The latest Case-Shiller numbers provide more ammunition to Washington policy makers who want to do more to fix the housing mess, according to Jaret Seiberg, an analyst with the Stanford Group, the policy research firm.
"These data just add to the tremendous pressure on the president-elect and the Democrats to stimulate housing," he said. "That means more lucrative tax incentives and broad foreclosure prevention. All of this will likely be in the stimulus plan that Congress adopts in January."
Nicholas Retsinas, Director of Harvard University's Joint Center for Housing Studies, agrees. "Housing problems are at the core of our economic problems," he said, "yet, of the government interventions made during 2008, few were focused on housing."
With a new administration and Congress in place next month, he expects to see a renewed interest in stabilizing the housing market.
Stabilize how? Give people a ton of money to prevent foreclosure and nifty tax breaks to make their mortgages more affordable. What then? There will still be no buyers, because lending standards just got a whole lot higher--like, 15% down and sterling credit higher, as the article itself points out:
And although interest rates are currently extremely low - the 30-year fixed-rate averaged 5.14% during the week of December 24, according to mortgage giant Freddie Mac (FRE, Fortune 500) - that's doing more to help people refinancing existing mortgages than it is to help new home buyers.
"Buyers still have to have a 20% down payment," said Newport, "and, in this environment, it can be hard to meet that criteria."
An 18% fall in house prices lowers mortgage payments a lot more than a similar fall in interest rates. As long as the rent-to-buy calculation remains out of whack--and for most people, it still is--new buyers won't be coming on the market. Besides, the lower the interest rate is already, the harder it is to generate new interest by lowering it. A 20% drop in a 9% mortgage rate saves the buyer 1.8% of the price of the house every year; a 20% drop in a 5% mortgage, only a little more than half that. With ARM rates low, the problem with mortgages is that the principal is too big, not that the interest rates have shot too high.
The housing bubble produced spectacular overbuilding. The only way those houses can be sold is to lure new buyers into the market--which, for the reasons outlined above, is better accomplished by lowering the principal, not the interest rate. The alternative is to keep prices high, but make markets illiquid--you don't have to take a lower price for your house, but it takes you a long, mortgage-paying year to sell it. This is not an improvement.
The housing bubble produced spectacular overbuilding. The only way those houses can be sold is to lure new buyers into the market--which, for the reasons outlined above, is better accomplished by lowering the principal, not the interest rate. The alternative is to keep prices high, but make markets illiquid--you don't have to take a lower price for your house, but it takes you a long, mortgage-paying year to sell it. This is not an improvement.
Add in the sucky job market and things won't get any better any time soon. Glad to see though that the asking line for bailouts is just getting longer. To those that supported the bailout, I hope you are happy. You helped open Pandora's Box.
Hey you crazy journalist
I'm pretty sure housing prices were down 18% YoY in October, not 18% MoM. So in this sense your post title is incorrect.
Not quite as bad as the headline proclaiming an 80% drop in jewlery sales, but:
Glass houses and all that...
And Ritholtz's blog has a great "Quote of the Day":
Scene: U of Chicago economics class taught by Milton Friedman. After a late night of studying, a student falls asleep in class. This sent Friedman into a tizzy and he came over and pounded on the desk, demanding an answer to a question he had just posed. The student, shaken but now awake says "I'm sorry Professor, I missed the question -- but the answer is increase the money supply..."
Can you say, Priceless!?
1) Somebody explain to me why the #()&* we're trying to prop up prices that are demonstrably above where fundamentals (median incomes, rental prices) place them.
2) I have sterling credit and enough cash that using it all for a 20% down payment would result in a monstrous mortgage I couldn't pay. I did not get there by paying way too much for things. I will not enter the market until prices reach reasonable levels. The more the government interferes, the longer that will take.
Are you listening Portland realtors? No commission for you until you bring prices back down to 3x income.
It's very simplistic to think that stabilizing home prices will resolve the financial crisis. As Brad DeLong pointed out, there has been a loss of say $2 trillion in subprime mortgages, but there has been a decline of say $20 trillion in the values of global capital assets, as credit spreads have widened on essentially every instrument known to man. Propping up housing prices won't make Slovakian sovereign debt, or credit card ABS, or stock in Google, worth what it was a year ago.
The subprime mortgage collapse was the trigger that started a global repricing of risk, but that global repricing would probably have been triggered by something else at some point, and in any case, it can't be undone very readily.
The government should absolutely not be propping up housing prices, but they do need to help people who already have mortgages to renegotiate them in a way that lets them stay in their homes. We don't need a massive rise in homelessness, and leaving more houses empty at a time when nobody's buying will only lead to a decline in the actual value of the houses due to neglect.
You're number 3!
#3: A Megan McArdle Christmas. The Atlantic's Megan McArdle saw one upside to the financial crisis: "It may break the rat race of constantly ratcheting consumption, which has surrounded most Americans with nice things that don't really make them happy." Later she provided readers with a "Holiday Video Game Guide" ("[Mario Kart for Wii] comes with one Wii wheel, but I recommend getting at least one more for multiplayer; we have four") and a "Holiday Gift Guide: Electronics Edition" ("You don't want [the Sony Blu-Ray] player if your television is smaller than 40 inches"). Well, she didn't say these things made her happy.
Katherine: "We don't need a massive rise in people moving from a house they can't afford the mortgage on to a smaller one they can afford to rent, and leaving more houses empty at a time when nobody's buying will lead to a drop in prices, increasing the number of buyers."
Fixed that for you.
Agree with y81. It looks like 'musical chairs' should be reintroduced as part of the finance & economics curricula.
We don't need a massive rise in homelessness
They won't be homeless, they'll be renting. And renegotiating to let them stay in their homes is propping up prices, because if they have to leave, the house goes on the market and helps to push prices back down. No house will be left empty unless it's overpriced.
Rob,
I have a friend who just put an offer down on a house that, if it is accepted, will mean that he will be paying $1098 a month vs. the nearly $2000 a month he would have pay if he bought 2 years ago.
That's nearly a thousand extra dollars a month that can go into savings, college funds, car payments, vacations, etc. You can see a whole new generation of middle class kids starting out in the world with an extra $1,000 a month in their pockets.
I think we need to weigh the pain of all those who got in at the peak against the huge gains 20 something kids about to start families will be able to enjoy for decades to come.
The government should absolutely not be propping up housing prices, but they do need to help people who already have mortgages to renegotiate them in a way that lets them stay in their homes.
1. Renegotiation has been shown to be pretty ineffective.
2. Please expand on the difference between the government propping up housing prices and the effect that the government helping people stay in houses they can't afford will have on sale prices.
jmo,
I'm not sure who you're arguing with, but it isn't me.
Rob,
I wasn't arguing I was agreeing :-)
I just wanted to add that people need to weigh the needs of current homeowners, against the needs to the millions of young people who will be able to start familes without the burden of crushing mortgages.
It's worthjwhile to click the link to go through to the NY Times story that this excerpt is from.
There is a terrific graphic on Home Prices in 20 Cities, which shows the overall US per cent rise and fall in house prices for about the last 60 months or so, and overlays that with the rise anmd fall for each of the 20 cities, one by one.
It really brings out where the house price appreciation was most exaggerated and where the greatest declines have been. One of those instances where an interactive graphic provides a very clear picture.
Hey sorry my stupidity, I think that the article Megan links to is a different one. This is url below (I don't know how to format it as an html link) to the NY Times interactive chart.
http://www.nytimes.com/interactive/2008/12/04/business/economy/HOUSING_PRICES_GRAPHIC.html
Earlier this month, I got approved with 5% down for a mortgage equal to a little over 3 times my income, at 5.75%. It's my first mortgage, I have a good but not great credit rating.
Maybe I'm an outlier or something, but is there any evidence that people really do need 20%, other than that someone said so?
The housing bubble produced spectacular overbuilding.
Just like the oil bubble. Anyone want $50 oil shale anymore?
I don't know why people are always surprised that goods with relatively inflexible demand react strongly on price to supply shortfalls and surpluses.
"Maybe I'm an outlier or something, but is there any evidence that people really do need 20%, other than that someone said so?"
I don't see why anyone would put 20% down right now unless they absolutely have to. The market could still be dropping for a while. It's not a bad time to buy (certainly better than it was anytime in the past 4 years), but if the value of the asset is dropping, why put more cash into it than you have to?
How common was that "3x income" rule? Did it ever apply in places like Southern California, where real estate is pretty valuable? I mean, if your household makes 100k a year and you buy a 300k house with 20 percent down, at today's rates your mortgage would be 1300 a month. That's only 15 percent of your monthly income. That's cheap -- in the nicer parts of SoCal that's what you'd pay to rent a one-bedroom apartment. Most people I know pay 30 percent or more of their income to rent.
too many steves,
They say you shouldn't spend more than 28% of your pretax income on housing.
Your 1300 a month only covers the mortgage. If you're talking about a condo in San Diego that would be another 300 a month in property taxes and another 250-300 in condo fees. So that takes you to 1900 or 23% of your couples pretax income.
How common was that "3x income" rule? Did it ever apply in places like Southern California, where real estate is pretty valuable? I mean, if your household makes 100k a year and you buy a 300k house with 20 percent down, at today's rates your mortgage would be 1300 a month. That's only 15 percent of your monthly income
You've forgotten real estate taxes and homeowners insurance. I don't know about Southern California, but in my city that comes to an extra 30% of the mortgage payment. (And that doesn't include upkeep, which is always so much more than new homeowners expect!)
In some areas. In other areas, the supply of housing is still too low, and prices need to fall more. In New York City and in metro California (as opposed to exurbs) they still need to build, build, build, but it's not going to happen. In fact, people are counting on that lack of supply causing the next bubble (and the next crash).
When the elasticity of supply is low, as in NYC, Seattle, many metro areas, it does not require overbuilding for home prices to rapidly decline if demand tails off at all. Low elasticity of supply guarantees that home prices both shoot up and plunge in response to changes in demand, rather than the housing supply increase.
The areas with the worst overbuilding are mostly areas with relatively little control on housing that neighbor areas with zoning and supply restrictions, or in a few cases areas with a massive number of people relocating from said high price areas.
1. Renegotiation has been shown to be pretty ineffective.
This is because we already have a well established method for dealing with second liens on houses etc. It's called foreclosure and the banks know how to do it. We do need to remember that many of these loans aren't owned by the banks (lots of people own parts of the loan), and that there are second mortgages attached as well.
I mean, if your household makes 100k a year and you buy a 300k house with 20 percent down, at today's rates your mortgage would be 1300 a month.
The problem is that 300K now only buys a run down 3/2 in a so-so neighborhood. 100K is a good income for the San Diego area considering a median household income of 60K. Throw in high state income taxes and sales taxes and Californians can actually afford much less home on their incomes than residents of other states. We do have prop 13 that keeps property taxes down, but that helps long time homeowners not somebody looking to buy.
The median house price given out by the median is the median house price of houses sold that month. Considering that right now the low end sells fairly well, but the mid and especially the high end have stagnated the median house price is a poor indicator of the housing market here.
In New York City and in metro California (as opposed to exurbs) they still need to build, build, build, but it's not going to happen.
There's about a 5-year supply of condos in downtown San Diego at the current inventory and sell rate. Urban San Diego seems to have more housing than they know what to do with.
With ARM rates low, the problem with mortgages is that the principal is too big, not that the interest rates have shot too high.
That's incorrect. The problem here is with price instability. Even qualified buyers with job stability won't buy if they fear that the price will fall just as soon as they've bought it. Nobody wants to catch a falling knife.
Rightly or wrongly, buyers will not care about the absolute price just so long as they can obtain a loan to support the purchase, and they don't believe that the price is going to keep sliding. They don't need to see prices rising, but plummeting prices make them and their lenders nervous.
Renegotiation has been shown to be pretty ineffective.
This is also inaccurate. If you look at the substance of what actually has been done, you quickly realize that substantive loan modifications have been avoided. These workouts have kept borrowers upside down, which makes these allegedly failed modifications a bad joke whose punchlines just got delivered.
It's quite obvious that the banks don't want to take the writedowns any sooner than they have to. Substantive workouts would include substantial principal reductions and permanent payment cuts, which are largely not happening. The lenders don't wish to recognize the losses, so they carry these loans above their fair market value in the hopes that they will one day appreciate back to an acceptable level.
In other words, the lenders are stalling, and they will keep stalling unless the incoming administration changes the policy to a more aggressive, ball-busting variant of the present one. The lenders have done little or nothing to resolve their troubled loans, preferring instead to outsource the entire cost of their failures to the government. The score at the end of the first quarter: Institutional Lenders 1, Treasury 0.
"Rightly or wrongly, buyers will not care about the absolute price just so long as they can obtain a loan to support the purchase, and they don't believe that the price is going to keep sliding."
As someone who bought a house 2 years ago, I don't care and say this is fine with me. You can be certain that if housing prices drop 50% a person is not going to care if they are catching a falling knife. They will buy the house not because its an investment but because it's a place to live and that place to live just got a lot cheaper.
Of course, I'm not upside down with my mortgage. We bought an old fixer upper, put a decent amount of equity into with a sizable down payment, and added on to it twice in two years.
I feel sorry for the people like my brother who bought his house and ended up 100k upside down, and my parents who used their abundance of credit to buy a monsterous and unneeded house and are now about 180k behind.
I'm a little less relaxed than Sam is, but I think he's basically right about the sentiment. If housing prices are reasonable, an equity drop after purchase isn't a complete disaster.
For this purpose, I think a "reasonable" price is one where a mortgage-plus-taxes-and-insurance modulo tax deductions is at least comparable to rental costs, and where housing is not so high relative to prevailing local wages that it's easier to give up and leave the area than it is to save enough money to buy.
If those conditions hold (they do in my area), homeowners in distress can, if necessary, move out and rent the house to someone better off if they can't sell it. That's much less of a blow to the credit rating than a foreclosure would be. A homeowner not in distress needs someplace to live anyway, and if the mortgage payment isn't higher than the rent would be, equity fluctuations don't have an immediate impact. Plus, many people, yours truly included, prefer to run a slight additional financial risk for the privilege of not getting jerked around by a landlord.
Of course, an area where those conditions hold is very unlikely to see a 50% equity drop, anyway. My local housing market is slow but prices do not seem to be off significantly--perhaps 5-10%. The interactive graph Gene posted a link to shows a similar pattern: areas with reasonable housing prices, such as Dallas, just haven't seen much of a hit.
Dictyranger,
Where do you live? I've never heard of any place where the cost of rent and owning is in any way comparable.
Actually, in our small town owning is often CHEAPER than renting.
That's why we bought when we moved here. It would be $300-400/month MORE to rent something the same size in worse shape, even taking utilities into account!
So even we don't make money on our house when we sell, we saved money.
Also, buying is often the only option for families with kids. Once you need 3 bedrooms and hope to have a yard, it can be tough to find rentals in non-dangerouse neighborhoods!
Deirdre,
Can you give me an area (don't need the specific town) so I can check the rental vs. for sale listings?
I have a hard time believing you. And if you are right this would be a great place to invest in rental real estate.
Can you give me an area (don't need the specific town) so I can check the rental vs. for sale listings?
In the Mira Mesa area of San Diego it's pretty much at that point for people who can put 20% down. sandiego.craigslist.org for rentals and www.sdlookup.com for home prices. This areas rents are somewhat bolstered by UCSD being nearby since there are nicer areas with similar rents.
The lenders don't wish to recognize the losses, so they carry these loans above their fair market value in the hopes that they will one day appreciate back to an acceptable level.
Lenders can't recognize the losses. The second mortgage holder has to agree to the workouts. Anybody else who has a lien on the property must agree to the workout as well. Banks are also worried about being sued by the mortgage security holders if they reduce the principal too far. The only way banks know how to make all of these problems go away is the foreclosure process.
Secondly, many of the people being foreclosed on can't afford them in any sense of the word. Even at today's market rate with a 30-year fixed loan they can not afford the house. Banks would need to bring the loan value down to below the current market rate for the house.
And last, the person just defaulted on a loan. If you're a bank wouldn't you rather foreclose and get cash for the house now, rather than re-loan money to a deadbeat?
jmo, I can't speak for Deidre but this is true for Pittsburgh. We live in a gorgeous 3-story four square, with hardwood floors, stained glass, new kitchen, original fireplaces, etc., and mortgage + taxes + PMI + homeowners is only $530/month. It would cost at least $100+ more to rent a house like this. I think this occurs because the COL is so low here that owning is cheaper than the minimum floor most landlords are willing to charge for the hassle of being landlords.
McFly,
$530 a month would mean you're carrying a mortgage of 77k. Can you really buy a house in your neighborhood for 77k?
McFly,
Eww I just checked and yes you can buy any number of homes in Pittsburg for 80k. Wow, that just blows my mind...
for jmo: Capital District, New York State. We bought our current house in 2006, and had been renting a smaller, shabbier house before then. If the mortgage deduction is factored in, we pay $150/mo. more as homeowners, for a larger house on a larger lot and a quieter street. Definitely worth it, especially since we like to do home improvements and can therefore generate sweat equity as a hobby.
I'm guessing you live in a large urban area. My San Diego-based father-in-law owns a condo in a middle-class retirement community, which is (at current market valuation) more than twice the value of our house. At one time, it was worth three times as much. Sorry, but I'm not going to make three times my current salary in San Diego. I consider New York City prices to be equally astonishing; I turned down a job on Long Island because the bump in pay wouldn't even come close to covering the increase in housing cost.
As McFly suggests, this is a common feature of older, settled areas with low cost-of-living. I suspect he's also right about the landlord issue. All I know is that when I watch shows like "House Hunters", I am perpetually astonished at the amount of money Californians are calmly willing to shell out for homes I wouldn't even consider living in.
Lenders can't recognize the losses. The second mortgage holder has to agree to the workouts.
Incorrect. A first lien holder takes priority over junior lienholders. The subordinate lien holders can object to new loans, but they can't object to the modification of existing loans.
In any case, you have it reversed. A junior lienholder would be delighted to have a senior lien holder reduce the principal balance and lower the interest rate owed to it. Those reductions would benefit the subordinate lenders, not harm them.
In contrast, the negative amortization deals that have been commonplace among these failed modifications harms the second lien holders. Their position is worsened when the balance owed to the first position lender goes up.
If you're a bank wouldn't you rather foreclose and get cash for the house now, rather than re-loan money to a deadbeat?
There is no reason that a bank benefiting from TARP money to pretend that things are business as usual. We gave them the money so that they would lend it out and fix their broken loan portfolios. But instead of lending it or doing substantive workouts, they are instead hoarding the money, using it so that they can ignore the problems on their balance sheets.
The hoarding/ostrich approach is counterproductive and absolutely the opposite of what was intended. To clean up a balance sheet, the bad assets on it have to be resolved. The banks are sidestepping the resolution process, and they are using our cash to pay for it. That's a poor use of taxpayer's money, and the lenders aren't honoring their part of the bargain.
This happens to be true where we live as well. It also happens to be the same reason why we bought. I speculate that it is because we live in a college town and that student rentals drive up the price for everyone; certainly it is true that at one point I lived in a house that cost more to rent while at the same time being both smaller and shabbier.
There's also the problem that in our small college town, the rules heavily, heavily favor the landlord. Students have died from carbon monoxide poisoning due to faulty heaters . . . after an inspection determined the heater was defective and needed to be replaced. In the case I'm thinking of, the landlord got off with a fine.
jmo, actually, our mortgage was only $54k! The "high" payment is a result of Allegheny County's insane property taxes (being strangled by legacy pension costs and a decreasing population).
A junior lienholder would be delighted to have a senior lien holder reduce the principal balance and lower the interest rate owed to it. Those reductions would benefit the subordinate lenders, not harm them.
No it wouldn't, the second mortgage has to be wiped out and the person put into a 30-year fixed. The second mortgage does have to agree with the deal, which can be sweetened with a cash payout from the first mortgage holder. You also didn't get into my other claims. Banks being opened up to lawsuits, and the people in the house not being able to afford a 30-year fixed loan with principal reductions anyways.
That's a poor use of taxpayer's money, and the lenders aren't honoring their part of the bargain.
Banks are lending the money back out, but lending it to the same people who got them into trouble in the first place is a poor use of money. Secondly, the idea behind the TARP was never to prevent foreclosures. It was to unfreeze credit markets so that worthy borrowers wouldn't be turned down. People who aren't repaying their debts aren't worthy borrowers. I agree with you it was a poor use of taxpayer's money. I have been against the TARP since it was announced. Who would have thought that giving banks billions of dollars with no strings attached would get them to do what we want?
McFly: Us, too. Only about half of our mortgage bill actually goes to principal and interest. (And that's with us deliberately choosing to live in a low-tax town.)
I bought a house in 2006, at the peak of housing prices in my area. Looking at listings in my development, I'd guess it's probably lost about 20% of it's value, putting me upside down since I put 10% down.
So in theory, I should be all for "housing price stabilization", right? Not really. I bought a house I could afford, have a reasonably stable job, some emergency savings, and am in no danger of losing my house. I didn't buy it to flip, but to live in, so the fact that prices are down, while depressing, doesn't really affect my day to day life.
So a bailout, in which my taxes go to other people - many of whom lied on their mortgage apps, or at least bought more house than they could ever reasonably afford - doesn't exactly warm my heart. I'd rather see them foreclosed on, prices drop and eventually, slowly recover, than have my money go to keep people in houses they never should have bought.
No it wouldn't, the second mortgage has to be wiped out and the person put into a 30-year fixed.
Once again, this is false, and as someone who has been paid to work out real estate loans, I have done this on numerous occasions myself.
A first lender can reduce its principal balance and/or interest rate if it so chooses. It's not a fun choice for the first lender because of the writedown that would entail, but it is certainly possible and no second lienholder could either prevent it or would object to that. The servicing agreement may bar it, but that is a self-inflicted problem for the first lender and has nothing to do with the junior lienholders.
the idea behind the TARP was never to prevent foreclosures
Again, this is false. Had TARP 1.0 acquired the loans and securities at a deep discount as originally envisioned, then the natural next step would have been to work out the loans so that they could be resold to the market. For an upside down loan, that would require reducing the loan balance to a level commensurate with the value of the property, otherwise there would be no market for the loan post-workout.
The lenders understandably don't want to do that because that would entail recognizing a substantial loss (read: facing the music for the mistakes that they made), but that doesn't mean that the tactic makes sense for the rest of us. In contrast, a buyer that acquires the loan for a fraction of par, i.e. 20 cents, would have no problem with putting it back out into the market for a higher price that bears some resemblance to market reality, i.e. 60 cents. This process was commonplace during the 90's and was key to working ourselves out of that real estate recession. The lenders could do it, they just don't want to.
Once again, this is false, and as someone who has been paid to work out real estate loans, I have done this on numerous occasions myself.
Not if banks want to utilize the resources in the hope for homeowners act. In this act the homeowner must be put into a 30-year fixed loan insured by the FHA. Why would the first mortgage holder modify the principal anyways? Without discharging the high interest second mortgage, more than likely the house defaults anyways. As a bank I'd much rather just foreclose and get my cash now, instead of lending money again to a deadbeat. Then I can use that cash to loan to a better qualified entity. Take a look at the current re-work numbers, the majority of the re-worked loans have already defaulted again.
The servicing agreement may bar it, but that is a self-inflicted problem for the first lender and has nothing to do with the junior lienholders.
So what? It still makes it difficult for banks to do any principal reductions. The point is that it is currently very difficult for banks to work-out loans for a variety of reasons. It is for these reasons that they foreclose on the house, because that solves all the problems of work-outs. Workouts may have worked in the 90's because we were talking about billions of dollars, not trillions of dollars.
Again, this is false. Had TARP 1.0 acquired the loans and securities at a deep discount as originally envisioned, then the natural next step would have been to work out the loans so that they could be resold to the market.
First off, the idea was to buy and hold until the crisis was over or until maturity. I heard no talk that they'd then modify the loans with the TARP money. It's possible that some Senators told the banks that they should loans to keep people in their houses. The original Paulson plan was to unfreeze the credit markets, it had nothing to do with loan modifications. Everyone was sold on the idea that these securities were worth a lot of money, just not if everyone needed to sell them at once. However, the intention was to give banks billions of dollars in exchange for worthless securities in the hope that they would lend the money back out. This is why Paulson wanted no oversight and no questions asked for the money.
The point is that it is currently very difficult for banks to work-out loans for a variety of reasons
That may be true, but if banks have saddled themselves with servicing agreements, nervous shareholders and bureaucracy that make life difficult, then it's disingenuous to fault the borrowers for poorly constructed workouts.
The point is that there has been no good faith effort to work out loans en masse. The "work outs" done so far have often been little more than mild changes and negative amortization modifications, which only make the problem worse for junior lien holders and for the market as a whole.
These modifications were engineered to fail, so it's disingenuous for the banking industry and the Comptroller of the Currency to express shock and dismay when anyone who understands this process knew up front that modifications like these wouldn't work. They were made to fail because they have been part of a stall tactic designed to hide the problems from investors, with loans moved temporarily into the "performing" category even though they didn't belong there because a future default was easily predictable to anyone who understands this business.
It's hard to accept the validity of a bank's balance sheet if we know that the values are overstated by design. TARP was supposed to fix this, and it hasn't.
The financial crisis was caused by lenders who lent too much money tied to collateral that couldn't support even the slightest economic downturn. Now, they are using my tax money to avoid facing the music that they composed.
Lenders should be made to recognize their mistakes, otherwise these bailout programs will only get more costly. Now, we are being made to pay for the bad underwriting, instead of them. If the feds are going to make a New Year's resolution, it should be to bring the lending market back to reality, so that we can have faith the numbers and properly assess what we have.
I speculate that it is because we live in a college town
That is definitely a factor. We paid less monthly in Charlottesville for a 3/3 on 1/3 acre in a prosperous subdivision than we would have paid for a 1-br apt that wasn't an absolute hole. And of course there simply were no comparable houses in comparable neighborhoods for rent. But to pull that off, we needed a Countrywide NINA; none of the (prudent) local banks would talk to somebody who was living off of student loans.
Now I have a good job, but I rent an irritating duplex in Portland and wait for prices to come down to reasonable levels.
Just shocking to see the difference between real estate prices. I'm also astounded at the idea of buying a house for 3x salary. Rule of thumb here is 5 or 6x at the lower end. But that's for family homes and starter condos, since you're buying for the long term and should see decent increases in salary going forward. Once you're over 45 the multiple should be dramatically lower, but a 3x multiple would put anyone on a close to median income in the ghetto.
Once you start getting into higher incomes, it's very easy to manage on total home payments north of 30% of income. On $250k, 75k to the house leaves about 75k in disposable income and puts you in a $1.7M house with 20% down. That's more than manageable and the difference in house with an extra $1M is "somewhat" substantial and definitely worth sacrificing $3k a month in disposable income.
The areas where you can get a nice house for a $57k mortgage have shockingly bad economies and lifestyles. You can keep your low mortgage and live in the 3rd world state that is upstate New York or Pittsburgh.
Re: 3x income -- Bubble or no bubble, real estate is going to be priced differently in different areas. Portland and Los Angeles are more desireable than Pittsburgh and Buffalo, and people are willing to spend more to live in the former places. In other words, you might be waiting a while for that Portland real estate to be as cheap as Charlottesville.
Portland and Los Angeles are more desireable than Pittsburgh and Buffalo
Portland's historical median price is 3x median income. Last time I checked (a couple of months ago), it was around 4.9, although it's probably dropped since then. Unless it has become dramatically more desirable to live in Portland since 2001 or so (when the trendline departs from the historical average, IIRC), housing remains overpriced. 14 months of inventory and a 40% rise YoY in foreclosures both agree with me.
Really? 3k a month would get you $1000 in savings, an S-Class Mercedes and a trip to Europe in the Summer and the Virgin Islands in the winter.
Is the house really that much nicer? I just can't see it.
That may be true, but if banks have saddled themselves with servicing agreements, nervous shareholders and bureaucracy that make life difficult, then it's disingenuous to fault the borrowers for poorly constructed workouts... Lenders should be made to recognize their mistakes, otherwise these bailout programs will only get more costly.
I think your putting some words into my mouth. The work-outs don't work for various reasons, that we can't change now. It's the banks fault for some of the reasons, but so what? There are also good reasons not to loan money back to people who just lied to you a couple of years ago to receive a loan. There are specific cases they can work, but as a whole it's not practical to work-out loans for every at risk loan. This means that the banks are going to foreclose on a lot of properties. Foreclosures bail out nobody, it's just having the bank enforce the contract they entered into with an adult. I'm not saying that there's anything wrong with this. If the bank feels like they'd lose less money by working a loan out, then they are free to do it. However, any government intervention at this point will at best push the can down the road a few years and we'll have the same problem, but an additional few trillion in debt on top of that.
Eww I just checked and yes you can buy any number of homes in Pittsburg for 80k. Wow, that just blows my mind...
Hehe. Of course, like I told my gf re rural Texas property values: "Yeah, but you have to live there."
It's the banks fault for some of the reasons, but so what?
To fix the damage to the financial system, much of the repair must be done via the banks. After all, that's why we are so intent on dumping hundreds of billions of dollars into their coffers.
We did not pump funding into the banking system because we are fond of the banks, but because the problem (broken assets) and the solution (fixing the broken assets while restoring credit) lie beneath their roofs.
If the bank feels like they'd lose less money by working a loan out, then they are free to do it.
That's the entire point -- they aren't working out loans because they are using TARP as a subsidy to avoid workouts, which is the opposite of what was intended.
With these carte blanche injections, the temptation to avoid meaningful workouts is obvious. Instead of fixing the bad assets, as they should, the bankers prefer to use our money to meet their increased capital requirements, increases that are made necessary because of these very same bad loans that they now refuse to work out.
If the loans were worked out, their capital requirements would decline. This was the entire point of the original version of TARP, to have the banks purge themselves of the bad loans so that their capital needs would be returned to normal and investors could price the equity accurately once the debt issues had been addressed. It's a shame that the feds didn't take more drastic action, as their failure to turn the screws on the banking system has simply socialized the losses even more than they already have.
On $250k, 75k to the house leaves about 75k in disposable income and puts you in a $1.7M house with 20% down.
I don't know how you calculated this. Trying to afford a 1.7M house on 250K is a bit much. I do know that even at those income levels saving up $300K+ is much harder than it sounds so don't take the down payment for granted, or even the opportunity cost for having it locked into a house. Loans are also more costly at those price levels, you aren't receiving a 5.0% interest loan at that price. Right now jumbo loans are around 7.0%. You'd more likely have an $10.7 a month house payment (principal, interest, taxes) on a $1.7M house with a $1.4M loan. That's $128K a year already and throw in maintenance, utilities, and insurance (possibly HOA and Melo-roos taxes) and you're starting to spend more than your pre-tax income on just a house.
JordanT,
I some of the nicer parts of CA property taxes, HOA, and Mello-Roos can hit 2.8% of value or $47,600 per year on a $1.7 million dollar home.
In most of the places where you would find $1.7 million dollar homes the taxes can easily hit 20-30k a year on the low end.
If the loans were worked out, their capital requirements would decline.
Foreclosing on the home declines their capital requirements even more and solves a whole host of contractual problems. I fail to see why work-outs are broadly favorable to the banks, versus a foreclosure and trustee sell. Especially considering the rampant mortgage fraud the last few years, it's possible the banks want nothing to do with borrowers from that period.
We did not pump funding into the banking system because we are fond of the banks, but because the problem (broken assets) and the solution (fixing the broken assets while restoring credit) lie beneath their roofs.
I don't remember agreeing to it or writing a check. Are you saying that Senators, Representatives and members of the executive branch aren't fond of the banking system or their campaign contributions? Members of the Fed aren't fond of bankers? Henry Paulson isn't on friendly terms with bankers? If it was so critical that the money be used a certain way, then why wasn't it written into the TARP bill?
As I said, the intention of the TARP bill was never to work-out mortgages. There may have been some analysts that hoped the TARP funds would be used that way, but where are the promises from the bankers and language in the bill that it would be use that way? The only thing I could find with Sheila Bair (head of the FDIC) asking for $24B in TARP funds to work-out loans. This was this month, so way after the bill was passed.
I fail to see why work-outs are broadly favorable to the banks, versus a foreclosure and trustee sell
They aren't favorable to the banks, but they are favorable to us. Our $700 billion was supposed to buy us something, but all it got us was a down payment to protect the bankers from the price of their mistakes.
As I said, the intention of the TARP bill was never to work-out mortgages.
And you are wrong to say that.
The point of the original version of TARP was to remove these loans from the banks and repackage them for sale in order to recover the government's money.
The arithmetic makes the mechanics required for this obvious. The only way to repackage an upside down loan for resale is to work it out.
No institutional investor is going to pay retail for an upside down loan with negative and falling equity in this market. The only way to make that loan marketable is to reduce its balance to the point that equity has been created and the borrower is able and motivated to service it. That resolution, by definition, requires a workout; in this market, such a market would be substantial.
Goldman Sachs was actively involved in this business during the 1990's, and we all know where Hank Paulson worked back then. The TARP program was intended to duplicate what capital recovery firms did to make substantial profits back during the RTC era. When Paulson talked about TARP turning a profit, this is how he intended to do it.
The only way to make that loan marketable is to reduce its balance to the point that equity has been created and the borrower is able and motivated to service it.
All the loans in question have been sliced up and packaged to the point where securities don't depend on a single loan. The TARP was advertised as this. Right now the securities were mostly worthless. They weren't worthless because the loans underlying them were that bad, but because on the open market with everyone selling at once and no one buying they sold for pennies on the dollar. Banks have to mark these assets to market, and if they do that would make a lot of banks insolvent. However, if someone was to buy these assets, even at above current market rates, and was able to hold them throughout this period of irrationality then they'd be worth more in the end. The argument in short was "The current market values mortgage backed securities irrationally, and we know what the true value of the securities are so trust us we won't overpay" Either way the point was never to work-out mortgages. Maybe you had assumed that based on what happened in 1990, but that was never the intention this time around. Otherwise, the original Paulson TARP bill would have included stronger language to force banks to do this.
Our $700 billion was supposed to buy us something, but all it got us was a down payment to protect the bankers from the price of their mistakes.
Which is why I was against the bailout, because I saw it for what it was. A transfer of $700B to banks that made bad loans with no accountability. Are you really surprised that banks didn't do the "right thing" and just looked out for themselves?
They weren't worthless because the loans underlying them were that bad, but because on the open market with everyone selling at once and no one buying they sold for pennies on the dollar.
You misunderstand the issue. The problem with the securities is that loans without equity have no value when property values are falling and the CDS's allegedly supporting them are in question. The doubt provokes a flight to quality because of the inability to quantify the risk.
The risk is ultimately the byproduct of a lack of equity, combined with some questionable borrower quality. Equity provides a cushion that reduces risk. Introducing equity adds quality to the portfolio, which reduces the risk.
If the loans were worked out, the underlying securities would be marketable again because the risk associated with upside down debt would be gone. They would not be valued at their original par value, of course, but their value would increase from their present depressed levels, which are currently a small fraction of their original value and a reflection of the doubt associated with the instruments.
Are you really surprised that banks didn't do the "right thing" and just looked out for themselves?
Quite the contrary. That is why the banks need to be forced against the wall, with workouts and discounted securities sales forced down their throats, instead of equity being handed out like candy, ala TARP 2.0. If we allow banks to continue to avoid the workout process, then it will simply prolong the problem and several times more taxpayer's money than it would have cost otherwise.
You misunderstand the issue. The problem with the securities is that loans without equity have no value when property values are falling and the CDS's allegedly supporting them are in question.
In the case of a principal reduction work-out, since there is less principal to pay out some of the securities are going to be worthless or worth less. That's the nature of mortgage tranches. Either way the holders of some of these tranches are going to be taking huge losses
I know Wikipedia isn't the best source sometimes, but this is how I understand it.
"The concept of future gains from troubled assets comes from opinion in the financial industry that these assets are oversold, as only a small percentage of all mortgages are in default, while the relative fall in prices represents losses from a much higher default rate."
This is essentially what I said, too many people are trying to sell with not enough buyers which has made the market irrational. So if there was somebody who had billions lying around they could buy these securities at firesale prices and make money in the long run.
I'm not saying that this is correct, but this is how Paulson sold the program. If he had an unspoken idea in his head, then that's difficult to judge. There has been some boilerplate "We'll help hopeowners whenever possible" talk, but I didn't hear anything about how mortgage workouts were critical for the TARP to work. If this was the case, it should have been part of the bill. My assumption is that it wasn't mentioned and wasn't part of the bill because there never was a plan in place to perform massive loan work-outs with principal reductions. It seems you are assuming there was an unspoken rule between the Treasury and banks about the mortgage workouts.
In the case of a principal reduction work-out, since there is less principal to pay out some of the securities are going to be worthless or worth less.
No, this is not really the issue.
Here's a basic numeric example. Loan X is a loan originated in 2006 for $500,000, secured by a home that is worth $525,000.
Not long after the loan is originated, it is sold, perhaps bundled into a security with other mortgages. The buyer probably paid par for the loan, i.e. $500,000 for it. Collecting the interest was enough of an inducement, so the buyer paid 100 cents on the dollar or something similar. If it was included in a security, it may have been part of a AAA rated MBS.
Two years have passed. The borrower has made payments as agreed. The principal has amortized slightly so that the loan balance is now about $485,000. Meanwhile, the property value has fallen by about 25%, so that it is now worth about $395,000.
This is a problem. Even though the payments are being made, the collateral is insufficient to support the loan. The loan is technically "sub performing", meaning that is being paid but isn't adequately secured.
Nobody will pay par for that loan, not because it isn't being paid, but because the collateral is inadequate. In today's brave new market, a buyer might not want to see anything more than a $316,000 loan on a house worth $395,000. Which means that this loan is unwanted, and is worth far less than the par value that it had just two years ago.
Bundle this with a bunch of other loans just like it, and now you understand why bank stocks have taken a dive in 2008. No one knows what these loans are worth, whether there is a market for them, how likely it is that they will default, or whether the alleged insurance and credit enhancement will do them any good.
Your neighborhood banking behemoth could remove the mystery from this equation by writing down the loans. A loan that is being paid and has sufficient collateral is a loan that others will buy and rate. A loan that is being paid but lacks collateral has far less value to the marketplace because of the insufficient collateral.
Your bank doesn't want to face the music that TARP intended them to face. The idea of TARP 1.0 was to remove these securities and loans from the banks and other institutions so that the holders could be fairly valued, without the burden of loans whose value is in doubt. A buyer that bought the loans for a fraction of their worth, such as the government, would be more motivated to fix them than someone who paid par, hence the need for the removal and clean up process being kept outside of the banks.
So yes, workout was always part of the plan, the plan as originally devised could not have functioned without it. The only alternative to workout is to sit around and wait, hoping and praying that the problem just sort of fixes itself and goes away. While that would be an understandable way for an individual to handle such a dilemma, hope and prayer are unacceptable approaches to use when managing the world's largest economy.
Because of this failure to work out the loans, the final tab can now be expected to run into the trillions of dollars, not hundreds of billions as originally budgeted. The brunt of the pain will now be borne by the taxpayer, instead of the institutions and their investors who don't wish to compromise anything. We will have to give the banks two chunks of money, one that will allow them to carry the toxic debt without doing much to fix it, and another chunk that they can loan out. Good times.
Re: You can keep your low mortgage and live in the 3rd world state that is upstate New York or Pittsburgh.
Upstate New York or Pittsburgh may have sluggish economies but they are not third world hellholes. Most of the people who live there are perfectly decent, law-abiding, productive citizens.
Re: I fail to see why work-outs are broadly favorable to the banks, versus a foreclosure and trustee sell.
In the current market foreclosures move very slowly. I recall an article in Fort Lauderdale before I moved stating that it was quite common for foreclosure auctions there to have no attendees, meaning that the lender is stuck with the property as REO (Real Estate Owned), which is a costly proposition, as the lender is then responsible for property taxes and some level of upkeep and utilities. Some REO properties have been on lenders' books for months, or even over a year.
RW,
Beyond the points brought up by JordanT, your recollections of the discussions leading up to TARP 1.0 are shaky at best. For one, stating that significant mortgage workouts was the only way it would have effectively worked, does not make that an key element of the plan. It is not just that the linkage's in your argument did not exist, but they were assuredly actively lobbied against by everyone outside of the financial industry.
Interwoven within the din of shouting from the public, that streamed into the offices of lawmakers, media houses and the commentariat, was the key issue that irresponsible homeowners would not be bailed out. The public fury over the bailout itself was barely mitigated by the argument that preventing systemic meltdown meant bailing out the banks was worth the cost. This simply did not extend to bailing out individuals via principle reduction. TARP 1.0 or anything resembling it would simply never have happened had it challenged the Social compact the way you propose. TARP 1.0 was created via a politcal process, because that is the mechanism for public policy making, and public policy is nestled within a larger socia-economic framework. The kind of command directives required to make what you propose work are not in the governments mandate. Retroactively, stating otherwise is simply disingenuous.
TARP 3.0 and a new administration may attempt what you propose, but numerous other problems are still not addressed. By illustration, within the context of your model, conceivably my over-indebted neighbor could have his mortgage principle "significantly" adjusted down to what? 25%,50%,75% of mine. Furthermore, the losses would be concentrated at our mutual bank, whose balance sheet despite detoxification in TARP 3.0 would still be impaired, therefore hampering my access to credit and financial services. all the while My tax burden has increased.
To prevent lasting trauma to the social contract, not just "bad" banks need to feel pain, but all principle's to the transaction.
With just as much documentation as you have given, may I suggest that your recollections are in error? iirc, not just the general public, but many prominent economists signed on to the notion that for TARP to work, it would have to make some accommodation for some sort of mortgage adjustment.
Nyongsea, the social contract has already been permanently and severely changed. Workouts are simply part of dealing with this change, and preventing further deterioration of this contract and damage to the economy. As RW pointed out, the cost to taxpayers will ultimately be much greater if the banks continue business as usual.
I don't really buy the moral hazard argument when that can be addressed by regulating the system so that these abuses (on all sides) can't happen in the future.
For one, stating that significant mortgage workouts was the only way it would have effectively worked, does not make that an key element of the plan.
Of course it matters. The price paid for the assets impacts how many assets can be acquired and cleaned up, and the ability of the program to make a profit as had been intended.
Do the math. If the government acquired the toxic assets from the banks at par, they would be grossly overpaying for them, because absolutely no one in the free market would pay anything close to that. (To get a sense of market reality, go research what terms Blackrock had with its deal with Merrill Lynch.) So discounting was implicit to the entire program concept.
Now, think of what the government would have to do. For the government to turn that Loan X example that I provided above into marketable paper, that loan would have to be substantially written down, even if it is being paid by the borrower. That requires giving the borrower a workout, not because we're trying to help "Main Street" but because it's the only way for the government to sell the loan and recoup its money. A lower realistic par value has to be established that has a realistic relationship with the underlying asset (in this case, home value) that supports it.
If you remember all of the talk about TARP turning a profit, this is how it would been accomplished. The government intended to pay market prices of the loans, which meant paying a fraction of their loan balances. The alternative would have been to overpay, which ironically is what McCain proposed doing during his campaign.
Hank Paulson didn't bother explaining the details because anyone familiar with this industry and how the RTC resolved the 1990's crisis didn't need the explanation. The rest of the country wouldn't have understood it. Paulson spent most of his professional life working with people who understood implicitly that you can't turn a profit by paying above-market prices for assets that you intend to fix and flip.
The end result of the failure of TARP 1.0 is that we have banks with grossly overstated asset values on their balance sheets, which are overstated to a degree that we can't easily quantify. This perpetuates the chaos in the stock markets, because investors have figured out that the balance sheets are somewhat useless in their present form. It's difficult to have a functioning stock market when investors can't believe what they read. Meanwhile, the price tag for the public has escalated severalfold because a dirty balance sheet requires a lot more cash to soothe the fears of shareholders. This is why banks are hording their cash, it's to offset the toxins that they refuse to purge.
I don't really buy the moral hazard argument when that can be addressed by regulating the system so that these abuses (on all sides) can't happen in the future.
Sure, they can, but what terrifies me is the political bluster suggesting that they won't -- at least not "on all sides". Witness all the talk about making it even easier to file for bankruptcy! The sense of American consumer entitlement hasn't abated one bit, and politicians certainly aren't going to be the ones to usher in that change.
Pittsburgh isn't the third world, it just has a government model from the third world (one party state).
Meredith, bankruptcy *was* easier to file before 2005 when the law was changed to make it more difficult as a favor to the credit card companies. Restoring it to its pre-2005 state would be help a lot of people get their financial act together; it's not like it was fun and games before.
Rez, I'm sure that most people who post here are well aware of what a joke bankruptcy requirements were pre-2005.
I appreciate your tautology, though: "Making it easy for people to ignore their debts will make it easier for people to ignore their debts." Deep.
Witness all the talk about making it even easier to file for bankruptcy!
Good. If banks are uncomfortable with the downsides of unsecured debt, then their response should be obvious -- they should loan less.
Bankruptcy is such an important protection that it is even in the US Constitution. These bankruptcy "reform" measures only deepened the credit crisis, because they encouraged the banks to provide more credit than they should have.
This is all part and parcel of the moral hazard problem, with institutions happy to act recklessly because of their ability to pass on the risk to others. Systemic risk would have been reduced had credit limits been lower and monthly payment requirements been higher, but the short-run profits and bonuses were just too good to pass up.
Portland's historical median price is 3x median income. Last time I checked (a couple of months ago), it was around 4.9, although it's probably dropped since then. Unless it has become dramatically more desirable to live in Portland since 2001 or so (when the trendline departs from the historical average, IIRC), housing remains overpriced.
1. In the 1970's, Portland drew an "urban growth boundary" that restricted development to a compact central area and left forests, farmland, and orchards untouched. Since 2001, buildable lots are increasingly in short supply (in desirable close-in locations). This is the logical economic basis for a median price far above 3x.
2. The logical basis for a 3x median-price ceiling, is the assumption that buyers do not have substantial net worth. True in many cities, but dramatically untrue in others.
For example, 26,000 multi-millionaires compete for desirable close-in houses in Seattle. This competition creates the expectation that houses, although "overpriced" today, will continue to be "overpriced" when today's owner wishes to sell.
3. A typical vacant lot in Palo Alto, CA, sold for $10,000 in 1970, and sells for $2 million today -- same dynamics of supply-demand.
In the 1970's, Portland drew an "urban growth boundary"...This is the logical economic basis for a median price far above 3x.
The trendline to which I refer did not deviate from 3x median income until 2003 or thereabouts. That is, the famous urban growth boundary didn't seem to have this effect for the first couple of decades. So unless something has happened in the last five or six years to change the supply/demand dynamics of housing in Portland, we're due for a correction.
I'm not suggesting 3x income as a hard and fast rule for every area in the country, all the time. I'm suggesting that in this city, it is in fact the historical average and there isn't any good reason to think that anything has changed suddenly.