A better fix for housing
December 3, 2008
Trillions have been spent to prop up the banks, but little has been done to address the other side of the problem: home prices keep falling and foreclosures climbing. Obama is right to keep bringing this up. The crisis must be attacked from both sides.
Paulson has introduced some programs, to be sure, but the money allocated is a drop in the bucket compared to bank bailouts. Much more was spent just saving Citi in one day than on all the homeowner help programs so far.
However the issue is not just one of funding. All programs put in place or proposed so far (even Sheila Bair’s) miss the point entirely because they deal with a symptom (foreclosures) rather than the cause (falling home prices). Today we hear Treasury may start a new plan to reduce new mortgage rates, which is encouraging, although costly, and just like previous ones, difficult and slow to implement.
My thesis is simple: The market is broken because buyers are on the sidelines, as they expect prices to keep falling and are clearly waiting for a bottom. Speculators and even most borrowers with aggressive ARMs have already defaulted (and learned their lesson). Most foreclosures nowadays stem first from owners being underwater and simply giving up, and second from those in dire financial straits (due to sickness, job loss, etc.) who aren’t able to sell their house and move to a more affordable one (or rent). Both of these affected groups will grow as prices continue to decline.
Some say homes are now undervalued. No one knows where the bottom is, but one thing is for sure, unless we take proactive action we are going to overshoot on the way down just as badly as we did on the way up.
Clearly the fall in prices must be contained at some point. I think the time is now.
Here is a proposal to do just that which has minimal upfront cost (potentially no costs at all), can be implemented quickly, gives no preferential treatment to anyone, and carries no moral hazards:
Have the US government guarantee primary home purchases against loss of value as long as the buyer lives in it for four years. If after 4 years the home is sold for 10-30% less than purchase price the government will cover 50% of the loss. 66% if over 30%. Participating home buyers pay an additional 0.5% over mortgage rate (Price Protection Fee) to participate, which pays for program costs and builds fund to cover at least some of the potential guarantee payouts. Buyer can opt out of guarantee at any time and stop paying PPF, but contributions are non-refundable.
This plan would:
– Reduce risk and inject confidence in the market so people on the sidelines waiting for a bottom are much more likely to jump in, increasing demand and helping prices stabilize.
– No approval process, so it can be implemented by lenders in a matter of days. A simple ‘checkbox’ while applying for loan will do.
– If prices stabilize no claims will be made and taxpayers will make money.
– If they don’t it is still helpful as banks include the government guarantee in their books when valuing the notes, reducing pressure on their balance sheets. Also, any costs due to payouts over contributions will be deferred and incurred over time (most participants won’t sell exactly after 4 years).
– Program can be ended abruptly as soon as prices level-off, or if it fails to stabilize prices in a timely manner, to minimize further loss exposure to the Treasury.
– Simple limits such as 1 million maximum property value, and one property guarantee per person or married couple (no corporations, foreigners or trusts) will minimize speculation and abuse.
– None of the moral hazard involved with direct foreclosure prevention, i.e. if my neighbor gets reduced rate due to hardship I will apply to program as well (and lie on application if necessary) even if I don’t need it because who doesn’t like a lower rate!
– Everyone is eligible automatically, so no preferential treatment.
UPDATE 12/13/08: A reader correctly points out the potential for fraud. I address it here.