Opinion

Felix Salmon

Housing crisis datapoint of the day, tax-relief edition

By Felix Salmon
August 2, 2012

In 2007, it became clear to Congress that there was a serious mortgage crisis, with lots of underwater borrowers. And it was also obvious that an important part of working through the mess would comprise some combination of short sales and principal reductions. Thus was the Mortgage Forgiveness Debt Relief Act of 2007 born. Until the act was passed, any lender offering a short sale or a principal reduction would in doing so leave the homeowner with a massive tax bill, since the written-off debt would count as simple income for income-tax purposes.

In 2007, however, no one had a clue how long the mortgage crisis would drag on for, or how slow lenders would be to offer principal reduction. The original act expired at the end of 2009; it was then extended, through the end of 2012. But here we are, in August 2012, and principal reductions are only just beginning in earnest.

David Dayen has a good piece on the expiry of the tax break, including the interesting nugget that the CBO has put the cost of extending it for two more years at $2.7 billion. If the average underwater homeowner pays a marginal tax rate of 20%, then that means the CBO expects write-downs from principal reductions and short sales of somewhere in the $10 billion to $15 billion range during 2013 and 2014. And this, remember, is six years after the housing bubble burst.

My guess is that the tax break will be extended, somehow, somewhere in the horribly complex mess of legislative give-and-take that will arrive with the fiscal cliff. But it’s instructive to realize that if Ed DeMarco had actually agreed to Fannie and Freddie doing principal reductions, they would realistically only get started, in earnest, in 2013. As it is, thanks to his obstructionism, they’ll probably only happen even later than that.

The housing recession is dragging on for longer than anybody anticipated, and there’s no end in sight. Principal reductions are a good way of bringing it to an end; they should of course not incur a massive tax bill. I hope that we’ll see most of them done by 2015, eight years after the housing bubble burst. But in my heart of hearts, I don’t actually believe that. This housing crisis, I think, is going to last a decade. Or more.

Comments
8 comments so far | RSS Comments RSS

Seriously? Just $10B to $15B of write downs? Somebody slipped a decimal point, or is betting that a very small proportion of the remaining loans will be adjusted.

And Felix, the reason it has been slow to resolve is because so many actions have been taken to ease the drop. The homebuyer tax credit delayed things by at least a year. We still haven’t seen the second leg of the decline, when interest rates rise again.

Posted by TFF | Report as abusive
 

If principal forgiveness is a good idea, then why not do it on FHA loans? After all, FHA now has more 90+ day delinquent mortgages than Fannie, but produces only a third as many modifications per month as Fannie.

Make HARP mortgages a 1-mo ARM with a 1-2% interest rate (easily done if indexed to 1-mo CMT) and a 4% lifetime rate cap. That drops the payment by 40% for a 5.5% mortgage. Direct most of that lower payment into paying down the principal faster either by setting up an option ARM with an artificially high teaser or simply a 20-year amortization term (easier to service, but can create more payment shock).

You have to use a short-term ARM (low rate cap for payment shock safety) in order to get the interest rate low enough to pay down principal quickly. Simply refinancing people into fixed rate 15-year terms helps those with 8% mortgages to build equity without payment shock, but most negative equity borrowers already have rates below 8% (remember that most Alt-A were hybrid ARM’s indexed to now rock bottom LIBOR).

This enables borrowers to reclaim their equity without forgiveness, lowers credit loss, reduces future foreclosure volume, improves house prices, and requires no Treasury payments. But this issue is about politics rather than economics, competition rather than compassion, and blame rather than solutions.

Posted by kentwillard | Report as abusive
 

Many folks anticipated this dragging on for quite a while. I remember several well-known blogs I read in the finance/investing world, and I believe even Case-Shiller, saying housing will be a 10-12 year ordeal to reach a firm bottom. We’re half-way there!

I would be interested to hear folk’s thoughts, or links to thoughts, on what happens when the Fed stops supporting long-term rates? It seems to me that housing will again fall nation-wide, because higher rates mean higher monthly payments. And I’m not talking inflation, I’m looking at just Fed intervention. Right now as I understand it there’s a gap between what the market would charge for long-term loans (5-6%?) and what is actually being charged due to the Fed’s intervention in buying long-term stuff.

Posted by Harpstein1 | Report as abusive
 

Yeah. There were a lot of TV numbskulls in 2007 talking about a “soft landing” but anyone who had been paying any attention was talking about a 10-year cycle, at least. Not much on TV though. Dominated there by re-litters.

Posted by Eericsonjr | Report as abusive
 

>> . . . they should of course not incur a massive tax bill.

Um, why? And why is this obvious? The need to pay tax on the principal reduction seems to me to at least have the potential to reduce the moral hazard. As Robert Heinlein famously wrote, TANSTAAFL (there ain’t no such thing as a free lunch).

Posted by Curmudgeon | Report as abusive
 

But Heinlein always did believe in a free lunch if you read his stories. The Moon is a Harsh Mistress was a Marxist parable, Battleship Potemkin in Space. His Farmer in the Sky was a Stalinist fable.

The “moral hazard” argument is usually just an excuse to do something nasty and say your doing it for the victim’s own good. That’s why it’s popular in HR circles. The guys arguing against giving small fry borrowers a tax break on loan forgiveness are the first ones lining up for a bonus when their bankruptcy cancels their firm’s debts.

We really only have so many choices. Americans used to have a reputation for doing what needed to be done, but now the Republicans and their ilk are arguing ideology like French philosophers.

Posted by Kaleberg | Report as abusive
 

Heinlein believed in a social contract, not a free lunch. That is part of what is implied by his TANSTAAFL. There is a duty owed both ways.

He didn’t invent TANSTAAFL, however. That dates back to at least the 40s.

Posted by TFF | Report as abusive
 

Great! Nice post. Hope to read some of your post in the future.. Serviced Offices Manila

Posted by NancyFarley | Report as abusive
 

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