Economics of Contempt is tentatively defending the "Own-to-rent" plan proposed by Dean Baker.
I must admit, when I first read Baker's proposal, it struck me as a gross interference with property rights to give tenants the right to rent the property for so long (especially after foreclosure). But the more I thought about it, the more comfortable I became with it. Yves Smith, in defending the proposal against Ken Bunnell's charge that it will degrade communities because renters tend to make bad neighbors, captures it perfectly: "Give people property rights, and they act like they have property rights."
I have great respect for EoC, and for Andrew Samwick, who is a fan. But as it happens, I've been going to a lot of events on the crisis and consumer credit over the last few weeks. And the consensus on this plan is it can't be done, for multiple reasons:
1) What is the "fair market rent" to be determined by an "independent appraiser" on a 90% empty exurban development without the legal minimum sales to form a homeowner's association?
2) The tenants may be willing to invest in upkeep, but who fixes the plumbing when it breaks? The servicers are not rental agents. Moreover, they have no legal ability to become rental agents under their contracts. There is no entity in the position to take the role of landlord to these people. This is seen as the biggest--nay, insurmountable--obstacle. The only way this would work is if the government took possession of the homes, i.e. gigantic government bailouts.
3) There will be considerable political pressure on the "independent appraisers" to keep the fair market rental value down, handing the banks a loss.
4) Most of the people with the really problematic loans probably can't afford to rent their house, either.
5) To the extent that they could afford the rents--i.e. that houses were massively overvalued--you're putting a big capital loss on the bank's balance sheet and keeping it there, year after year, rather than writing it off.
6) The worst hit homes are in "developing areas" that are now rapidly "undeveloping", meaning that there aren't adequate services there. Encouraging people to stay in those areas is not, in the long run, a good idea. It also isn't a good idea to make people less mobile during an economic downturn.
7) Some of the worst hit homes are in areas where the tax base will not support the cost of basic services to the developments that the government is encouraging people to stay in.
8) Who gets to vote on the board of the homeowner's association? Are various servicers supposed to send people to represent their interests? Who pays the property taxes? You're sticking banks with a long term asset that neither they nor the servicers are set up to handle at all.
9) Keeping bad assets on bank books for years and years was, many argue, the main factor that made Japan's economy so festive in the 1990s. We should probably not repeat their error.
The rent-to-own plan is an attempt to engineer a bailout for free. And like most such "free" goodies, it seems like it will probably end up costing us more in the long run.
The worst hit homes are in "developing areas" that are now rapidly "undeveloping", meaning that there aren't adequate services there.
???
Most of what I have seen suggests that the worst hit areas are in inner cities. Google "Slavic Village +Cleveland" for an example.
I don't by the way support Baker's plan, which I think is pretty nutty, but I would support a reform whereby people already renting homes that go into foreclosure should be allowed to stay through the end of their lease, and according to its terms, paying rent instead to the mortgage-holder or new owner until then (repairs could be undertaken at their owen expense and deducted from rent payments). Currently renters have almost no protection and since, assuming they are current on their rent, they have done nothing wrong, they should be held harmless in these situations. Their presence would even be a positive sincet he house would remain occupied and a source of income for the mortgagee who is otherwise collecting nothing while having to pay taxes and certain basic utilities and services to keep the house habitable.
$10/gal gasoline will vastly change where middle class and less than middle class choose to live. People may decide to live within walking distance of merchants selling food, cleaning, drugs, and other day to day supplies. They may come to prefer narrow streets over broad avenues, interior courtyards over spacious lawns, and other changes that occur when people walk rather than ride.
Currently unsold housing may become unsellable.
Sol, you must live in a nice city neighborhood, filled with agreeable people.
I don't. My urban neighborhood is filled with nasty people who act like overgrown adolescents who blast their music out of their cars as they roll up at all hours, thump each other against the walls, and those merchants selling food? Uh, yeah, ick. Oh, but there's plenty of drugs within walking distance, although I'm sure that's not the drugs you meant. Or maybe it is, I'm not sure. And I haven't even mentioned the roaches my wife and I have been dealing with because the neighbors don't take to cleanliness as might be optimal to keep the pests away.
When you move to the suburbs, you have a greater choice in neighbors. This is why people choose to live there, and will continue to do so. Thankfully, in the Information Age, the means will be there to offer telecommuting options so that the liberal utopia of forcing us all back into the urban lifestyles that seem so wonderful to you, Sol, might not have to happen to all of us.
Megan
If item 2 is, as you write, "the biggest--nay, insurmountable--obstacle", then this shouldn't be too hard a policy to effect. The simple solution is to require servicers to hire property management companies using standard contracts to provide standard services and then tack the cost (or some to-be-determined share of the cost) of said management on to the rent. Government possession isn't necessary.
I think the fair market rent issue is much harder to get right. As you suggest, it is difficult to determine the "fair market" price of something that is traded thinly (if at all). One possibility would be to hold auctions for the assets held by the servicers, with all parties understanding that the rent would be the 30-year amortized value of the auctioned price. Servicers that hold them could themselves bid on these assets, of course. There are problems with this approach, including potential info asymmetries, but offhand I don't think it's unreasonable to think it could do a decent job. An added bonus of the auction approach would be that it addresses your item 3 as well as item 1.
Item 4 involves an empirical question that I don't have the data to answer. I will say, tho, that I suspect that in equilibrium it wouldn't be true that "Most of the people with the really problematic loans probably can't afford to rent their house, either". If the people living in these homes can't afford to rent them, then either there is someone else out there willing to pay the mortgaged value of the home (doubtful, given the current crisis) or the value of the home is lower than the mortgaged value -- which is the starting point of the own-to-rent approaches as I understand them.
My understanding of the issue in item 5 is that the write-off would happen once, up front, tho again this ain't my usual bailiwick.
Item 6 is a fair point, tho it's also not clear that it's efficient to simply leave an enormous amt of sunk housing capital there to rot. The key question here is the extent of network externalities that lead to potential coordination problems (I will live in area A if and only if you will, and you will live there if and only if I will).
Item 7 is a good point.
Item 8 is intriguing. But I'm not sure how leaving foreclosures to occur ameliorates it. Also, there is probably a way to give the managers I suggested above an equity stake to induce them to participate in HOAs. Another thought is that a Coasean analysis would suggest likely consolidation of properties held by dift servicers in order to minimize such operating costs (though as ever in Coasean situations, there is the question of how costly bargaining among servicers would be).
Item 9 is basically item 5 restated, so I won't comment further.
I don't think it is true that "The rent-to-own plan is an attempt to engineer a bailout for free." I'm guessing that a thoughtful small-govt guy like Andrew Samwick (for whom I do not claim to speak!) supports this sort of plan not because he thinks it's free, but rather because it's better than the alternative situation. Yes it may involve some costs. But so would laissez-faire.
Just my 9 cents.
(repairs could be undertaken at their owen expense and deducted from rent payments)
That's supposed to be a solution? I mean, sure, arrangements like that are feasible when the renter and tenant negotiate the terms on a case-by-case basis. For example, I once patched, repainted, and re-caulked a couple restrooms while subletting a room for the summer, because the landlord and the primary renter arranged for such things as they came up, and it was a faster and less invasive means of getting minor repairs and maintenance accomplished.
However, if this were a legally-mandated term of a foreclosure lease extension, such an arrangement would be wide open for the same kinds of fraud that occur in government contracting.
Re: However, if this were a legally-mandated term of a foreclosure lease extension, such an arrangement would be wide open for the same kinds of fraud that occur in government contracting.
Presumably one would need receipts and either credit card statements or cancelled checks to back up the deductions. Certainly not just word-of-mouth claims! There are already many rental markets where tenants have the legal right to do this if landlords fail to make needed repairs so such a system can work.
Re problems 5 and 9, I don't see why banks can't sell the land, encumbered by the lease, and take the writeoff.
All these problems seem to have solutions. They might not be perfect solutions, but the present situation is far from perfect. The question is whether Baker's solution improves over the present.
Michael:
Well clearly there are various kinds of urban areas, and of suburbs. If your area offers greater choice in style of suburb than in urban area, then fine, it sounds like you should move to the suburb!
But don't assume that that's the only kind of urban area possible. Walk a few nice districts in any European city when next you're there. I think Sol would like to see more of these spring up in American cities.
Megan,
I'd like to invite your blog readers to visit our site at http://www.SwapRent.com and provide some further comments. Thanks.
rrrrrrrfrfrrrrrrrrrrrr
Michael, at $10 /gal, unless you are very rich, you will have to choose between buying gas and buying clothes, food and precription legal drugs.
For most drivers $10/gal equals $1/mile just for fuel!
There is no question people will have to make choices, given our current environmental laws.
There is more oil off our continental shelf than there is in the Middle east - but is legally untouchable.
There is more oil locked in oil shale in the Rockies than there is in the Middle East - but it is legally untouchable.
There is more oil under the polar ice cap than there is in the Middle east but it is legally untouchable.
There is more oil locked in Western US coal deposits than there is in the Middle east but it is legally untouchable.
So get used to moving back to the ghetto Michael because you voted for the men and women who created the laws that stopped oil production and refining in the US and will give us $10+/gas, which will happen when 1 billion Indians and 2 billion chinese start driving to the sea shore or the mountains for their European vacation.
Re: For most drivers $10/gal equals $1/mile just for fuel!
Surely most cars get more than 10m/gal?
Anyway I don't see 10/gal unless there's some sort of major disaster (a massive war or natural calamity shutting down production for a long while). Most likely we will see the current bubble pop and gas fall back below $3/gal before the election (for obvious reasons-- remember September 2006?). Of course there's no going back to the 90s prices, and long term we will see a gradual rise so that in a generation or two that 10$/gal may be on the horizon but by then we will be doing all sorts of things to substitute for oil. And, yes, $10/gal makes alternative fuels entirely economical even today.
Why would a bank trash its mortgage, incur lots of expenses and troubles to foreclose a property only to get stuck with the foreclosed property to become a landlord to the irresponsible borrower when it could simply leave its existing mortgage intact, give the homeowner in need a fair monthly subsidy and become a temporary "economic landlord" through a simple SwapRent (SM) transaction? The bank could subsequently transfer this real estate exposure through the SwapRent (SM) contract to some other investors much easier and cheaper than trying to sell the actually foreclosed property. This is a new consumer finance concept we introduced years ago as "economic renting" of a property while letting the homeowner continue to keep the legal title ownership. For more details please review the research info at http://www.SwapRent.com . Further comments would be appreciated. Thanks.
Since I was about 12 years old, my preferred solution for what to do with exurban developments has involved napalm. So I don't really have anything to contribute to this conversation.
What nobody seems to be bringing up is that any of these compulsory "buy-to-rent" schemes are retro-actively changing the terms of an agreed-upon contract.
By forcing the bank to take a bad deal (becoming landlords of these deadbeat properties) as an alternative to foreclosure, you are essentially laying an ex-post-facto punitive action on them when they did not, in fact, do anything wrong beyond making the foolish choice to loan money to somebody that was unlikely to pay them.
The best thing that could happen for the market would be for the government to do NOTHING. People who took out "balloon payment" loans will walk away losing nothing, because they have NO money tied up in their homes. They effectively rented a house for a couple years at astonishingly low rates. They're left with no equity, but they never paid into building any equity, so you can't say they lost anything. Lenders will lose some money foreclosing and re-selling the houses in question, and they should. The market price of real estate will dip for a year or two, but there's a reason why economists call it a "correction" when a market bubble bursts. All is as it should be, given the choices which all parties involved made.
Just as sometimes the best treatment for a fever is to let it run its course, the solution to the current mortgage crisis is time. Time, and a lack of monkeying with the market which could ultimately do way more harm than good.