Mike the Mad Biologist

Over at Beat the Press, economist Dean Baker describes his plan to deal with the wave of foreclosures:

1. Gives homeowners facing foreclosure the option of renting their home for as long as they want at the fair market rate. This rate is determined by an independent appraiser in the same way that an appraiser determines the market value of a home when a bank issues a mortgage.

2. The proposal requires no taxpayer dollars or new bureaucracies. It would be administered by a judge in the same way that foreclosures are already overseen by judges. It simply changes the rules under which foreclosures can be put into effect.

3. The proposal does not bail out in any way lenders who made predatory mortgages or made risky gambles in the secondary market.

4. There are no windfalls for homeowners. They will have the right to stay in their house, but will no longer own the home. This means that there is no real incentive to abuse the program. The plan would be capped at the value of the median house price in a metropolitan area, so it will not benefit high income homebuyers.

5. Rents will be adjusted in later years by the Labor Department’s consumer price index for rents in the area. If either the owner or renter believes that their rent is unfair, they can arrange, at their own expense, to have the court make a second appraisal.

6. After the foreclosure, the mortgage holder is free to resell the house, but the buyer is still bound by the commitment to accept the former homeowner as a tenant indefinitely.

7. By allowing homeowners to stay in their house as renters, this plan will help to prevent the sort of blight that often afflicts neighborhoods with large numbers of foreclosures. Homes will remain occupied, and long-term renters will have an incentive to keep up the appearance of the property. This should help to sustain property values for whole neighborhoods.

Now, I realize some, like CNBC’s Douchebag of the Economy, Rick Santelli, will screech that this is TEH SOCIALISMZ!!!, but consider this (italics original; boldface mine):

…despite my conflicted thoughts about personal responsibility, I’ve come to put most of the blame on the banks and mortgage brokers (pushed by a ravenous Wall Street securitization machine), rather than the regular folks who got in over their heads, even if those regular folks suspected they might be reaching too far.

It comes down to this: there’s a massive information disparity between the two sides at the mortgage table. The banks and brokers knew damn well that the people they were putting in these houses couldn’t pay them off if the market turned (and whether or not they thought the market would utterly collapse as it has, these financial types know a market always turns). But they didn’t care because they knew they could unload their dirty deeds on some sucker running a pension or hedge fund via the magic of the mortgage-backed securities and collateralized-debt obligation markets.

Ma and Pa Smith, sitting across the desk from Broker Bob, may have worried about whether they’d be able to pay the adjustable-rate mortgage when it reset in four years, but who doesn’t–even if they can afford it. All thirty-year commitments are to some extent a leap of faith, and you’re some kind of sucker if you believe the Smiths weren’t being cajoled and smooth-talked past their worries by the brokers.

This isn’t to mention the outright criminality on the part of the brokers (and yes, the crimes go all the way up the chain to the banks, Wall Street, and the credit-ratings firms–but that’s a somewhat separate story) that was rampant in the boom years. Fudging people’s incomes or conning them into refinancing or giving them ARMs they didn’t want. Want to know the extent of the shadiness? This Wall Street Journal investigation from late last year found that at the peak of the boom, 61 percent of those who got subprime mortgages likely qualified for much lower cost prime loans. Did those home buyers put themselves into higher-cost subprime notes or were they deceived into them? Guess.

Anyone who made ninja loans, loans based on absurd market valuations, or cajoled people into taking on more debt than necessary (which makes it more likely that they’ll default) deserves what he or she gets. As I’ve noted, even prize-winning economists aren’t very sophisticated when it comes to their own investments. If we are to have caveat emptor, then we must also expect caveat mutuor. The good news is that the Obama administration’s plan incorporates these principles, if not the precise plan:

But the key to Obama’s plan is the bankruptcy provision. Until now, every government-enacted plan to reduce foreclosures has relied on incentives to encourage the banking industry to keep people in their homes. As Drum notes, bankruptcy is the stick behind those carrots. Obama is supporting a bill in Congress that would enable bankruptcy judges to reduce the amount a borrower owes to the present value of the home. The beauty here is that investors who own the mortgage securities, not taxpayers, will have to eat the losses. In short, investors will be held responsible for making a poor investment….

If Congress can’t pass bankruptcy law reform, the government should simply force banks to modify loans. The strategy would be simple–either keep borrowers in their homes, or return your check from the federal government.

“Ohio Congressman Marcy Kaptur and economist Dean Baker have some smart ideas,” Nichols writes. “They argue that the proper role for the federal government is not to fund mortgage negotiations but to insist that banks–many of which have already collected billions in taxpayer dollars–carry them out.”

(You might remember Kaptur as the congresswoman who urged people to squat in their homes if the banks botched the paperwork).

I’ve said this before, but it bears repeating: lots of people are going to have to eat shit sandwiches before this is all over–the question is who should do so, and how much.

Comments

#1 Lee
February 22, 2009

There’s another element of the mortgage risk her that gets overlooked. For many people it was a simple business risk decision.

The lenders were telling first time buyers: you can buy a home with zero or low down, short-term affordable terms, perhaps interest only on a 5 year balloon.

From a pure business perspective, one would be a fool to say no. If the market goes up, people with no or little investment in their home make a chunk of money on it. If the market goes down and you cant cover the 5 year mortgage at refinance time, then you didn’t lose much – you’ve been living in a nice home for 5 years for the cost of the mortgage payment, and foreclosure leaves you no worse off than when you started.

The upside of large possible gains resides with the borrower. The risk of large loss resides with the lender. And the lenders were telling borrowers: We are eager to this risk with you. Please borrow our money!!!

How on earth would a rational person say no?
#2 Moopheus
February 22, 2009

“This rate is determined by an independent appraiser in the same way that an appraiser determines the market value of a home when a bank issues a mortgage. ”

Which is to say, the appraiser makes up a number to make the bank happy. Oh, wait, we’re supposed to be over those sorts of games now, right? Actually, I suppose there is a limitation on this–if you offer the foreclosee a rent that’s much higher than market rate, they’re better off moving to a place that is market rate.

The main thing I object to in the government plan–and this is true of all the government efforts to date–is that a big part of the goal is to keep house prices “stabilized”–that is, keep the bubble from deflating–at levels that are still unaffordable to many middle class families in a lot of markets. indirectly it protects the investors who made the stupid loans to begin with. This makes no sense. Housing prices should be allowed to fall as far as possible, and when they’re at levels that people who want to buy can actually afford, people will buy.

And, as noted above, a lot of people made little or no investment of their own in their houses. So why should I want tax money spent to protect this noninvestment? Why should I want to have my tax money spent to keep house prices propped up at a level that I can’t afford? Sure, a lot of people were victims, but a lot weren’t. Many were quite willing participants in a great ponzi scheme that they thought would never run out of new suckers. I don’t feel very sorry for them.
#3 Erasmussimo
February 22, 2009

I think this is a great plan, because it allows the banks to transform the non-performing loans into performing rentals. They still get an income stream from them, which is immensely important. Remember, the problem is not that homeowners have no income at all, the problem is that they can’t afford the payments. In many such situations at the high-finance level, a renegotiation of the debt is done because it’s the best option for the creditor. Renegotiation is too messy a deal for the mortgage holders, but a rental arrangement provides them with some coverage. And in fact, when the housing market eventually stabilizes, there’s a chance that the mortgage holders will eventually get an adequate return on their investment.

The big problem with this scheme — and it is a killer problem — is how the mortgage holder will be able to satisfy his obligations to the renter. If the water heater breaks down, it is traditionally the owner’s responsibility, not the renters. I think this contract would have to reverse that relationship, so that the renter is responsible for maintaining the property in the same condition as at the time of the foreclosure.
#4 Moopheus
February 22, 2009

“The big problem with this scheme — and it is a killer problem — is how the mortgage holder will be able to satisfy his obligations to the renter.”

This is why it doesn’t already happening. Technically, there’s nothing preventing a bank from doing this now. The bank really, really does not want to be a landlord. It’s not their business. They don’t have the staff to deal with it, they don’t want to deal with maintenance, taxes, snow removal, and all that other stuff. Of course, a lot of landlords don’t either, but that’s a different problem. Ideally, banks want the foreclosure cleaned up and sold off their books as quickly as possible.

It is not unheard of for investors to buy foreclosures and rent them back to the former owners.

When, as now, selling off foreclosures can be difficult without taking a huge loss, the way some banks appear to be dealing with it (and firm numbers are hard to come by, but it appears to be common) is to not foreclose. If a borrower is in default in a house the bank doesn’t think it can resell, they’ll let the borrower stay, because then it’s still the borrower’s problem and the REO is not on the bank’s books. Better to take the small loss on the payments than the big loss on the foreclosure.

None of these plans are actually going to do anything except delay the inevitable, at great cost. And delaying will only make matters worse–if housing continues to be unaffordable, if banks are not cleaned up, markets will not function and foreclosures will remain elevated. I say we should let it all happen as quickly as possible, so we can start rebuilding from a clean slate.
#5 abb3w
February 22, 2009

Slight concern: the (immediate) poor decision may not have been made by investors, but investment managers. (Admittedly, trusting J. Random McGargle as the manager was an additional but less immediate poor decision.) Ideally, the incompetent managers (and scoundrel loan officers) should be the ones made to suffer most heavily… or at the very least, the system should be examined to see if that can be arranged should anyone try a similar game.
#6 katastrofa
February 22, 2009

@abb3w

This is the subject of the agent-principal theory in economics. Agents are motivated by short term profits (bonuses and commisions), principals by long term profits (survival of the company, dividends, long-term share price increase). Their interests are not aligned.

@OP

What I would be worried about is that the US government doesn’t know how to be a landlord much more than the banks do. You effectively create council estates without having the European experience of running them and solving the too-well-known social problems. Not that these problems will not increase during the crisis anyway…
#7 Moopheus
February 22, 2009

“Agents are motivated by short term profits (bonuses and commisions), principals by long term profits (survival of the company, dividends, long-term share price increase). Their interests are not aligned.”

It seems that over time, at least for public companies, legal and market forces have pushed the principal to act like an agent, to be more concerned with short-term gain instead of long-term stability and/or growth. Privately-owned companies seem to have a bit of an advantage here–less pressure from outside shareholders. The principals can act like principals and consider more than next quarter’s share price and profit. In the financial world, it has been argued that a big mistake for the investment banks was changing from private partnerships (the partners having their own money in the investments) to publicly-traded corporations playing mainly with the money of outside investors, with which they were much less careful.
#8 Paul Murray
February 22, 2009

IMO: the banks do not have a contract with the mortgagees.

A contract is not a bit of paper witrh a signature on it. It is an agreement between parties. The paper is just a record of that agreement. Now, if one party does not understand what they are agreeing to, then there is no agreement.

If course, the presumption is that an executed bit of paper means that the executors came to an agreement as described. But in the case of these absurdly complicated financial agreements with cotchas hidden in the fine print, that’s obviously not the case.

No agreement. No contract.
#9 katastrofa
February 23, 2009

If we allow people to default on contracts by saying “oh, I didn’t understand it”, it’ll create chaos. This would be an easy way to free oneself from any inconvenient obligation.
#10 D. C. Sessions
February 23, 2009

If we allow people to default on contracts by saying “oh, I didn’t understand it”, it’ll create chaos. This would be an easy way to free oneself from any inconvenient obligation.

The burden would necessarily fall on the debtor to demonstrate deception. Fortunately, that burden has already been met in many cases and can be reasonably inferred in related ones.
#11 abb3w
February 28, 2009

katastrofa: This is the subject of the agent-principal theory in economics.

But does said theory shed any light on the question of how to most pecifically and efficiently make sure the incompetent agents suffer, or should I just continue heating the branding irons? =)
#12 mirc
April 15, 2009

thanks.
#13 Tom buy foreclosures
May 16, 2009

they could buy foreclosures and then rent then out
#14 Dr Valley foreclosures
May 17, 2009

They should try this with the valley foreclosures it might work