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Weller on Time to Avoid a Banking Bailout

posted by Bob Lawless

Former Credit Slips guest blogger Christian Weller wrote me over the weekend to point out that the charge-off rate on credit cards hit an eye-popping 5.47% for the second quarter of 2008. That led to an e-mail conversation about what was happening with the banking sector and how things look like they will get worse. Christian, who is an associate professor at UMass-Boston's Department of Public Policy and Public Affairs and a senior fellow at the Center for American Progress, made some really interesting points and, even more importantly, had some ideas for some actions that needed to be taken to prevent things from getting worse. I asked Christian if he would write up his ideas so they could be posted here, and he was kind enough to do so.

From Christian Weller:

Policymakers at the Federal Reserve and in the administration were slow to admit that they had a mortgage mess on their hands. The solutions have thus been tepid and so far not particularly successful in stemming the tide in foreclosures. Foreclosures are shattering previous records, setting new ones, just to be broken a few months later. The Mortgage Bankers Association reports that the share of mortgages that entered foreclosures in the second quarter of 2008 stood at 1.1% and the share of all mortgages in foreclosure was 2.8%. Since the 1970s, the share of mortgages entering foreclosure never exceeded 0.5% before the end of 2006 and the share of total mortgages in foreclosure never exceeded 1.5% before the second half of 2007.

And yet, many observers still believe that things will just be okay with a little tinkering. The track record of interest rate cuts and voluntary industry based work out efforts so far does not inspire confidence. The government's intervention in Fannie Mae and Freddie Mac seems sufficient proof that things aren't working out as planned.

Instead, policymakers need to address more forcefully the record foreclosures by helping struggling homeowners. The alternative is a massive bailout of the U.S. banking system.

One step would be to expand the ability of communities to purchase foreclosed properties. This is an idea that two of my colleagues, David Abromowitz and Andrew Jakobovics, at the Center for American Progress developed as the Great American Dream Neighborhood Stabilization (GARDNS) program. They advocated allocating up to $20 billion for this program, while Congress only allocated $3.92 billion in the last housing bill to this purpose. There is a lot more to be done and it should be done quickly.

Another option is to provide financial support to homeowners, especially lower-income ones. For instance, Sen. Obama has proposed a refundable "Universal Mortgage Credit" of up to 10% of mortgage interest.

Another possibility is to enact a second stimulus that is well targeted and temporary, e.g. by expanding fuel assistance and food stamps.

And finally, the bankruptcy code could be changed to allow bankruptcy judges to write down the part of a mortgage of a principal residence that is no longer secured by property because its value has gone down. This option already exists for vacation homes and second homes, but not for people’s own home and has been advocated by a number of consumer advocates, including the Center for Responsible Lending.

Comments

While I understand the need to prevent foreclosures, the problem with housing lies in the fundamentals, or the lack thereof, which caused the astronomical rises. So yes, another round of stimulus will help some homeowners. And yes, communities purchasing abandoned homes will ease the drop in home prices. And yes, mortgage workouts will help many that were trapped by predatory lending.

However, two HUGE problems remain. One, once the speculative factor was removed from housing prices, there simply weren't enough well-paying jobs to support housing prices. Prices must be tied to some metric, whether it be price/rent ratios or median home price being a multiple of median income. Nothing that the government can do, other than creating new jobs or inflation, will fix the underlying fundamentals. Yay. My housing hasn't fallen nominal in value, but headline inflation is at 6%.

Two, it's impossible to quantize how significant rising home prices were to our everyday economy, whether it be automobile sales or the meteoric rise in education prices. Simply put, American homeowners were withdrawing nearly a trillion dollars a year from their homes during the height of the bubble. Bye-bye home ATM. Buying hitting the jackpot in selling the row house you bought in 2001. The destruction of credit and debt is deflationary. As such, home prices MUST fall with it.

The government has only so many bullets with which to tackle the housing crisis; the question really becomes which of the players gets bailed out.

"policymakers need to address more forcefully the record foreclosures by helping struggling homeowners." Aren't these the same policymakers who set & monitored the policies that caused this mess?
"Another option is to provide financial support to homeowners, especially lower-income ones."
These are noble gesture, but wouldn't it be prudent to first, do away with NON-RECOURSE mortgages?

Any comments on the Fannie/Freddie conservatorship? Apparently this has triggered $1.4 trillion in CDS defaults, because of the language of 'conservator', used in the swap agreements. Is this a legal definition?

The problem for actual, you know, consumer-type citizens is that home prices are too high, not too low. All schemes to prop up home prices, such as (Federal) "financial support for homeowners," or (Federally-funded) "municipal purchases of foreclosed homes" are counterproductive and are really the brainchildren of shills for banks. I can't grasp why you want to transfer more money from the pockets of ordinary Federal-payroll-taxpaying joes to the crooked managers of large banks. Or to put that another way, why do you want to rob the thrifty to spoil the improvident? (Improvident bankers even more than improvident consumers.)

The proper response to the "mortgage crisis" is for people who cannot now (really, never could) afford to own, rather than rent, the houses and condos that corrupt mortgage brokers and syndicators put them into-- without down- payments, without sufficient income, without any ability to qualify for legitimate mortgages-- for those folks to go back to renting. Their overpriced former dwellings should be sold at market prices: prices in line with rents and in line with buyers' incomes.

The new prices will be much lower than prices at the height of the bubble. The lower prices will permit honest working families to buy homes (something which is currently impossible in markets like Los Angeles, California, where prices are still unaffordable to nearly 90% of inhabitants).

All the people suckered into signing loan documents to "buy" houses at unsustainable prices using 100% financing can just go back to renting while they save up a down payment for some future home purchase. The lenders (yes, including bondholders) should eat the cost of their reckless actions.

It is wrong to denounce, as Bailey does, "single-action" laws or the like which prod lenders to look to their security interests for value after a mortgage default. Those laws date back 75 years or more. Any lender who loaned impecunious people 100%+ to buy an overappraised home did so with full understanding that the loan was (mostly) "non-recourse." (Not that it matters; an practically unenforceable judgment against a defaulted mortgage borrower already living hand-to-mouth wouldn't do any bank any good.) Diligence: it's not just for consumers, it's also for large publically-traded companies with scads of accountants, for large publically-traded mortgage insurers with scads of accountants and actuaries, and large government agencies with scads of accountants and investigators. All of those "non-recourse" loans were written by lenders with every ability and opportunity to evaluate the proffered security and the borrowers' ability to repay. All of them were written so that people in the origination chain (salesmen, brokers, bank executives, MBS syndicators...) could get rich off fees while the party lasted. The whole thing was one giant Ponzi scheme. Defaults were postponed "for the duration;" reckless lending kept pushing prices up, so penniless "borrowers" never got caught failing to make payments-- they just kept refinancing or swapping properties, always making last month's mortgage payment with this month's new loan proceeds-- until the music stopped.

Now that the music has stopped it's time for everyone to go home. We should not ask working people to pay off the mortgages of the flakes who took the zero-down, 0% interest for the first 24 months, mortgages... "look Ma! the broker got $9,000 in commission and paid for the appraisal out of it!" Bondholders: sue the syndicators. Syndicators: pay back all your commissions and bonuses, obtained in many cases by full-on fraud. Empty-wallet borrowers: move out. Banks: auction the REO-- real no-minimum auctions, not the phoney "winning bid will be treated as an unsolicited offer to purchase" auctions you've been running in Southern California.

If it was just homeowners being foreclosed on, Washington would still be sitting on its hands watching the money roll in from the lobbyists.

Until the investment banks and funds gambling with mortgage pools and CDO's started taking hits it was perfectly OK to let even 7 to 9% of subprime properties get ground through the sausage machine - after all, until very recently, one man's REO was another man's next loan.



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