Thursday, May 15, 2008

In Search of Answers to the Foreclosure Crisis That Won't Make Matters Worse

Most Americans are now aware of the rippling impact that the home mortgage foreclosure crisis has had on the real estate and banking market. But as summer approaches there's a new concern ... mosquitoes and the spread of West Nile Virus.

KCRA in Sacramento aired the following story in February

The one thing about the current foreclosure that everyone ( consumers, politicians, bankers and health officials) seems to agree upon is that something has to been done about it quick and in a hurry. However, very few parties agree on the correct course of action.

In April, Senator Amy Klobuchar (D-MN) appealed for a long-term solution to this crisis which is impacting every area of the economy.

As Sen. Klobuchar stated, "Congress must work together to get this done". However one of the major points of contention is how to help those in true need without rewarding speculators and those who created this crisis in the first place. The following two stories which were recently featured on point out this troubling conundrum.

First Nicholas von Hoffman reports on Federal Reserve Chairman, Ben Bernanke's demonstration of concern in his article, "Bernanke's Federal Reserve Freakout"

What's got Bernanke scared is that "about one quarter of subprime adjustable-rate mortgages are currently 90 days or more delinquent or in foreclosure. Delinquency rates also have increased in the prime and near-prime segments of the mortgage market.... foreclosure proceedings were initiated on some 1.5 million U.S. homes during 2007, up 53 percent from 2006, and the rate of foreclosure starts looks likely to be yet higher in 2008."

Spooking Bernanke is the Fed's discovery that many thousands of delinquencies are not caused by unemployment or even, perhaps, inability to keep up with payments but rather by the quick, steep drop in the price of real estate. "Sharp declines in house prices, and thus in homeowners' equity, reduce both the ability and incentive of homeowners, particularly those under financial stress for other reasons, to retain their homes," he said.

The denouement Bernanke and not a few others fear is that "high rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets, and the broader economy. Therefore, doing what we can to avoid preventable foreclosures is not just in the interest of lenders and borrowers. It's in everybody's interest. "

The Fed's remedy is apparently, first, to stop the drop in prices, and next to push them back up to the point that real estate is at least worth the mortgage debt it carries. A bill presently in Congress aims to do that, although nobody can be certain about its succeeding, since such a thing has not been done before.

The cost would be immense in dollars and in civic morale, since any broad save-the-real-estate scheme would include saving speculators, wealthy people's vacation homes, those who lied to fraudulently obtain mortgages, and spendthrifts who put their homes under water so that they could buy large sailboats and/or Cadillac Escalades. The mere thought of such a bailout has the millions who saved for down payments, bought sensibly and have sacrificed to keep up with their mortgage installments somewhere between a slow boil and a tooth-grinding rage.

...the much respected Floyd Norris, a premier business writer of the New York Times, says, "The government may eventually decide that it is necessary to bail out the undeserving as well as the deserving, no matter how repugnant that seems at the moment, and no matter how bad the inflationary impact may be."

The following is an excellent article which I recommend that anyone with an interest in finding a solution to the US home foreclosure should read in it's entirety.

excerpt from

Three Things That Won't Help The Foreclosure Crisis

By Dean Baker and Liz Chimienti, Center for Economic and Policy Research.

Dean Baker is co-director of the Center for Economic and Policy Research. Liz Chimienti is a domestic policy analyst with CEPR.

Falling home prices, rising foreclosures rates, and a slowing economy have created a perfect storm for homeowners who bought in bubble-inflated markets, or used subprime, adjustable-rate mortgages to purchase their homes.

Members of Congress have responded to the crisis facing their constituents by proposing various measures, some strong, like amending the bankruptcy law to cover primary residences, and some misguided. The following are three major proposals that would actually do more harm than good. As Congress seeks to pass legislation to stem the foreclosure crisis, legislation containing elements of these proposals should not be on the table.

Subsidies for Home Buyers

Homeownership can be a useful way for families to accumulate wealth and to provide good secure housing. However, if families are buying homes with bubble-inflated prices, then they are not likely to accumulate any wealth in their home, since the price is likely to fall back to its trend level before they sell their home. (The median period of homeownership for moderate-income families is just four years.) Furthermore, they are likely to pay far more in housing costs each year, than they would to rent a comparable unit.

In the case of moderate-income families facing serious budget constraints, the additional housing costs associated with owning an over-priced home are likely to come at the expense of other necessary items, such as health care and child care. It is difficult to see how the government will have helped a family by encouraging them to buy into such a situation.

. Artificial Price Floors

This has nothing to do with linoleum, and everything to do with how prices get set for homes that are refinanced and backed by FHA loans as proposed in legislation being considered by Congress.

If prices continue to fall, then many homeowners will again find themselves owing more than the value of their home. This situation leads to defaults for two reasons. First, if a homeowner owes more than the value of her home, then she does not have the option to borrow against equity in order to make her mortgage payments. This eliminates an important source of security if job loss or unusual expenses leaves the homeowner temporarily unable to pay his or her bills.

The other reason why this situation increases default rates is that homeowners who owe more than the value of their home can effectively save themselves money by simply surrendering their house to the bank. If a homeowner owes $200,000 on a home that is currently worth $180,000, the homeowner can effectively save $20,000 by just giving the house back to the bank. While this move will hurt the homeowner's credit rating, if they don't have any special attachment to the house, a homeowner may choose this option.

Incentives to Build More Homes

Not letting prices fall back to their equilibrium (see above), or giving generous tax credits to homebuilders will encourage them to build more homes. The more homes that get built, the greater the over supply. This will imply a longer adjustment process and a larger price decline. There is no public interest in taking any steps that can delay the process of price adjustment in the housing market. This process is very painful, but delaying it will only make it more painful

Hopefully Congress, the Fed, and the banking industry will come up with a solution that helps those who are hurting the most. Until then some cities are taking matters into their own hands.

Related posts:

GOP Stalls Vote on Senate Housing Bill

Everybody Takes Advantage of An Opportunity

We're A Long Way From Bedford Falls

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