Categorized | economy, happenings

A mortgage bail-out?

Because mortgage problems and foreclosure rates are not only impacting the economy at large, but small businesses and entrepreneurs in particular (I have five clients that have either gone out of business or have gone into hibernation because they are directly involved in things like home renovation, i.e., cabinet manufacturers, etc.), it seems reasonable that the fastest and most efficient way to electro-shock the economy back into shape is a federal mortage bail-out, like the one Glenn Hubbard describes in the Wall Street Journal of all places:

Recent news articles suggest that the Treasury Department is considering a plan to offer a 4.5% mortgage for home buyers for a period of time. Let’s hope it does. It would help arrest the decline in house prices that is at the base of the ongoing financial crisis and recession.
Raising the demand for housing makes sense now. While fundamental factors clearly played a role in driving down house prices that were at excessive levels two years ago, we have argued in a paper (to be published in the Berkeley Electronic Journal of Economic Analysis and Policy) that in most markets house values are today lower than what is consistent with the average level of affordability in the past 20 years.

Arnold Kling says no and double no. Now, liberal blogs and talk radio have been gnawing on this particular bone for awhile, and I’ve been consulting with a mortgage lender in their lobbying efforts for just such a proposal.

It seems right on the surface. After all, since the slide in housing prices is pulling down the rest of the economy, driving the foreclosure engine, and shoving banks into so much trouble that we need to bail out the banks, why not throw the water on the source of the fire?

The more I’ve worked on this problem, the weaker my enthusiasm grows.

It’s not “if,” but “when” and “how” such a federal bail-out of home mortgage holders will happen. I’m not an economist, but it probably will do little to help the situation at hand. In fact, if a federal mortgage bailout were a sure thing and a client walked through the door whose livelihood depended on some aspect of home building or renovation, I’d be telling them to retrench. Don’t count any chickens at all, I’d be saying, let alone ones that haven’t hatched.

Here’s why.

My main argument against this plan is the same argument I’ve been leveling at conservative economists and political types about the insane deregulation of the last 20 years:

The fundamental basis of middle-class (and, by extension, American) wealth is wages or small business/entrepreneurial income, not debt. Debt is many good things, but it is not wealth. It’s debt. It can buy you a house, a Mercedes, and a good time in Aruba, but it’s not wealth.

Mortgages, as debt, have value because they allow wage-earners and others to turn savings, income, and wages into equity, that is, wealth. In the last twenty years, consumer debt has rapidly outpaced wages and income. One could still turn debt into wealth, say, but flipping houses and getting out before the market goes bust, but the basic principle of turning income into wealth has been totally undermined.

I believe very strongly that the solution is not more debt. The various mortgage bail-out proposals, including Hubbard’s, are basically arguing that consumers borrow their way out of the crisis. Housing prices need to continue sliding until purchasing a house with a mortgage becomes again a reasonable way to convert income into real wealth.

Hubbard argues:

Nonetheless, without policy action house prices are likely to continue falling . . .

Housing prices are falling for a wide variety of reasons:

  • Yes, mortgage credit has contracted. But more importantly, the endless rise in capital available for mortgage loans has, well, ended. The mind-boggling rise in home prices and the lunatic building craze to profit from that rise was built on a flood of money into mortgage lending and the false belief that that money would continue to flood (the purpose of a flood, after all, is to “run out” all the excess). Back in 2005, we had hit an era in many markets where home buying in certain markets was simply crazy even for people with good credit. I remember looking at home prices in 2006 in LA and going dizzy from the thought of a nine hundred thousand dollar 2,000 square-foot home on the wrong side of Olympic (the crack and crime side).

    While the economy is contracting, low interest rates would spur housing activity.

  • The measure of the market’s insane exuberance can be measured by the over-supply of housing units. Whether or not the government bails out current mortgages, housing prices will continue to slide until the excess supply is used up. Unless the government starts giving out free mortgages, no economist believes that supply will be used up within the next year and a half. Low-rate loans may speed up the consumption of the housing over-supply, but that’s only if the housing over-supply is due to non-performing loans.
  • The problem is not interest rates, it’s over-supply, which we have because builders were infected with the same bug the crazy folks who bought over-priced houses were infected with. Until we work through that over-supply, housing prices will continue to slide. With low interest rates that slide will be slower and less steep, but there’s still a ways to go.

    Some have argued that lenders should earn more than the average 1.6% spread, to compensate for the fact that housing is a much riskier investment today. We don’t think so. Recall that a mortgage can be thought of as a risk-free bond plus two possibilities that increase risk to lenders: default and/or prepayment. Historically, the risk of default adds about 0.25% to the interest rate. The remaining spread of the mortgage rate over the Treasury yield represents the risk of prepayment and underwriting costs. With falling house prices, the risk of default could indeed add 0.75% or more for a newly underwritten and fully documented loan. But 4.5% would be the lowest mortgage rate in more than 30 years — so the additional risk to lenders of prepayment would be almost nil.

  • Every once in a while, someone makes an argument that requires you go soak your head in cold water to make sure you’re not having acid flashbacks from college-year imbecilities. We have seen an economic meltdown whose central cause, whose ground zero, whose reason for being has been a serious, mind-numbing miscalculation of risk, primarily in the mortgage industry. A serious, mind-numbing miscalculation of risk at higher interest rates than those proposed by Hubbard. And now we get a proposal for the “lowest interest rate in 30 years” as a solution to a decade of miscalculating mortgage risk? Is it just me, but does “cheap debt” seem to be the wrong solution for all the economic problems created by “cheap debt”?
  • Non-performing payers are probably not going to be rescued by a lower interest rate; the numbers are in on refinanced non-performing loans from IndyMac, and they’re not good. Lower interest for many is a longer rope on the sinking anchor, not a longer lifeline.

    Moreover, a 4.5% mortgage rate will raise housing demand significantly. A simple forecast can be obtained by applying the 2003-2004 homeownership rates to 2007 households.

    That’s right. Because in 2003 and 2004, we were smack-dab in the midst of the one of the worst business downturns since the 1930’s, just like we are now. Lots of people losing their jobs and lots more in line. Oh, wait, another acid flashback.

  • A low-rate fixed mortgage is not going to help homeowners who are losing their homes because of economic circumstances, such as being laid off. What those homeowners need is an exit plan; they need mobility and so need some way out of their mortgage without increasing their debt.

    Moreover, trillions of dollars of refinancings would retire a large number of the existing mortgage-backed securities.

    This is true and one of the reasons many liberals back a mortgage bail-out. Rather than steadily bleeding money to either purchase or prop up troubled securities from banks big and small, you simply erase them from the books by, well, paying off the underlying debt with refinancing.

    But . . .

    We don’t know the circumstances of these contracts. They may have provisions to protect counter-parties in the event of prepayment. There are sure to be some (actual rather than theoretical) losses on some of these securities.

    Here’s a problem: what about smart homeowners? You know, the ones (like me), who purchased our homes at a reasonable price with an affordable, fixed-rate mortgage? Who told the truth the whole truth and nothing but the truth? Who said “no, that’s crazy,” when we qualified for loans three to four times greater than the one we actually took? Who also said, “no, that’s even crazier,” when we were offered ARMs or, worse, interest-only ARMs (“no-one lives in a home longer than three years anymore,” we were told)? Who said, “holy bejeesus, that’s the craziest thing we ever heard” when housing prices shot up all around us (our property tripled in value)? Who, despite the slings and arrows we’ve suffered in the economic downturn, can still afford our mortgage because we planned our mortgage around the possibility of household economic distress?

    Why should making good economic decisions disqualify a homeowner from a low, low subsidized rate unless they buy a new home at what are still inflated prices? And if we want to be fair, do we really want the federal government propping up every home owner?

    And doesn’t it make sense to “bail out” the smart mortgage holders who can still pay their mortgage? Doesn’t that remove them from the pile of potentially distressed homeowners? Allow them to spend income on home improvement and repairs? Does it make sense to make a mortgage more affordable to a group of homeowners who may not still have the wherewithal to make basic repairs? How does a house sliding into disrepair help the “slide” in home prices?

    Here’s some starting points for a genuine mortgage bailout which should really proceed one mortgage at a time:

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  • One Response to “A mortgage bail-out?”

    1. Hard Money says:

      I know of a website where lenders can find borrowers with bad credit yet still have enough equity to arrange hard money loans or possibly FHA. There use to be very intense competition on mortgage leads 2 years ago. In 2008 between 80%-90% of the brokers left the mortgage business. As of March 2009 only handful of good lenders/brokers can enjoin very excellent leads almost exclusivity in certain part on the country. When it comes to bad credit situation borrowers find solution by searching many sites and many lenders. Borrowers with bad credit are no longer asking “Where I can get the best rate”, but “where can I find a lender who can do my loan period”. started 10 years ago and now is looking for good lenders to join and more borrowers with bad credit residential or commercial to bestride the software.


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