing.
Prices have since fallen about 30% nationally as the artificial demand created by this free money and accompanying gold rush psychology collapsed. Despite this, prices remain elevated by historical metrics. The net result has been 5 million foreclosures, and counting. One in four “Home-owers” are underwater — meaning, they owe more on their mortgages than their houses are worth. There are probably another 3-5 million foreclosures coming over the next 5+ years.
What are the net result of this grand experiment?

1) There are an enormous number of families living in homes they cannot possibly afford.
2) Banks are holding a tremendous amount of bad loans (and potential bad loans) on their books.
3) Real Estate Sales, despite being propped up with historic low mortgage rates and tax purchase credits, continue to slide.
4) The overall economy has been weak, with a very slow, soft recovery.

Whether its a function of populist politics or bad economics, the proposals we have seen so far appear to address items one and three. But upon closer examination, they do nothing of the kind. In fact, they are actually gaming the system to help issue two — the bad loans the banks are carrying.
What the real estate market needs is to allow the price normalization process to continue. Even though home prices have fallen dramatically, they have yet to reach their historical means relative to income or the cost of renting. This is to say nothing of the usual careening past the median towards under-valuation that typically follows a massive misallocation of capital.
Why should we allow these foreclosures to proceed unimpeded? Consider the following benefits of foreclosure:
• Increasing Economic Activity: The areas of the country with the greatest foreclosure rates have seen a big increase in real estate activity. Look at California and Florida — they have seen enormous upticks in RE activity versus the lower foreclosure states.
When someone purchases a home they actually can afford, they end up spending quite a bit of money on additional goods and services. They do renovations, hire contractors, make durable goods purchases, they paint and repair, they buy cars, they spend money in the local community.
The people who are hanging on by their fingernails, however, do none of these things. They end up paying a vastly disproportionate amount of their incomes to service their mortgages. This is not productive economic activity.
• Helping Families: It moves over-stretched families into housing they can afford. The banks charge all manner of excess fees prior to foreclosures; they squeeze whatever they can form delinquent homeowners. The loan mods and HAMP programs have been totally ineffective in keeping families in their homes. They have been an enormous taxpayer subsidized boondoggle for the banks, however.
The last thing these families need is a banking fee orgy, before they ultimate lose the house anyway.
• Punishes the Prudent: The boom and bust saw irresponsible reckless behavior by both lenders and home buyers. They were reckless, overused leverage, disregarded risk. Having the taxpayers subsidize this behavior presents a moral hazard.
But worse than that, it punishes the people who behaved prudent and responsibly. Those who refused to buy a home they could not afford, chose not to over-extend themselves, and have been saving for a down payment are the net losers in this. By working so feverishly to artificially reduce foreclosures and prop up home prices, we punish the first time home buyer, the newlyweds, the savers who want to buy a house they can afford. By preventing home prices from normalizing, you are puni9shing this group.
• Rewards the Banks: Despite the helping families rhetoric you hear, they are irrelevant. Thevariosu mortgage mos and cramdowns are little more than a game of kick the can down the road. All of these programs are part of a broad “Extend & Pretend” mind set. They are an extension of the FASB 157 rule changes that allows banks to hide their bad loans.
The various foreclosure programs are essentially a way the banks don’t have to take their hits now. Were the banks required to report their mortgages accurately and/or write them down, they would be revealed as insolvent.
~~~

Now we get to the ugly Truth: The mortgage mods and foreclosure abatement programs are really all about propping up insolvent banking institutions on the taxpayer dollar at the expense of the middle class.
These programs are another losing round of helping Wall Street at the expense of Main Street. It is the worst kind of trickle down economics that has been seen in decades . . .

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Related:
Bank of America to Reduce Mortgage Balances
DAVID STREITFELD and LOUISE STORY
NYT March 24, 2010   
http://www.nytimes.com/2010/03/25/business/25housing.html
Bank Launches Big Plan to Cut Mortgage Debt
JAMES R. HAGERTY And NICK TIMIRAOS
WSJ, March 25, 2010 
http://online.wsj.com/article/SB10001424052748703312504575141763259183050.html
The Housing Crisis and the Resentment Zone
CASEY B. MULLIGAN
Economix March 24, 2010  
http://economix.blogs.nytimes.com/2010/03/24/the-housing-crisis-and-the-resentment-zone/#more-57981