Moral Hazard of the Coming Mortgage Bailout
“Why am I being punished for having bought a house I could afford? I am beginning to think I would have rocks in my head if I keep paying my mortgage.”
-Todd Lawrence, Norwich, CT homeowner with a traditional 30-year mortgage
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Herein lies the simple problem in trying to “save” so many mortgages: A huge swath of them should not be saved. Some of that is due to price, some of it is due to not wanting to reward irresponsible behavior, but the bulk of it is simply because the people living in these homes cannot reasonably afford to pay for them, even after a 20-30% workout.
There are now more than 10 million “home-owers” underwater, with their mortgages greater than the present value of their homes. Since they have little skin in the game — thanks to banks that did away with down payment requirements — there is little incentive for them to tough it out.
Not surprisingly, it is FDIC Chairman Sheila Bair who is leading the push towards a mortgage workout plan. She wants policy makers to take action to help people stay in their homes — thereby taking pressure off of the FDIC, which insures the banks.
Why? More foreclosures = more bank failures = bigger FDIC obligations.
The problem with this current rescue plan is that it is designed to “prevent the continued downward spiral of the housing market.” But that is EXACTLY what the housing market needs — overpriced homes that are not selling need to come down in price. We had a normal price increase from 1996-2001, and then a near vertical set of price gains from 2002-06. Any framework for systematically modifying loans that fails to comprehend that is doomed to failure.
(permanent post here)
Here is the grim reality about home prices: They remain elevated by just about every historical metric. Look at the median income to median home price, or look at the cost of renting versus the cost of ownership. Look at the inventory for sale, relative to 5 year trailing price increases.
The bottom line is that in much of the country, prices are still too high. That’s reflected in all the inventory that is not selling.
And home sales typically tend to be a chain of prices and sales: The seller of the starter home tot he newlyweds then can move to the larger home with room for their growing family, and that seller moves to an even bigger manse, and so on and so on. But if the newlyweds cannot afford that first purchase, the entire chain gets slogged down.
The notable exceptions? Where foreclosures have driven prices down 40, 50 even 60%, home sales surge. Much of our leadership fails to understand that simple truism about home prices.
As we detailed in our “Fixing Housing Proposal,” you want to save the homes where there is a reasonable justification for a mortgage workout. This means where the home price can be reasonable, the mortgagee can afford it, and the mortgage holder willing to take a modest haircut. Otherwise, you reward bank lenders and home buyers who were utterly reckless, and punish those people who were prudent and responsible.
Moral hazard not only encourages recklessness, it leads to people looking to avoid responsibility for bad decisions. We see this in groups seeking credit card debt forgiveness — only because the current climate encourages it.
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(permanent post here)
Previously:
Fixing Housing & Finance: 30/20/10 Proposal (9/22/08)
http://www.ritholtz.com/blog/2008/09/fixing-housing-finance-302010-proposal/
Sources:
Mortgage Plan May Aid Many and Irk Others
DAVID STREITFELD
NYT, October 30, 2008
http://www.nytimes.com/2008/10/31/business/31bailout.html
Treasury, FDIC Said to Craft Plan to Curb Foreclosure
By Alison Vekshin and Robert Schmidt
Bloomberg, October 29 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asOlfO5uPwIY
Relief Nears for 3 Million Strapped Homeowners
MICHAEL R. CRITTENDEN and JESSICA HOLZER
WSJ, OCTOBER 30, 2008
http://online.wsj.com/article/SB122531677860781723.html
More U.S. Homeowners Have Mortgage Higher Than House Is Worth
Dan Levy
Bloomberg, October 31 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aYyk2_TLjGao
Groups seek credit card debt forgiveness
(AP) October 29, 2008: 9:47 PM ET
http://money.cnn.com/2008/10/29/news/economy/creditcard_bailout.ap/index.htm
New Loan Fix Is Unlikely the Last
FDIC Plans Mortgage Guarantees; Lawmakers Consider Pressuring Reluctant Investors
JOHN D. MCKINNON and JESSICA HOLZER
WSJ, OCTOBER 24, 2008
http://online.wsj.com/article/SB122477138431362499.html
White House Is Said to Want Limits on Loan-Guarantee Proposal
Alison Vekshin and Robert Schmidt
Bloomberg, October 31 2008
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aQomFeVyf9tk
Friday, October 31, 2008 | 10:09 AM | Permalink
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Comments
Hallelujah.
Posted by: Pilgrim | Oct 31, 2008 10:16:18 AM
If Bush has taught us nothing else, it is that paying back loans is for wimps.
Posted by: Comrade NSA | Oct 31, 2008 10:17:47 AM
I'm one of the responsible that didn't purchase a home that I couldn't afford. Now, it appears as though I'll be punished while others will be rewarded for irresponsible behavior. Is that what America stands for?
I'm very angry about this turn of events and I find it hard to believe that I am alone. At some point there will be a backlash.
Posted by: creechrr | Oct 31, 2008 10:21:40 AM
christ....i could not have said it better
Posted by: harold hecuba | Oct 31, 2008 10:29:03 AM
Saver here. I say no way!
Posted by: BeerdedOne | Oct 31, 2008 10:33:50 AM
Welcome to the USSA (United Socialist States of America). And who's doing all of this? The Republicans -- Bush, Paulson, McCain, etc. The Republicans (including McCain) are pushing the govt-backed restructuring of mortgages based on the homeoccupier's "ability to pay" -- right out of Karl Marx's playbook. It's the apex of hypocrisy for the Republicans to call Obama a socialist.
Karl Marx then:
"From each according to his ability", to each according to his need (or needs) is a slogan popularized by Karl Marx in his 1875 Critique of the Gotha Program. The phrase summarizes the principles that, under a communist system, every person should contribute to society to the best of their ability and consume from society in proportion to their needs, regardless of how much they have contributed.
Republicans now:
The Washington Post says that the Treasury Department and the FDIC are considering a plan to guarantee millions of mortgages. According to the Washington Post, the plan under consideration would encourage lenders to reduce borrowers monthly payments based on the "homeowner's ability to pay". To attract lenders into the program, the government would guarantee to repay the lender for a portion of its loss if the borrower defaulted on the reconfigured loan.
Posted by: Bill J. | Oct 31, 2008 10:37:28 AM
"The faster we dump all these losses on the U.S. taxpayers the faster we can forget about this wake-up call from hell and get back to some serious partying."
- unnamed White House occupant
Posted by: Winston Munn | Oct 31, 2008 10:41:01 AM
I, too, stayed out of the market as it bubbled to unsustainable heights. So I'm along with other responsible individuals are being punished.
Both parties are doing the screwing. I'm madder than hell and agree a backlash is coming.
What form will it take?
Posted by: kelja | Oct 31, 2008 10:41:26 AM
I have waited for years for housing prices to return to fundamentals. From an economic and mathematical perspective: I have been correct. From a perspective of responsibility: I have been correct. I continue to throw money away on rent, because for years I have known that housing prices would fall -- and fall dramatically. Now I learn that I will be taxed to help support that which cannot be supported by fundamentals. Where is my bailout? And why on earth would I want to play this game?
Posted by: ignatz | Oct 31, 2008 10:42:54 AM
Unfortunately, nothing the govt is doing will make people buy homes, or stop the fall in prices. Especially as unemployment is about to jump big time.
Its unavoidable. But you are right, policy could have been designed better. For now, its a continuation of reverting back to the mean.
Posted by: UrbanDigs | Oct 31, 2008 10:46:54 AM
I rent a small 2 bedroom apt with my wife and 2 kids. We all share a single bathroom. Why? Because housing prices have doubled since 2000 and I didn't want to be caught underwater. What was I thinking? Underwater is apparently the place to be.
Posted by: BarryB | Oct 31, 2008 10:48:47 AM
@ignatz:
I have done exactly as you, patiently renting, awaiting the correction, and now I am so disillusioned I don't know what to do. I certainly don't understand this game.
Posted by: Bill J. | Oct 31, 2008 10:51:27 AM
They should be able to figure it out pretty quickly.
30-yr fixed rate mortgages for people with good credit are very reasonably priced right now. If their documented income can't support a refinanced 30-yr fixed rate mortgage, then they probably shouldn't be in the house.
I think the plan should be focused on restructuring to a new 30-yr fixed rate mortgage with no fees or points. Give the folks who have documentable income adequate to service the mortgage an interest rate of about 6.25% or so.
Any cut in the principal should be structured so that it eventually comes out of house sale proceeds at closing if there is a profit after the mortgage, broker, real estate etc. fees and taxes are done. It is only a true writeoff if the house doesn't appreciate significantly.
I think that this type of program would help keep many people in their homes without a great deal of moral hazard.
Posted by: rd | Oct 31, 2008 10:52:19 AM
Winston Munn. Ditto.
It can be summed up with one word. 'Politics'.
(And 'Politics' usually has the unintended consequence (or perhaps it is intended) of making things worse.)
Posted by: John | Oct 31, 2008 10:53:10 AM
I have a good job that pays well and is going to be for the most part unaffected by the economic downturn. I have an excellent credit rating. However, what this teaches me is that I should probably run out tomorrow, buy a 1 million dollar house that I know I can't afford and immediately stop making payments on it because the government will ensure that I get to keep my house. And oh, by the way, I'm also going to stop paying off my credit cards every month and run up huge credit card debt since those people are next to get bailed out. I want my fair share of the pie.
Totally disgusted.
Posted by: Molecules | Oct 31, 2008 10:54:30 AM
I own my house outright and I understand the value of my home will drop if there are lots of foreclosures, but, in the long run, I'll come out better.
I think the idea is once people are no longer underwater, they can sell their home, but I think what will happen is the same thing that happens during rent control. No one moves. They get a sweet deal on their existing home and a relatively bad deal on a new home. Peoples ability to relocate is very important for a healthy economy.
This will end very badly if enacted.
Posted by: charlie | Oct 31, 2008 10:58:49 AM
I'd also like to add that I think if such a bailout were to occur, there should be major repercussions for any family/individual that has the loan he can't afford renegotiated. Similar to the CEO pay cap. Something like you are forced to give up all credit cards and your credit score goes to 0. Not that any politician has the guts to suggest anything like this.
Posted by: Molecules | Oct 31, 2008 11:00:03 AM
Comrade NSA,
Don't despair. You are not alone. I am organizing a small group of dedicated individuals to lead the revolution. You are welcome to join us. We will be issuing firearms in the coming weeks. I anticipate numerous summary executions of those individuals responsible for this mess and our government's pathetic response, which makes all financially responsible Americans feel like chumps for living within their means. Feel free to send me names for addition to the list.
Seriously yours,
Posted by: Hankster | Oct 31, 2008 11:02:27 AM
Forgive us our debts, as we forgive our debtors…..it’s one of the difficult aspects of Christianity to accept. Where’s the accountability? This mortgage bailout hinges on popular support. I happen to be in the camp that bought a modest house in 2007 that I could afford with a 30-yr fixed and paid 20% down. If I lost my job, there is certainly the possibility that I could find myself in the camp struggling with mortgage payments trying to provide my family with food, clothing and shelter. Not that I would demand, expect or even request help from government, but few people seem to have any pride left to refuse a handout when they’ve lost hope and hit rock bottom.
The devil is in the details. I bought a MODEST house I could AFFORD that is my PRIMARY and only residence. Nobody wants to bail out the guy who invested in 3 rental properties and upgraded his primary residence to a McMansion who chose to risk being “underwater” for the reward of potential profits.
The problem is, the government is terrible with details and lawyers and tax accountants have a knack for exploiting this. Assuming government continues to spend like crazy and bailout everyone with a pulse, won’t TIPs be a safe investment for the long run? Any other good long term investments? I’ve never liked gold that much as I prefer something I can eat.
Posted by: GreenMachine | Oct 31, 2008 11:03:50 AM
The politicians are creating a new moral hazard so just as we debate this disgusting affair, the lowlifes with just enough brains are scheming. If they can't swing a mortgage, they'll surely max-out their credit cards.
Posted by: Bill J. | Oct 31, 2008 11:04:44 AM
30yr fixed jumbo loans are over 10% APR right now. In So Cal and nicer parts here in AZ, 417,000 isnt going to get you very much.
Posted by: whaa? | Oct 31, 2008 11:07:22 AM
Barry: why not bailout homeowners? The gov't is bailing out everything else, except Lehman and that "mistake" isn't suppose to happen again. The truth is, lenders/secondary market investors have been making sweet deals for homeowners by reducing principal (95% of market value) and interest (3.5%) to prevent foreclosures. This isn't due to the goodness or charity--its self preservation.
Posted by: johnnyvee | Oct 31, 2008 11:09:20 AM
I dont understand the fear sales pitch our countries leaders continue to use and fall for. Save 'such and such" or else things will get worse... I just picture Big Ben standing above congress yelling "Do it, Do it, Do it" The problem is simple, asset class that bubbled, levered contracts written on them. Nothing will fix this but time or possiblily inflation. What do we save next? Do we buy all the credit card abs, because people cant pay their credit cards? Or are we going to buy student loans because students have no job prospects and wont be able to pay down their loans? Check out the link below, great speech from Buffet, it rings loud and true about sticking with investments you understand.
http://darthbeta.typepad.com/blog/2008/10/long-buffet-spe.html
Posted by: darthbeta | Oct 31, 2008 11:10:44 AM
Let the pigmen and the debt-slaves burn. Period.
Posted by: Ignatz | Oct 31, 2008 11:13:48 AM
I agree totally - the whole thing is a sham to make the Wash DC politicians look good while they tell us how they feel the pain of the "little guy". See my post at: http://sfpeninsulareguru.com/any-homeowner-mortgage-bail-out-will-not-be-fair-and-will-not-work.html
Just letting homes go to foreclsoure will typically hurt the lenders/investors who hoped to profit from these absurd mortgages. Most of these homeowners do not have a dime into the property so basically they have rented the property for a few years. Their credit was already bad so it won't get any worse.
America is the land of opportunity.
It is NOT the land of guarranty.
Posted by: Arn Cenedella | Oct 31, 2008 11:20:07 AM
