Liquidate The Homeowners!


GOP MOSTLY QUIET ON FORECLOSURES – Morning Money spent some time yesterday looking for other Republicans who might back House Minority Whip Eric Cantor (R-Va.) in his strong opposition to a moratorium on home foreclosures. None immediately turned up. (If you ARE one, drop us a line). Banking executives and their lobbyists said they were not yet aware of any of their usual allies in the GOP willing to take a strong public stand in favor of allowing foreclosures to continue, highlighting the sensitivity of the issue so close to the midterms.

One top lobbyist for a big bank said it would take more high-profile independent analysts coming forward to explain how disastrous a moratorium (or state moratoria) could be in order to get more politicians to step up. “They need some cover,” the lobbyist said. For now, the Obama administration remains the firmest voice opposing any kind of federal moratorium, arguing that many foreclosures are legitimate and that the process, while painful, is necessary to heal the housing market and the broader economy.

Well let’s provide some anti-cover. The massive wave of foreclosures have almost certainly been a major problem that has large spillover effects and has dampened the economy recovery. To the extent that it isn’t, the way we are approaching it is the worst possible.

Separately, is anyone else disturbed by the “Liquidate the Homeowners!” approach that is implied here?   That we need to force as many foreclosures as possible in order to heal the housing market?   Isn’t that like letting someone who’s arm is cut off bleed out to heal him instead of applying a tourniquet?

Basics here:  Foreclosures have large contagion effects.  This has been extremely well confirmed by such esteemed financial econometrician as John Campbell, and that is for normal times, not extreme crisis times like we are currently. A foreclosure brings down the price of neighboring properties, making it harder for neighboring homeowners to sell their own. These have cumulative effects.

Foreclosures are usually lose-lose-lose-win. Homeowners lose, as they are kicked out of their homes. Lenders lose, as there is usually a price the homeowner can pay above the recovery value. Communities lose, as there are now abandoned and foreclosed properties laying about. Servicers, middle-men and foreclosure mills win however. So good for them.

The “look the other way” at the foreclosure fraud and the lack of emphasis on modifications and workouts that has been the de facto policy in the country may have transferred huge costs to municipalities that now have to cover taxes and upkeep, an ugly and anti-stimulus form of bank bailout. (See here for more.)

The IMF recently found a strong correlation between foreclosures and unemployment, concluding: ” Measures to raise the number of mortgage modifications, and if needed allowing mortgages to be renegotiated in courts (“cramdowns”), could also be important, as they would help to clear the housing markets more quickly.”

The problem is a debt overhang, not irresponsibility of people who happened to buy at the wrong time. People buy assets at the wrong time all the time; how that loss is shared and worked down in a fast, clean and efficient manner is the most important point. Allowing banks to rework mortgages in bankruptcy is normal in every corporate situation and every other type of situation except home mortgages. We can even create a special type of bankruptcy if we needed in order to protect other consumer debts. We could also emphasize short-sales or, even better, a right to rent approach. A good modification has all the benefits of foreclosure without most of the costs.

We have been on the “Liquidate!” path, though it is not too late to turn back.

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9 Responses to Liquidate The Homeowners!

  1. “Foreclosures have large contagion effects”

    What evidence is there of contagion effects? The paper you cite says, “Despite the plausibility of these concerns [contagion], we find at the zipcode level, the prices of forced sales have little predictive power for the prices of other transactions in the housing market.”

    They do detect a correlation, but its small and they can’t prove causation. In other words: bad local market conditions may be correlated with foreclosures but that doesn’t mean the foreclosures are causing the bad local conditions. To quote, “A challenge in interpreting this result [correlation between foreclosures and local market conditions] is that local economic shocks, such as plant closings, may drive both house prices and foreclosures… foreclosures are endogenous to house prices because homeowners are more likely to default if they have negative equity, which is more likely as house prices fall.” The solution would be to find an instrument uncorrelated with local housing market conditions but correlated with the probability of foreclosure. They didn’t find such an instrument.

    Even if we interpret their estimate causally — each foreclosure reduces home prices within a tenth of a mile by 1% — this 15% is dwarfed by the overall reduction in house prices over the last couple of years.

  2. Hah, something got cut-off in my previous comment.

    Where did the 15% come from in my previous example? In my head I was comparing the extreme case of having all my neighbors foreclose with the average price decline. So the ~15 neighbors that are within a tenth of a mile to me leads to 15% reduction in the price of my home. By contrast, my home price probably went down 30-40% in the last couple of years for reasons unrelated to foreclosures. The point is that even in an extreme case of massive foreclosures in my neighborhood would have less of an effect on my home price than the general decline.

  3. Two Things says:

    Hey! In your “lose-lose-lose-win” formula you left out one IMPORTANT group: prudent home-buyers who sat out the bubble and now want to buy a home at a price close to the long-term (50+ year) trend line! Why should the government prop up housing prices? That’s just taxing the prudent to reward the imprudent!

    Damn and blast the people facing foreclosure because they cannot afford the mortgages they mostly got by loan-application fraud and HELOC abuse. Those people aren’t even “homeowners” because they NEVER had the ability to pay off their mortgages– they were just speculators who expected greater fools to cover their bets. Real homeowners (those with reasonable LTV and ability to make payments) are NOT facing foreclosure.

    The best way to resolve the “foreclosure crisis” is to assist people who can’t afford their mortgages to move out so their houses can be sold for reasonable prices.

    Try my proposed government program on for size:

    1. We give everyone who is “upside down” on a house or condo and whose mortgage payments exceed 40% of their after-tax income a chance to move out now. If they do, we give them a sizeable grant for moving expenses. Most will be moving to rentals they can afford.

    2. All the empty homes are put up for auction.

    3. Lenders eat most of the nominal losses (difference between loan principal and auction price). Yes, that means institutions holding MBS will take losses. No one promised them a rose garden.

    4. Former borrowers have to pay income tax on forgiven debt (as it was before the recent emergency exclusion), but we give each a special exclusion of up to 15% of the original purchase price of his former home. That way the HELOC abusers, many of whom borrowed more than their equity(!), will at least partly reimburse the gov’t for the expenses of the relocation program.

    (NOTE: I am NOT minimizing the problems with fraudulent foreclosures by servicers and others who quote-unquote “lost” the actual paperwork/notes. Those people should all be prosecuted and sent to jail after their personal assets have been confiscated for the benefit of the MBS investors. However, the fact remains that many people facing foreclosure have no ability or intention to make their mortgage payments. Though I would not deprive them of their right to be evicted, if at all, through legitimate legal process, I also would not make a gift to them, at the taxpayers’ expense, of the homes they are squatting in.)

  4. Jack Shipley says:

    At the gym a passing acquaintance in conversation said he had just bought a home on foreclosure auction, then turned around and negotiated an affordable seller financing arrangement with the family in the home, who had been baited into a toxic loan. No comment on the upward mobility greed or lack thereof of the family: Many realty agents simply told people what they could afford and very frequently the toxic loan was discovered at the closing table — sign or lose.

    The acquaintance relayed this:

    The bank lost money, probably the same as if it has modified the loan for the family in the first place. He has an asset turning him a roughly 4% return — more than his bank would give him. The family? They’re pretty happy, too.

    Banks seem to have three choices:

    a) Foreclose, lose money, cost community value as a recorded damaged value sale.
    b) Short sale, lose money, cost community value…
    c) Modify, lose money, retain community value (it’s not a sale so doesn’t damage “comps.”)

    Do you feel that’s correct?

    • ace says:

      I like it. It’s something that first occurred to me when the first of the yogurt was hitting the fan. X – 3% is better than 100% of an REO, for all parties concerned. One of those ‘it makes too much sense for it to actually happen.

      This passing acquaintance could practically start a small business doing this sort of demi-mod

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  6. Laurence says:

    contagion is non-linear. 15 neighbors defaulting has probably a much bigger effect than one.

  7. Laurence says:

    A foreclosure affects the prices of *all* the houses in the area (so you need to multiply by all the houses in the radius). On non-linearity: I can’t find appendix table 17 where they did other specifications (but it’s linear in the text). But, distance matters. The closer the neighbor, the bigger the discount (suggesting non-linearity). There are other things. The discount is bigger in poorer census tracts and for cheaper houses, so the poor are hit worst. Also, let’s look at dollar values to get a sense of importance (at p. 18), ” the typical foreclosure during this period lowered the price of the foreclosed house by $44,000 and the prices of neighboring houses by a total of $477,000, for a total loss in housing value of $520,000. If we use the diff erence-in-difference estimate […] the typical foreclosure in 2008 lowered the price of the foreclosed house by $44,000 and the prices of neighboring houses by a total of $148,000, for a total loss of $192,000. “

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