Jewish World Review April 18, 2008 / 13 Nissan 5768
The Case for Housing Help
By Mort Zuckerman
http://www.JewishWorldReview.com | The head of General Motors in the Fifties famously said that "what was good for our country was good for General Motors and vice versa." Today, with homes the largest asset on America's family balance sheet, amounting to about $21 trillion, what's good for housing is what's good for America.
Or very bad for America.
The unprecedented crash in home values, the first since the Great Depression, threatens the entire economy, and it's not over. Home equities are predicted to drop 10 to 12 percent in each of the next two years, reducing value further by the staggering total of $4 trillion to $6 trillion.
The bubble in the housing market that has now burst is causing a daisy chain of damage in America's financial system. The increased defaults in subprime mortgages began to depress mortgage-linked securities last summer, and soon the contagion spread to all sorts of products in the financial world as confidence went into free fall, along with housing prices. This has made it difficult to stabilize the financial markets.
Banks have reacted to their losses on mortgage-backed securities by pulling back mortgage loans, as well as other loans, intensifying the credit crunch and further compounding the economic downturn. The Fed's attempts to halt this negative spiral by cutting interest rates have been largely upset through rising interest rate spreads, i.e., the growing gap between mortgage loan rates and the federal funds rate. The result: Mortgage rates today are higher than when the Fed resorted to emergency rate cuts in January. And because of tighter standards, many types of people who were able to borrow two years ago cannot today, at any interest rate.
No bottom. There is probably no way to stop house prices from falling, but the current crisis won't end until buyers think prices have hit bottom. Only then can we hope to clear the excess supply from the market.
What's critical to recognize is that house prices had begun to fall even before the recession began and without the shock of higher interest rates. This is conclusive evidence that a speculative bubble was in place. It was fueled by excess credit creation and lax lending standards. The estimated losses exceeding $1 trillion are not fanciful when you realize how many of the mortgages that originated in the past several years came with little or zero down payments. Borrowers putting a 10 or 20 percent down payment on their homes are almost mythological figures today.
The stark possibility now is that 15 million homes will have mortgages that exceed their value. We are talking about almost 30 percent of the nation's 51 million households ending up with negative equity, which means the owners have an incentive to walk away from their mortgages. Today, 8.8 million homeowners have a clear financial incentive to abandon their homes. The housing binge is ending with a hangover.
If millions of Americans do walk away from their homes or are forced out by involuntary foreclosures, the effect on the value of whole neighborhoods may be catastrophic. Abandonment increases decay and crime and accelerates further reductions in home values. What a challenge it is to American daily life and American politics! The economy is back at the heart of our politics, and so is fear.
Political policy contributed to where we are. Can it get us out of the mess? Politicians had long wanted to raise homeownership through subsidies, tax breaks, and dedicated agencies, such as Fannie Mae and Freddie Mac. When George W. Bush became president, he challenged lenders and others to create over 5 million new minority homeowners by the end of the decade. In 2003, he created a program that would offer money to the poor so they could secure a first mortgage. Many lenders stopped requiring sizable down payments from people who couldn't afford them. They often did the deals without documentation of family income and net worth. These "no docs" homes amounted to almost 44 percent of subprime borrowers in 2006 alone. But they weren't the only borrowers who were encouraged to take the over-the-top mortgage money. Included were people with higher incomes who wanted to speculate on housing and many homeowners who refinanced to cash out their equity stake, thus assuming more mortgage debt than they could afford. In a word, the nation gorged itself on accelerating home prices.
Both the Republican president and Democratic members of Congress pressured the government mortgage lenders Fannie Mae and Freddie Mac to provide the funding for riskier mortgages, and then Federal Reserve Chairman Alan Greenspan resisted the use of the Fed's authority to regulate lender behavior aggressively on the grounds that the economy and the financial markets did best when they operated as freely and as unregulated as possible. So if the public in this election asks who is at fault, the answer is that the failure stretches across party lines and includes regulators.
Now that the housing bubble and the financial bubble have both burst, how do we get back to stability?
The government is finally seeking to assist borrowers who owe their banks more than their homes are worth. The government program aims to have the Federal Housing Administration encourage lenders to forgive a portion of those loans. If they take the loss and issue new, smaller mortgages, they'll get the federal government's financial backing. The most hard-pressed borrowers will be able to repay loans that are too large relative to their incomes or the diminished value of their homes.
So far, so good. But the government has to enforce tight standards. And it should not bail out any of the following:
Flippers: speculators who never occupied their homes or people who bought second homes they couldn't afford for purposes of resale.
Liars: who took out what are now called "liars' loans," which exaggerated their income or their net worth or pledged that they were going to become owner occupants when in fact they were just speculators.
Certain lenders: those who made imprudent loans in order to generate fees and bundled the loans and sold them off as securitized obligations to other financial institutions.
The legislation should be restricted to help only those who can and will stay in their homes with a modest amount of aid.
Remedies. The proposal of the House Financial Services Committee is that the new loan would be worth no more than 85 percent of current appraised value and must adhere to other federal loan limits, such as a top amount of around $730,000. Further, homeowners would be required to share any profits if they sold or refinanced within five years. Some estimate that this plan could save as many as 2 million homeowners from foreclosure.
This legislation is not without its problems. The first is finding the actual owners of the mortgages so that they can be brought to renegotiation-no simple matter, given how many mortgages were bundled together. Other questions arise. What standards should govern how the property is appraised? Should the value be the likely proceeds from the patient sale of a house? Is it the price in today's chaotic market, or is it what the price would be in a calmer market? How do you appraise the value of the house if there are no buyers because prices are still declining? Bloated appraisals were part of the problem in the past because appraisers, paid by either the borrowers or the lenders, too often exaggerated the home values to maximize the amount of financing. Such risks to worry about were captured by the headline of a newspaper ad for a jeweler: "Guaranteed to appraise for more."
The Senate version is as close to a boondoggle as you can get. The worst provision is retroactive tax breaks for home builders and banks, which is nothing more than a typical response to the powerful lobbyists of these two groups. Please explain why these institutions deserve benefits at taxpayer expense, given their overwhelming business misjudgments of the past half-decade-never mind the huge profits they made. It would also provide billions of dollars in block grants to let cities and states buy properties from grateful banks at still-inflated prices. Which homes are to be bought in which markets and at what prices is barely considered. The best part of the Senate program is the $7,000 tax credit for buyers of foreclosed properties, which should help limit the number of houses sitting vacant and deteriorating.
Clearly, any good rescue legislation cannot be created in a stampede simply to make it look as if politicians are doing something. One thing for sure is that the government should steer clear of spending billions on buying already foreclosed homes. Why bail out the lenders who made the excessive mortgages in the first place? Any program must be carefully framed to avoid sticking the government with billions of dollars of additional losses. As a recent Financial Times article put it, "The prudent should not have to bear the cost of the profligate."
This crisis represents a major challenge to our political leadership. But to come up with the right programs, Congress should set up an advisory group made up of professionals in the world of mortgage finance and residential housing to ensure that programs are effective and fair to the public.
The basic thrust of the programs must be to protect homes from being foreclosed. When that happens and the houses are thrown on the market, they just compound the downward pressure on prices. The main focus, then, should be to protect certain home occupiers by helping them refinance their mortgages to make the debt service affordable. The natural question is: Why should the federal government bail out homeowners in a declining home market any more than it should bail out stock buyers in a declining stock market? The answer is: because the whole economy, including the stock market, turns on the housing crisis.
Many have opposed the use of public money to stabilize the situation. But the private sector has to date failed to stabilize the housing crisis, and time is running out. The first duty of the Federal Reserve and the financial regulators, and ultimately of the politicians, is to make sure the financial system doesn't collapse. Because if it does, the economy could go with it.
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© 2008, Mortimer Zuckerman