The other day, Ryan Avent had a good post on who is actually defaulting on their mortgages. Though you commonly hear the discussion framed as a question of when interest rates reset, Ryan points out that this isn't really accurate. The problem is not principally people who can't pay their mortgages because their interest rates have reset--people will cut back on a lot of other things to keep their house, and if you can't afford a 1% rate increase even with drastic lifestyle cuts, you probably have too much house. Rather, the main problem is people who have an income shock. Normally, if you lose your job, and you can't afford your house, you're eventually forced to sell it. But when the market drops 20%, if you're a recent homeowner, or if you did a cash-out refi, you can't sell it, because you'll end up owing money at the closing. Obviously, if you had tens of thousands of dollars to hand over at closing, you wouldn't need to get out in the first place.
This has tricky policy implications. The supply of credit--for which interest rates are usually a good proxy--has huge effects on home prices in this world of majority mortgage financing. We've pushed interest rates down as far as they're going to go, but that's not going to reinflate the bubble. So huge numbers of people who have income shocks are going to end up in foreclosure unless their bank allows a short sale.
But what's the alternative? Huge write-downs to the mortgage principal of everyone who gets in trouble? They'll still have to sell the house in a lousy market. And it makes the banks more fragile, while unfairly handing a giant subsidy to those who happen to lose their jobs.
On the other hand, it does mitigate the claim that this is about irresponsible borrowing--at least in a lot of markets. In places like California and Florida, where prices of large houses have dropped 30-50%, the most sensible downpayment policies wouldn't have kept people from going underwater. Though to be fair, highly insensible downpayment policies helped inflate the bubble, and a lot of people with tiny downpayments are getting themselves in trouble.
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Though to be fair, highly insensible downpayment policies helped inflate the bubble
That's kind of key, isn't it? If you have to come up with 20% down, you can't pay the crazy prices people were paying. And if nobody can pay those prices, then guess what? Nobody will pay them, and the bubble gets a lot less severe. So in fact, the bubble and subsequent foreclosures are inseparable from the issue of irresponsible borrowing.
Remember, you can't just change one variable and assume the others don't change.
In places like California and Florida, where prices of large houses have dropped 30-50%, the most sensible downpayment policies wouldn't have kept people from going underwater.
Sure they would, because a substantial number of these people wouldn't have bought houses to begin with.
Can we reframe the issue as "irresponsible lending?" So we don't have to continue to have one sided beatdowns on the people who possibly could be "unfairly hand[ed] a giant subsidy to those who happen to lose their jobs." Like they wanted to lose their jobs. It's not just about personal responsibility, it's also about professional responsibility.
Only if you can convince me that people were forced to borrow in the first place.
I do not argue that there is an element of personal irresponsibility involved in the housing bubble. There is enough blame to go around. But you can't convince me either that banks were forced to lend in the first place. It's just my irritation that Megan who seems pretty fair minded about most economic matters keeps beating down the borrower. This line of thinking seems to lead to more complete loss-complete loss scenarios than lose a little bit-lose a little bit ones.
I think it should be widely agreed that like any other bubble, this came down to expectations that were widely accepted. Borrowers thought it was great to buy something that would gain over 15% in value in a year, lenders thought it was great to get huge fees and interest rates from borrowers who wouldn't have to actually pay off the loan over 30 years, and the government thought new high assessments would be great for tax revenues. However, except for the government, it seems these groups have been suffering already (between dropping home values and defaulting loans). In fact, other parties are suffering as well since this bubble affected the whole market and now the entire economy. It'd be nice to see the government sacrifice something for once, like cutting property tax assessments, but don't hold your breath.
But banks were forced to lend, its called the CRA. While banks were not forced to make every loan they made, they were forced to make some of them. Yet, not a single borrower was forced to borrow, and that's worth remembering.
The banks were wrong not in making the loans, but in structuring themselves so that the loan non performance could ruin them.
BD: A government is run and operated by people, and here in Colorado at least, many of the state offices have been subject to hiring freezes and shutdown days, and some are being confronted with possible personnel cuts. Foreclosed houses don't generate tax revenue so neatly as occupied houses, and they do generate government paperwork besides, so the government isn't necessarily making out like a king just because the assessments are princely.
Moreover, to prevent the government from jacking up property assessments on a whim, many jurisdictions have fairly strict laws on when assessment may be done and what the reference points will be. It hurts homeowners who are paying bubble tax rates, but long term the alternative might hurt more.
BD - California's assessors have been lowering assessments, and counties have been screaming about it. There have been news stories in the San Francisco Chronicle and local papers, and probably also the LA Times.
There are some limits on that process, as people who bought before the peak were not reassessed at bubble-peak valuations due to Prop 13; and if a house's current value hasn't fallen to its original sale price (plus 2%/year), the assessed value won't actually be reduced. If you paid $300,000 in 2000 and haven't added rooms, your maximum assessed value in 2009 would be about $360,000, no matter what the house might have been worth in 2007. Most $300k houses in 2000 are still more than $360k today.
I suspect, based partly on my own experience, that the cannier assessors are re-assessing at slightly higher than the actual market value, just enough so that the cost of challenging the assessment would be higher than the tax savings from winning the challenge.
In particular: the property tax rate is around 1.1% to 1.3% most places in California. Challenging a reassessment would probably require having an outside appraiser do an appraisal which costs about $400. Having your assessment lowered $30,000 will save you about $330 to $400 for the year. In my case, I think my house's reassessed valuation is about $30,000 too high, but it's not worth spending $400 to challenge that, when next year's reassessment might be completely different.
Does not requiring a 20% down payment qualify a lander as an irresponsible lender?
Then I agree.
I have a hard time with those who seem to think it is all the fault of the 'evil lender'. When you sign your name to a piece of paper that says you are on the hook for hundreds of thousands of dollars, you need to take the time to understand what you are getting into. If you don't understand something, you find someone to _ask_. Common sense ought to tell you that the lender _does not_ have your best interests at heart - they are there to _make money_.
Seriously - at what point does personal responsibility begin?
Perhaps we should just stop all lending for mortgages because any borrower might get fired and be unable to shoulder his/her personal responsibility.
If income shock is the primary cause of default now, than your personal-responsibility argument begs this for a solution. Not a great way to stabilize the housing market in an era of growing job loss, is it?
If you are left with no savings after putting your 20% down, is it a good decision to buy a house? I would not call that responsible. Basically, you just have to look at your life situation and what (reasonably) could happen and ask yourself how long you could continue to make payments should it happen - unemployment, unreimburse medical expenses, etc... My view is that it should be _at least_ a year - if not, you should wait (rent) and buy later.
These are judgements you have to make for yourself - noone can do it for you. I don't really think it is rocket science.
The problem is also that you have to decide what the market-wide goal here is--is it to have the market reach bottom, so that more potential buyers can afford to buy houses and prices can start stabilizing then going up again? Or is it to keep the more troubled homeowners in their homes and out of foreclosure in order to try and halt or slow the downslide in prices? Because if the former, that means a lot of hurt for the most vulnerable, which could hamper economic recovery (even if it's considered "fair" to let the most vulnerable lose their homes, savings and credit, since they assumed the risk of buying a home and shouldn't be bailed out). If the latter, it prevents home prices from reaching the point at which less affluent new home buyers can buy into the market at a more natural level. The problem with what the government has been doing so far is that it doesn't seem to have adopted either goal, but is just tossing cash around as if hoping that a lot of inflation might solve the problem for us.
I hardly think plummeting home prices and historically low interest rates qualify for "inflation," and I don't think anyone's predicting inflation in the housing market in the near future. I still see prices falling, and the number of short sales increasing rapidly. My nephew just had a short-sale offer accepted; he expected to wait two or three months for an answer on his offer, and instead got it in two weeks. It makes me wonder if banks are getting better at processing through the paperwork to help stave of their losses faster.
For foreclosure, a concern would be continued job losses. Nationally, as workers lose health insurance, medical crisis may also play an increasing role in income shock. So solving the problem requires both stemming job losses and finding some way to insure workers who are no longer insured via work.
But one thing is true; home prices had outpaced income; and a lot of people are sitting on houses that will likely to never be worth what they paid for them; at least in their lifetime. This, I think, is the gamble they signed on for, not much different than betting on a stock today that turns out to be worth just pennies tomorrow. Hence the importance of having successful short-sale capacity in place in a bank.
It's good to hear that banks are understanding that they need to move forward and accept more short sales. It means they're starting to accept some responsibility instead of the "you're a irresponsible deadbeat for losing your job" that Megan's post seems to lean (to me at any rate).
Requiring 20% is responsible lending. Of course, not requiring 20% does not imply irresponsible lending in all cases, but it's a pretty good place to start looking for irresponsible practices.
The CRA as the reason for the housing bubble is the Republican attempt to paint every goddamn problem in the US on Clinton. They REALLY need to accept some blame and move forward.
The Republicans (or at least Bush) certainly deserve some of the blame. After all, they also pushed home ownership for people who aren't financially ready.
http://www.anonymousliberal.com/2008/09/truth-about-minority-home-ownership.html
Bush and Clinton can share the blame on this.
You know, with Barack and Michelle's record of steadily overspending their income and borrowing against the rising value of their home during the home price bubble, he got elected to the Senate just in time.
If he hadn't won that election -- which was entirely possible (up until the allegations of Six of Nine) -- Obama could've faced foreclosure when the bubble burst.
An interesting counterfactual: Would he have deserved a bailout?
Would you?
Nonsense. Royalties from a third book about his father would certainly pay the bills for some time. And in a pinch, you can't beat having neighbors like Tony Rezko
"up until the allegations of Six of Nine"
That's Seven of Nine, buddy. You're confusing here with Six from BSG.
Ohh, negative ten nerd points for you. Seven of Nine is the name of the character and the show was Star Trek: Voyager.
Well, crud, I just looked up Number Six and now I see where you were going with that. Of course, maybe JG was hybridizing them intentionally.
up until the allegations of Six of Nine
In fairness, the probability that Obama would have lost to Jack Ryan is exceedingly small. Kerry won IL by 10+ points in 2004. There is nothing to suggest that Obama was especially unpopular for a Democrat (indeed, the evidence suggests the opposite of this), or that Ryan was an especially popular Republican.
Now, you're on stronger ground if you are arguing that Blair Hull might have beaten Obama in the primary if his own spousal abuse allegations hadn't emerged. I still think that he and Hynes would have split the downscale white vote enough to allow Obama to win with his coalition of African-American and high income/well-educated white voters, but this is hardly a foregone conclusion. (I'd put the odds at maybe 60 (Obama) - 30 (Hull) - 10 (Hynes). In the general, maybe 95-5 Obama.)
I'd be fairly ok with the substantial subsidy to people who lose their job because there's no (or very little) moral hazard issue.
Bailing out people who bought more house than they could afford is one thing, but people mostly don't get themselves fired so they can get help with the mortgage.
The problem is, whether you were buying more house than you could afford is dependent on the model of the future you were using. If your model was that house prices always either went up or at least stayed the same, and that was based on everything that had happened in your area for the last 30 years, then it wasn't very risky to buy a lot of house, because the house would either go up or stay stable in value, which meant that if you got in over your head, you could sell the house and pay off your debt. This looked completely different from, say, borrowing a lot of money and investing it in your favorite "sure thing" in the stock market or the horse races, or borrowing a lot of money to take a really nice vacation.
In fact, the almost-universal advice we got before buying our house[1] was to buy as much house as we could afford, as house prices always went up or stayed stable, so we couldn't lose money this way. House payments were seen as combining paying for your place to live with saving money.
ISTM that almost everyone in this market was working with a model of the world in which significant drops in house prices was simply not possible. In light of that model, the ratings on CDOs and CDO-squareds, the willingness of people to take a 5 year interest-only mortgage with a baloon payment at the end to get into that wonderful dream house, and the willingness of folks without much income to buy a house at all seem much less imprudent. Now, it's clear that this model was wrong, but I sure heard a lot of smart, aware people using it a few years back.
[1] Fortunately, we also had advice the other direction, from family members who got burned badly when house prices fell many years earlier. Thus, we bought (about a year ago) less house than we could afford, and negotiated hard on the price.
Agreed. Basically I don't want to subsidize people who thought that housing prices would never go down, but am more sympathetic to helping people who thought it was unlikely that their income would drop.
I don't think that in general that we want people to be as risk averse as they would become if they felt like they could lose their jobs at any moment, and so I'd be much more willing to provide temporary mortgage support to people who have lost their jobs, rather than people whose payments have risen above their income.
Rather, the main problem is people who have an income shock.
In California it was buying too much house period. Many of these people can't afford their mortgages, even if somebody re-financed their loan to a 30-year fixed 4.5% interest loan. The only way they were affording their house was because they could always use a HELOC or a cash-out refi to fund their lifestyle for a while longer. There's also the people that will not see the point of paying more money for their than renting if there's no big profit to be made. They are just stopping mortgage payments and riding out the free rent.
Secondly, I don't agree that you'd see a spike in foreclosures on reset day. Many people can hold it together for many months, even if they can't truly afford it.
Thirdly, we aren't talking about a 1 point rate increase for the 2/28 ARM. The 2 year loan was a low rate designed to build your credit for an eventual refi. Without that refi the interest rate will likely sky rocket, especially given the rate environment in 2007 and 2008. The rate resets can come every 6-months as well, so it's not a one time deal. The reason why we don't see as many foreclosures from subprime 2/28 and 3/27 ARMs anymore, is because we've gotten through them already. People who were loaned money in 2003 and 2004 were likely able to re-fi to a better loan. Currently, subprime default rates are higher then prime, but prime default total numbers are higher. Our current high foreclosure rate is because prime default rates are on the rise and there are far more prime loans than subprime.
"We've pushed interest rates down as far as they're going to go"
This isn't true with respect to conforming mortgage rates. The national average for 30-year fixed rate mortgages is 4.96%. As Columbia economist Glenn Hubbard has noted, mortgage rates typically hover about 1.6% above the 10-year Treasury yield. Current 10-year Treasury yields are 3.125%, so if Hubbard and Mayer's plan were implemented, mortgage rates would be about 4.73% now, and could be dropped even more with some targeted QE.
"But what's the alternative?"
John Hussman described an alternative a few times, including here:
Here's the alternative:
The government does nothing. The bank cuts its losses and does one of 3 things: gives the defaulted homeowners a better deal, forecloses and sells the property to someone else at an affordable price, or if the bank thinks the prices are *too* low, it goes into the rental business. Some banks will fail, but the ones who had better lending practices will likely survive, as it should be.
You don't need new government plans when good existing ones (FDIC) are already there.
"The government does nothing."
The Andrew Mellon approach. It certainly would clear "the rot" out of the economy (while killing some currently healthy tissue along the way), but doing nothing about foreclosures isn't a politically viable choice, particularly since, as Dr. Hussman notes later in that piece, the bulk of the variable mortgage resets are still ahead of us. Given that the government has and will continue to do something, Dr. Hussman's proposal is worthy of consideration, especially since it is equitable for all parties and doesn't require the use of any taxpayer funds.
"Some banks will fail, but the ones who had better lending practices will likely survive, as it should be."
Hussman has no problem with bad banks failing. Click the link above and read the first part of his piece, which lays out his proposals for dealing with the banks.
Are the bulk of variable mortgage resets really still ahead (other than in the trivial sense that a 5/25 ARM will reset 25 to 50 times after the first 5 years)?
The big problem, aside from income shocks, are the loans which had unrealistically low teaser rates (as Byrk described above), and which are re-setting to market rates. When my 5/25 ARM starts re-adjusting, I'm not going to be in a world of hurt (unless the Big Inflation hits first), because my starting rate was about what the indexed rate was. In fact, if my loan reset today, my rate would go down. The people who got loans with a 1% for 1 year teaser rate will get hammered as their loan payments will double or more. But most of those loans have already reset.
"Are the bulk of variable mortgage resets really still ahead"
Look at the Monthly Mortgage Rate Reset Chart from Credit Suisse that Dr. Hussman includes in his column, in the section titled "The Danger of Inaction". First Hussman shows the sub-prime chart from Credit Suisse, which shows we're over the sub-prime hump, and comments:
Then Hussman shows the (non sub-prime) Monthly Mortgage Rate Reset chart I mentioned above and comments,
The good news is that we have stopped building new houses and that prices are back to 1980s levels when adjusted for income (at even lower rates). The bad news is that it will take another 18-24 months to work off the inventory of distressed sales. In some markets, like the Inland Empire of CA and Pasco County, FL, the best solution might be to blow up the inventory. These houses are 50 miles plus from anywhere and should have never been built in the first place.
Being "underwater" on your mortgage doesn't mean anything unless you have to sell. I still don't know how we help people without creating a huge moral hazard where people, who otherwise can pay their mortgage, will simply give the house back, especially if they put little money down and the value has fallen below the debt. There are tens of millions of Americans who are "underwater" on their car loans. This is OK because dealers will usually exchange these clunkers as a proxy for a downpayment on a new car. This is not so easy with houses.
Consider this scenario. I buy a $200K house and put $10K down and borrow $190K. The house rises in value to $350K and I take out another $120K. Then, I lose my job and hand the house back to the lender. Am I a victim? Hardly -- for a $10K investment, I pulled out $120K. Plus - unlike the stock market - the govt let me float my investment at a pretax rate.
We can solve alot of our problems with two easy steps: 1) give the banks a modest financial incentive to rework toxic mortgages for credit worthy borrowers, and 2) reinstate the 20% down payment rule. Having hard cash equity in a house makes one much less tempted to surrender the keys to the lender. Plus - it keeps the inventory from getting bloated by artificial demand. I also liked Cramer's idea of creating a national exchange where any credit worthy borrower could swap their mortgage for a new 4.5% mortgage.
I own 2 houses debt free. I am in the process of taking out $350K on one house at 4.25% (with 2.5 points). If you can't invest at a compounded rate of 4.5% pretax, you don't know that you are doing.
2) reinstate the 20% down payment rule.
Better do that slowly, or you're going to drop housing prices again.
The other point is that an "income shock" only leads to foreclosure if one doesn't have enough savings. Many people felt secure in thinking of part of their mortgage payments as a deposit in their home equity savings account. How many people thought to themselfs, "If worse come to worse, we an always take some money out of the house?"
Indeed I've heard many people (including many realtors) suggesting that you should buy as much home as possible as it is a form of forced savings. We would be in a much better poistion if home prices fell to the point that the median home could be afforded by someone with a median income who was still able to save 5-10% of his/her salary in a form other than home equity.
I live in So Cal and there was a belief here that house prices could never fall. For the life of me, I could never understand that. The simple fact that house prices doubled over a 3 yr period, while incomes rose only a few percent should have been a tipoff. Anyone who watches the news or reads the paper regularly should also have noticed prior real estate crashes in other parts of the country - they too thought prices had nowhere to go but up.