Category: housing

Economics correspondent Chris Farrell got the main points of the Own-to-Rent proposal across yesterday on Marketplace Morning Repot and added a bit of his own spice. From the transcript:

You know, the idea is out there. See there's a real problem with bailouts and let's just use the word bailout loosely all right? You don't want to reward speculators and you don't want to reward lenders. You really want them to suffer, you want that pain. They deserve to go to the seventh circle of hell anyway right? Now, but you do want to protect the homeowner that was misled. The benefit of this idea is that it's the most targeted idea I've seen that helps out that person, doesn't throw them out on the street, doesn't force them to go through foreclosure, and at the same time forces the lenders and the speculators to take a financial hit.

And I would add--the proposal does not force the taxpayer, whether directly through a government bailout or indirectly through greater involvement of Fannie Mae or Freddie Mac, to take a financial hit. This is what most makes it appealing to me, of all the different proposed interventions I have seen.

From today's Providence Journal, Dean Baker grants my request to co-sign his proposal to help struggling homeowners rather than bailing out hedge funds. Here's our co-authored op-ed:

THE MORTGAGE-MARKET meltdown has gotten big enough that even Congress is taking notice. Members of Congress, especially those running for president, are now racing to propose bills that promise relief to the millions of homeowners who can’t pay their mortgages.

They are right to act. In the run-up to this crisis, there was precious little counsel to families at the margin of homeownership that it could be better economically to not take on the commitment of ownership. There was aggressive marketing of deceptively worded mortgages that were virtually certain to reset to payments that these families could not afford. And the government has for years been abetting this process, pointing to ever-increasing rates of homeownership as a policy success and pushing for the low short-term interest rates that fostered the bubble in prices and the increase in leverage that precipitated the crisis.

In light of this history, it is important that policy be focused on assisting financially strapped homeowners, not lenders that issued deceptive mortgages or investors who foolishly speculated in mortgage-backed debt.

Some of the proposals currently on the table, for example, getting Fannie Mae and Freddie Mac more involved in the subprime- and jumbo-mortgage market, will do more to help the speculators than the homeowners. After all, if private investors are not prepared to hold this debt, why should these government-backed agencies jump in and buy risky mortgages at above-market prices?

There is a simple way to allow troubled homeowners to stay in their homes without also bailing out the mortgage issuers and speculators.

Congress can pass legislation granting current homeowners the right to stay in their homes as long as they like, simply by paying the fair-market rent. In other words, no one gets tossed out on the street, as long as they can pay the rental value of their house. The fair rent would be determined by an independent appraiser — exactly the same way that a lender is supposed to determine the size of a mortgage that can be issued on a home.

Under this plan, homeowners would turn over their property to the mortgage holder. This would generally not be a loss since borrowers currently face crises precisely because they owe more than the value of their house. If the value of the home exceeded their debt, then they wouldn’t have to sign up for the program.

As a renter with secure tenure, the former homeowner would have incentive to do necessary maintenance and keep the home from falling into disrepair. This would prevent the blight that is already hitting neighborhoods where foreclosures have become commonplace.

The mortgage holder would get possession of the house, but they would be stuck having the former homeowner as a tenant. Otherwise the mortgage holder is free to hold or sell the property as they choose. Being stuck with a renter may reduce the resale value of the house, but intelligent investors knew there was risk when they got into the business.

To limit the size of the program and to ensure that it only benefits those who are really in need, there can be a cap placed on the value of homes that qualify. For example, Congress could stipulate that only homes with a market value below the median price for an area are eligible for this plan.

This security-of-housing proposal meets the needs of the homeowners who were victimized by deceptive lending practices and pro-homeownership ideologues. It gives them the right to stay in their home as long as they want. It accomplishes this task in a way that provides minimal opportunities for fraud and should require very little by way of new government bureaucracy.

It also manages to benefit homeowners in crisis without also rescuing the financial institutions that were speculating in mortgages gone bad. This will give the presidential candidates, and other members of Congress, a clear choice between helping distressed homeowners or bailing out financial institutions that should have known better.

Jim Pethokoukis picks up on Dean Baker's proposal in the current U.S. News & World Report. He quotes a phone conversation we had as follows:

Andrew Samwick, former chief economist for Bush's Council of Economic Advisers, admits his first instinct is that the government should do nothing. Yet he admits feeling more than a "pang of sympathy" for people who were misled when taking out subprime mortgages. So if the government does take action, he would prefer a plan like Baker's that "leaves as small a footprint as possible" over one that creates billion-dollar bailout funds or sweeping changes to Fannie Mae and Freddie Mac. Even Andrew Mellon might have approved.

This answers some of the thoughtful comments on the last post. In particular, if the government is going to intervene in some way, I want it done in such as way that it assists borrowers, not lenders. Baker's proposal in fact helps borrowers at the expense of lenders and does not create or expand the government (or government-sponsored) bureaucracy by much. My views of what happened in the floating rate mortgage market are very much influenced by advertising come-ons like this one that I blogged about last year. So I was persuaded fairly easily that some government-mediated remedy might be appropriate.

In the comments on the last post, ed asks a very good question:

Why should we give advantages to foolish buyers not enjoyed by prudent renters?

... or prudent buyers who locked in a higher (but still low) fixed-rate mortgages, ... or prudent buyers who chose a home that they would be able to afford when the ARM reset? These questions will arise any time that the government intervenes on distributional grounds. If these are your concerns, then you will join me in looking for the government intervention on the smallest possible footprint. This is not a policy that I think of as permanent, and it is certainly one that should only be invoked when there is evidence of systemic fraud or abuse.

The comments also point out that the problems of implementation and equity with Baker's proposal rise with the length of the guaranteed tenancy. That's a key parameter to be decided through the public policy process if the proposal moves forward.

Here are some more details from Dean Baker on how his proposal to ease the burden on subprime borrowers would work.

If the government is going to intervene in the aftermath of this meltdown, I haven't seen a better proposal than this one.

Paul Krugman tells us to "Say No to Bailouts" in his column today, and he's largely right:

Consider a borrower who can’t meet his or her mortgage payments and is facing foreclosure. In the past, as Gretchen Morgenson recently pointed out in The Times, the bank that made the loan would often have been willing to offer a workout, modifying the loan’s terms to make it affordable, because what the borrower was able to pay would be worth more to the bank than its incurring the costs of foreclosure and trying to resell the home. That would have been especially likely in the face of a depressed housing market.

Today, however, the mortgage broker who made the loan is usually, as Ms. Morgenson says, “the first link in a financial merry-go-round.” The mortgage was bundled with others and sold to investment banks, who in turn sliced and diced the claims to produce artificial assets that Moody’s or Standard & Poor’s were willing to classify as AAA. And the result is that there’s nobody to deal with.

This looks to me like a clear case for government intervention: there’s a serious market failure, and fixing that failure could greatly help thousands, maybe hundreds of thousands, of Americans. The federal government shouldn’t be providing bailouts, but it should be helping to arrange workouts.

I don't see the market failure, but I don't disagree with the last paragraph if that assertion is removed. We had financial innovation that lowered the upfront costs of financing real estate transactions and raised the costs in the event of default. That we are now "in the event of default" and seeing the higher transaction costs does not mean we have a market failure. That, by itself, does not warrant the government involvement.

However, in addition to the shift on financing arrangements, we had fraud at various points in this process, and determining the financial penalties in those instances would likely have to be worked out over years in protacted legal battles. Congress can pass legislation to substitute for those battles. I haven't seen a better idea than Dean Baker's, which I discussed in the last post.

The consequence of passing it is that it gives the borrower the upper hand in the workout negotiations--the borrower can stay and pay rent as a substitute for the mortgage, and the holder of the mortgage can hold or sell the property (without evicting the tenant) in light of that. I presume that most dispositions will be in either of two forms. Some borrowers will realize that they really cannot afford the house and find a more affordable one, without being evicted unless they also cannot pay rent. In other cases, the holder of the mortgage will sell the property back to the borrower at a discounted price, with new financing on more sensible terms from a new lender. This avoids the need for the government to get actively involved in the terms of the workouts, placing the cost of disposing the property on the lending community where it belongs.

And what of the Wall Street entities that have taken a financial beating as the bottom dropped out of this market? They get to be the roadkill on the capitalist highway, food for scavengers in the financial market. You wouldn't know it from the headlines dominating the news media today, but there are plenty of financial institutions that have been prudent and maintained their liquidity though this chaos. They are going to get some bargains in the months to come.

Via Tanta at Calculated Risk, here's a post by Dean Baker that I would co-sign if I could. The teaser:

The whining from Wall Street is growing louder. Those brilliant high-flying hedge fund managers are now facing the prospect of financial ruin. It seems that they are holding hundreds of billions of dollars of mortgage debt, some of which is worthless, and much of which is worth considerably less than it was a few weeks ago. Since the hedge funds are heavily leveraged (they borrowed heavily to buy assets), many of them could be wiped out.

Given the gravity of the situation, the hedge fund crew is doing what all good capitalists do when things go badly: run to the government.

Specifically, they want the Federal Reserve Board to bail them out with lower interest rates. They hope that this will buy them the time needed to dump their mortgages on less well-informed investors.

The hedge fund folks say that this is the Fed’s job, that it must step in as the lender of last resort and restore order to the market. That ain’t necessarily so.

He's diagnosed this exactly right and proposes a novel idea at the end of his post about how to protect some of the mortgage borrowers who may lose their homes. Read the whole thing.

Keeping with the theme of betraying conservatism, I should point out that government bailouts of risky or stupid businesses are right near the top of the list. I thought St. Louis Federal Reserve Bank President Bill Poole had it right in his speech last month. A key excerpt:

The Federal Reserve had followed developments in housing and the non-prime mortgage markets very closely this year (Bernanke, 2007a, 2007b, 2007c). A highly visible development is the growing amount of financial stress among some of the millions of households with non-prime mortgages. We know that many non-prime mortgage lenders and brokers have gone out of business or tightened their lending standards this year, reducing the flow of mortgage credit to borrowers unable to access the prime market. Financial markets have dealt harshly, but on the whole appropriately, with banks, hedge funds and certain other investors who were heavily exposed to the riskiest segments of the non-prime securitized mortgage market.

While none of these developments is pleasant for the lenders and financial firms most directly affected, one cannot help being impressed with the even-handedness of it all. Until we receive clear evidence that basically sound financial decisions and arrangements were disrupted by erratic and irrational market forces, I believe we should conclude that this year’s markets punished mostly bad actors and/or poor lending practices. Lenders who made loans to borrowers without documentation, or who did not check borrower documents that proved fraudulent, or who made adjustable-rate loans to borrowers who could not hope to service the debt when rates adjusted up, deserved financial failure. As is often the case, the market’s punishment of unsound financial arrangements has been swift, harsh and without prejudice. While I cannot feel sorry for the lenders who have gone out of business, my attitude is entirely different toward the relatively unsophisticated, but honest, borrowers who have lost their homes through foreclosure. Many are true victims.

Read the whole thing.