Let housing find its clearing price
The U.S. government should just get out of the way and allow the crash in U.S. housing; the market is too big, has too far to fall and Americans’ finances are too strained.
President Barack Obama’s measures, unveiled on Wednesday, are part of a $275 billion plan to try and stabilize the housing market and prevent foreclosures. It aims to encourage lenders and their agents to cut repayments for homeowners in difficulties to lower, more affordable levels as well as other steps.
The reasoning is that there is a largish group of borrowers within the U.S. real estate market who may slide into default because their loans are too big and expensive or because they have run into temporary cash flow issues.
Give them a cheaper loan and you break the circuit of foreclosures, more stock coming on to the housing market driving prices down further and giving other mortgage borrowers more incentive to simply walk away from their debts.
There may be some who are successfully modified out of their troubles, but they will be outnumbered by those who will only default again, or even worse in some ways, by those who keep paying on an asset that isn’t worth the underlying loan.
“You probably have about two to three million homes that we overbuilt, a lot of those have to be converted to rental units. We overbuilt on the high end of the market. We just don’t have enough people in this world who can afford these high-end homes,” said Paul Miller, a banking analyst at FBR Research. “Government should just get out of the way.”
While the maths often cited is that a repossession and sale can cost a lender 50 percent of the value
of the loan, that rather attractive number hides the fact that modifying loans successfully is just very difficult.
Data from the Office of the Comptroller of the Currency shows that more than 53 percent of loans modified in the first quarter of 2008 had re-defaulted again within six months. Nearly 36 percent went bad within just three months. And this was when the U.S. economy was in better shape than it is today and unemployment lower.
Now it may be that those modifications were given to the wrong people and under the wrong terms, and it may also be that the new plan makes that all right. But I doubt it.
LET’S FIND A CLEARING PRICE
The Mortgage Bankers Association did a study in 2008 http://www.mortgagebankers.org/files/Research/LoanModificationsSurvey.pdf that found 70 percent of foreclosures were on properties either not occupied by owners, were on borrowers who could not be found or did not respond, or on borrowers who had already had a modification and were defaulting again. Of the 30 percent not in those categories must surely be quite a few of tomorrow’s re-defaulters!
The housing rescue plan is in part an attempt to rescue banks, whose balance sheets will be further undermined by falls in house prices and defaults causing many more failures. The bottom line is that many Americans who now have mortgages would be better off renting.
American consumer balance sheets are incredibly stretched. The average American has perhaps 30 percent of equity in his house, but that hides the people who own outright, thus leaving a huge rump, especially at the bottom end, who have very high loans-to-value. About 28 percent of mortgage borrowers now owe more than the value of the house, according to Zelman & Associates. And with stocks down 45-50 percent their assets have shrunk more alarmingly, leaving them less good risks.
There is an absolutely credible argument that many Americans, particularly less well off ones, would be better off out of home ownership entirely. They would rid themselves of the yoke of a mortgage on an asset which, even after a principal write down, may not end up being a good investment.
“They are going to try and keep you in a home that arguably you don’t want to be in. You might be able to go up the street and rent for half the price,” said Ivy Zelman, a housing analyst who was early in identifying the issues.
A person paying rent and with the flexibility to move to where there are jobs is better off than one anchored to an underwater mortgage in a town with high unemployment, even if the lender has to go bust in the process.
Prices of housing in the U.S. were driven too high by too much leverage even as supply increased. Let’s accept that, allow prices to fall, the banks to fail and start again on a new stable footing.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns, click here. —