The government’s foreclosure flop

August 12, 2009

The Obama administration has attacked the problem of rising home foreclosures with a humanitarian zeal. Their program — the most ambitious in generations — was intended to save up to four million people from being thrown out of their homes.

A few months on, this $75 billion policy has been a humiliating flop. Only about 270,000 mortgages have been modified since the scheme was announced in February, according to government figures, and if past experience is anything to go by, half of those could be delinquent again within six months.

The root of the failure is that the Administration crafted its policy on a powerful narrative of banks hoodwinking borrowers into taking out exotic and extremely dangerous loans.

Instead, homeowners’ own reckless borrowing and unemployment have been far more important.

The Making Home Affordable plan aimed to help victims of bank sharp practice, offering various incentives to lenders to bring monthly payments back down to around a third of an owner’s income. It was not designed to aid families whose income had disappeared due to unemployment, those who had large debts beyond their primary mortgage, or those suffering from serious negative equity.

If the administration is serious about stemming foreclosures they need to go back to the drawing board and consider some politically perilous alternatives

A study of 4,000 foreclosures from 2006 to 2008 in Southern California by Michael LaCour-Little, a finance professor at California State University at Fullerton, found that many borrowers were not the hapless victims either of machinations by the banks or of an unlucky decision to buy at the top of the market.

Rather, the study suggests that they borrowed excessively against the rising value of their homes using fairly conventional loans. These foreclosed owners took around $2 billion in equity from their homes, or nearly eight times the $262 million they put in, while lenders lost about $1 billion.

About 80 percent of borrowers had attached a second lien to their property and about 20 percent had a third.

Consumers, it seems, were more than capable of getting into trouble using plain vanilla products.

Leaving aside the moral argument against bailing out such borrowers, the presence of so much additional debt makes them harder to help through government modification schemes, because of both the presence of extra liens and the high levels of negative equity.

“We get tranche warfare as holders of junior liens are unwilling to go along with modification for fear of being cut out,” says Lacour-Little.

Meanwhile, the number of homeowners losing their homes due to nefarious lending practices is being dwarfed by unemployment-driven foreclosures.

“Short of requiring a 40 percent down payment there was no way many of these mortgages could have been designed to avert disaster,” Paul Willen, an economist at the Federal Reserve Bank of Boston, said in an interview.

This has important implications for government policy. Firstly it means that a Consumer Financial Protection Agency alone — though very necessary — would not have protected most Americans from the current foreclosure crisis.

(Cynics might suggest that consumer advocates such as Elizabeth Warren and Michael Barr have overstated the role of egregious lending standards in the foreclosure crisis when making the case for the new agency.)

Secondly, it means that the White House anti-foreclosure drive needs to be completely rethought. For those looking to prevent the next bubble, curbs on mortgage equity withdrawal might help. Using derivatives to protect borrowers and lenders against negative equity should become part of high loan-to-value mortgages.

The options for stemming the current crisis are less appealing. Adding a top-up payment to the unemployment benefit of homeowners would be hard to justify on equitable grounds, and would certainly raise howls of protest. However it is one of the few workable alternatives.

Unless the administration is willing to reverse course, the United States will remain on track to hit 9 million foreclosures by 2012.


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“homeowners’ own reckless borrowing” from who? Poor defenseless lenders (you know, the financial wizards who came up with collateralized debt obligations)? The problem is that the lenders are unwilling or (back to CBOs) unable to re-write loans to make them affordable. The solution: mortgage modification in Chapter 13 bankruptcies.

Posted by MYOB | Report as abusive

This is news. Please even an idiot like me could see this. The whole article fails to mention the amount of conventional loans to exotic loans. If you want to compare to items use apples to apples not apples to oranges. Say something about the gas prices and who is profiting from them not this worthless piece of history.

Posted by matt | Report as abusive

As we the people look back on the decissions of banking and government, resultant windfall for bankers, abject failure for borrowers and taxpayers absorption of the sum totality of the larger portion of the bankers losses, we must begin to ask our self if we are not as individuals adequately managing our government through a pro-active approach to elected officials and agencies of governance.

Ultimately the bankers have rather rich bonuses, the people are impoverished and the government has almost 5 trillion dollars in new debt to oppress several future generations.

While we have no economic engine to fuel US Entrepreneurial Growth and Leadership, while our beloved System of Bankers trades between themselves the appropriate vig on the losses generated for all but themselves.

Yet there is insufficient public outrage to restore Civil Order to the Lawless White-Collar Society in Michael Bloomberg’s New York City which has emptied the Wallet of Every American to fund the oppulent orgy of greed and malfeasance.

And not one Question of our National Interests in our Financial Capital being done a disservice by obiedence to the (“basic law”) of the land established by Term Limitations by a man who is loyal to no party other than the ‘New York City’s Party of Capital’ and its disloyal conduct to the Principals of the Nation that created it and no visible ethical loyalty to their fellow Americans.

You could starve in the street and a hedge fund manager would sooner piss in your cup than admit wrong doing.

Michael Bloomberg assures they will be able to piss on every American for another Four (4) Years. He has done nothing to assure Law and Order in Whitecollar matters in the city he had a responsiblilty to the People of the Nation to Govern to a high standard of principals.

Such High Principals have in High and Global View not been maintained in New York City under Mayor Michael Bloomberg who has overseen the most violent economic attack on the US Public in the History of the United States.

Say something about how t-bills are bought and sold. Say something about who gets paid each time t-bills are issued. Say something about how many other companies the government could use to issue t-bills.

Posted by matt | Report as abusive

Lets get real here. The author has an agenda. I have an agenda. The whole problem comes down to conflict of interest. When a person in a position of power if faced with two or more choices. The person will most likely choose the option that best benifits him or her personally. Just that simple.

If the author had anything to say he would be saying it. Instead we get this crap.

Posted by matt | Report as abusive

[...] Post By Google News Click Here For The Entire Article Buy and Sell Real Estate Without Paying a Broker! Share and Enjoy: These icons link to social [...]

It is pretty clear you are a former Bloomberg writer as notwithstanding an interesting headline you bury the lede

Posted by Rob | Report as abusive

[...] It shows consumers got into trouble out of their own choice keeping their eyes open. Without discussing about the moral issue of the necessity of bailing out these types of borrows the existence of so much superfluous debts because of additional liens makes it harder for government modification schemes to work. [...]