Since the peak of the financial crisis, both the Bush and Obama administrations have been trying to rescue both large banks and homeowners, often announcing programs for both in the same press conference. The programs for large banks have gone well, from the beneficiaries’ perspective (but not for small banks); programs for homeowners, not so much. As more people walk away from underwater mortgages, Assistant Treasury Secretary Herb Allison recently said, “We haven’t yet found a way of dealing with this that would, we think, be practical on a large scale.”
The failure of the Obama administration so far to come up with a working solution to the problem of mass defaults and foreclosures may be due to practical barriers, such as lack of capacity among mortgage servicers or legal uncertainties regarding securitization trusts. Alternatively, however, it may simply be that the administration doesn’t care that much. Perhaps the primary goal of homeowner assistance all along was to detoxify the toxic assets on large banks’ balance sheets; now that those banks are off of life support, maybe the mortgages themselves don’t matter that much.
Congressman Brad Miller’s proposal in The New Republic should put that question to the test.*
Miller says we should stop expecting the mortgage lenders, securitizers, and servicers who created this mess to be the ones to clean it up. Instead, the government should create a new Home Owners’ Loan Corporation, modeled on the one created by FDR in June 1933 (three months after taking office), to buy up mortgages and modify them. The HOLC could pick and choose the mortgages it buys and modifies, so it could focus on mortgages that could be successfully modified to keep the homeowner paying something and give the HOLC a small profit. I spent half the article wondering how the HOLC cold avoid overpaying for the mortgages (since the banks would try to hold it up for a high price), and then Miller suggested the solution: eminent domain. (The idea would be to take market data about mortgage prices and force banks or trusts to accept that in exchange for the mortgages, instead of letting them demand the inflated prices they may be keeping those mortgages at on their books.)
Both administrations, and the Federal Reserve, took absolutely extraordinary measures to rescue the financial system, simply shoving the private sector out of the way and, for example, buying over one trillion dollars of agency bonds and mortgage-backed securities in order to prop up prices in the market. By contrast, the homeowner assistance measures have been tentative, based on “nudging” private sector actors to do the right thing through small cash incentives. Those measures have largely failed; the cash incentives seem to be motivating mortgage servicers to “extend and pretend,” stringing homeowners along to keep them paying something without ever making the principal reductions that are necessary for a real solution.
Will the administration take bold measures — either those suggested by Miller, or something else commensurate with the steps taken to save large banks — to keep homeowners in their houses and stop the wave of foreclosures? Or is it content to pretend that its half-measures are working?
* Note that as far as I can tell Miller actually writes his own articles (and blog comments, even), as opposed to many public figures.
Update: Paul Kiel at ProPublica has yet another story on the challenges facing homeowners trying to get their mortgages modified through the government’s program. Among other things, modification trial periods were supposed to last only three months, yet 475,000 homeowners have been in trial periods for longer. That’s a lot of people. This is the problem that Miller is trying to fix. The administration may not agree with his solution, but I think something similarly bold is necessary.
The Baseline Scenario 
Mortgages in the 1920s/1930s were the old-fashioned kind with 20% down payments and borrowers with the capacity to repay. They did not go bad and cause the Depression; they went bad because of the Depression.
The mortgages of the 2000s were completely different; they were bad at the moment of origination. They could never have been paid back without permanent house price appreciation. They were not caused by today’s Depression; they were the cause of today’s Depression.
This is why Miller’s proposal is naïve, as is any attempt to “fix” this problem with taxpayer money. The mortgages were born bad. They are not going to “work out” because house prices are still inflated. A modern HOLC would simply transfer yet more taxpayer money to fill the holes in the balance sheets of banks and housing speculators. (Anybody who bought a house they could not afford is a “housing speculator” by definition.)
The bets already went bad. The money has already been lost. The game now is to figure out how to stick responsible workers and savers with the bill. Sure, why not, good work, keep it up.
Why not just send everybody a check for the difference between what they owe on their mortgage and what their house is worth? At least that would be honest.
The disaster has been exacerbated by refusing to let housing prices fall. The whole thing has been political. Savage those who were prudent. Bail out and engorge the banksters, titilate the under water ‘homeowners’ whose gullibility was at least half the problem. Engineer another bubble in the stock market. Suck in the retail who still have anything left to lose. Now we’ll see the same thing with soverign debt. Bernanke gave a great performance this morning before Congress. To hear his version one would thing the whole problem is behind us. We’ll see.
I have to call out both Kwak and Miller on this one. Both of them seriously underestimate the scale of the problem. According to a recent report (http://www.loanperformance.com/infocenter/library/Q4_2009_Negative_Equity_Final.pdf) the aggregate negative home equity in the US is $801 billion (and growing). That is essentially same as the overvaluation of mortgages and MBS on balance sheets. US banks probably cannot withstand a writedown of $800 billion (their record profits in 2009 were $55 billion), but Miller’s eminent domain suggestion would force it on them. Subsidies of the proposed HOLC that allowed them to overpay would have to come from the public (TARP II?). Miller suggests that not all mortgages would have to be purchased and modified, but it would have to be a substantial chunk of $800 billion to be credible.
The hostage situation continues apace, and Jack Bauer is nowhere in sight.
I agree with Nemo here; the federal government already subsidizes home ownership too much. The positive externalities of home-ownership have been oversold and the negative environmental externalities have been down played for too long. I appreciate that allowing large numbers of individuals to default now will be deflationary, but there have got to be better ways to stabilize aggregate demand than to maintain housing prices at their current levels. Rent to own is a good idea, but if homeowners are so far underwater that they cannot pay market rents to stay in their homes then they should walk away. The money they save on housing may even be enough to have a significant stimulative effect on the economy.
I wanna see you get eminent domain against banking industry assets through the Senate. No, really, I want to see that. But it will not happen.
We have been stuck in this trap since negotiations began back in 2006, when this problem was still on the horizon. The only way to solve this problem is through resolution. The only open question is what percentage of the (known to be fraudulent) book price of those assets would a resolution authority pay.
The banking industry knows that any number below 100% puts quite a few of them out of business, enough of them that they have no incentive to deal; going out of business from not selling to a resolution authority is no worse than going out of business because your assets were devalued. The government knows that it just flatly cannot afford 100%, especially when they’d be doing good to get much more than 50% back when they sort out and resell the assets, so the government is unwilling (and mostly unable) to go above 50%. And after three and a half years of on-again, off-again negotiations, after three years of everybody involved getting more and more desperate, there’s still no way to close the gap between the 50% that’s all the government can pay and the 100% the banks have to have.
Mr. Kwak wrote:
“The failure of the Obama administration so far to come up with a working solution to the problem of mass defaults and foreclosures may be due to practical barriers, such as lack of capacity among mortgage servicers or legal uncertainties regarding securitization trusts. Alternatively, however, it may simply be that the administration doesn’t care that much.”
To use a colloquialism……..That dog don’t bark.
Why is the lobby for small banks so ineffective?
His proposal works if you have solid, risk adjusted numbers managing who gets to participate in the program. The feds can look at what you earn, what the adjusted value of the house would be if they were to buy it, and only if you could pay the adjusted mortgage rate would you then get the privledge of participating in such a program.
“Why not just send everybody a check for the difference between what they owe on their mortgage and what their house is worth? At least that would be honest.”
Because it would be fiscally stupid. The government buying up these houses expect the majority of them to be paid back, with interest. If we were looking for financial responsibility in government, this program should wash out: the interest rate should be set to cover the expected number of defaults, so that no money is gained or loss when the program runs out.
Great idea. Bold action is required here.
Unfortunately, I don’t see it happening because it would be cast as a “government takeover” of business. The Dems don’t have the spine to fight against such claims.
Game over.
That said: I don’t think this program is the right answer.
As the post industrial era draws to a close with capital and power becoming ever more concentrated the too big to fail phenomenon is spreading thru all sectors of the economy. As more and more corporations become wards of the state the beauty of capitalism turns ugly. The housing debacle is just the tip of the iceberg.
The only effective way to put this behind us is for the federal government to dispense 1,000,000@ to each and every family in America. That should allow all the house debts to be paid off and spending to restart. It will make consumer spending to go to 95% of the economy and guarantee economic growth for centuries to come.
Jake, I couldn’t agree more. Fact of the matter is, there are MANY people out there with cash on hand who are just dying to get into the housing market. Yet, the government is letting all the negligent people who spent beyond their means stay in homes where they now owe more than the house is worth. It’s ridiculous!
Sorry, but the clock has struck 12. Give up the place, let the prices fall a bit… once a true un-artificial bottom out takes place, housing purchases will SORE (especially if the US dollar falls and people start jumping up to snag commodities to hedge the fall).
Meanwhile, those *other* individuals out their who exercised prudence and fiscal responsibilities watch their hard earned tax dollars get further eaten up by the main streeters who, for years, threw caution into the wind. How grand!
Better way to use $75 Billion, plus maybe a few billion more from the jobs bill. Assuming an average price of $250,000 – $75 Billion will purchase 3 million housing units. Purchase them only from underwater homeowners who have no real ability to own a house. They get the debt wiped away and they can go rent. Make sure only local community banks own the mortgages, and purchase the properties from the areas of the country with the most housing overstock.
Then pay people to tear them down. Sell the reusable parts to help offset the cost, like the copper, working appliances etc. Dispose of the rest where ever you do that sort of thing. (great stimulus for the local scrap yards etc, the lowest income workers) Then fill in the basements, dig up or treat the ceptic systems and oil tanks – and turn the lot into open space.
This accomplishes many things at once:
1. It gets bad mortgages (these should be mortgages that became bad not were bad from the get go) off the backs of community banks and credit unions who are most likely to lend to the middle class and who have massive commercial lending issues coming up.
2. It is fairly stimulative for the economy as it employs lots of people directly and indirectly through recycling centers, heavy equiptment renters etc.
3. It reduces the housing stock by roughly 3%, which should help keep prices from falling quite as far – supply and demand.
4. It reduces neighborhood blight which tends to led to crime and civil unrest. Presumably these homes would be abandonned for a long period which brings nothing but problems.
5. It’s good for the environment, more open space – even an empty home has to have the heat at some level, certain electronic items keep running.
There are probably others. This sounds nuts, but it’s a much more cost effective use of $75B than more complicated mortgage purchase, refinance, rework schemes. Plus, this entire project could be done through existing agencies and since it would be temporary some wealthy, important citizen like an Elizabeth Warren type could run it and not create a new government agency. I can’t imagine how many people would be working for HOLC II, and the agency would have to keep going until the mortgages were paid off – there’s 30 more years of new government spending.
The Right would have a field day with this. If the health-care initiative is a Bolshevik plot to take over health-care, then this plan is the start of establishing communes. This idea may have been feasible a year ago, but in this current political environment, this idea would never fly.
I suppose it would be better than any other aspect of the Bailout.
I’m probably only saying that because I like the idea of seizing bank “property” through eminent domain in principle. (Although technically it would be unnecessary since via the Bailout we already bought the insolvent big banks and now own them and all their “assets”.)
But this proposal would contradict the entire thrust of the Bailout by actually doing something to help anyone other than the big banks. It would only partially help them. Given that their absolute bedrock demand is to be paid off for their “assets” at at least a dollar on the dollar, and preferably more, and given that no one’s been able to shake the government in its commitment to such a bailing out, why would anybody be willing to go for this?
Even more fundamentally, given that the system’s one and only idea and goal is to reflate the bubble, and that the one and only goal with housing prices is keep the market from discovering their real, non-bubble price (which is, along with bank asset valuation demands, the main reason they won’t do mods via principal writedowns), why would anyone acquiesce in a project which acknowledges lower values than the original bubble price?
No, that price has to go back up, according to the “logic” of the system.
I think you are off a decimal. $75 billion “only” buys 300,000 houses. This problem is very large indeed.
Housing: The Best Leading Indicator for the Economy
2/24/2010 02:24:00 PM -CalculatedRisk on -excerpts
“Historically the best leading indicator for the economy (and employment) has been housing. I’ve been writing about this for years. For a great summary paper, see Professor Leamer’s presentation from the 2007 Jackson Hole Symposium: Housing and the Business Cycle….
So these leading indicators suggest any growth will be sluggish and choppy.
Now some people might argue that housing starts and new home sales are about to increase sharply. Based on what? That seems unlikely with the large number of excess housing units (new and existing homes and rental units). See: Housing Stock and Flow
As I noted above, it might be different this time with exports and technology leading the way, but I’ll stick with housing as a business cycle indicator.”
http://www.calculatedriskblog.com/
* This dog can bark
I second dennis. According to the report I cited above, 11.3 million US residential properties are currently in negative equity territory — a number that rose 0.6 million in 3 months (so much for prices bottoming out).
There are few ways that this story can end. Among the rosier scenarios, described in this blog and elsewhere:
1) A protracted, crushing deflationary period of low growth and high unemployment (Japan mk II)
2) Nationalization of the banking system (the only way the banking system can write down $800 billion quickly)
3) Monetary policy of hefty inflation (dubbed “re-inflating the bubble by many in these comments)
(Yes, those are the more attractive scenarios)
The comparison to the Great Depression is a propos.
Banks did essentially none of the heavy lifting to increase credit in the Great Depression. All the increased lending came from the government.
I pulled the numbers here:
http://www.asymptosis.com/banks-who-needs-em.html
I chose #2…plus abolish the Federal Reserve. This will solve more than just the housing dilemma.
How about all the responsible people who were at the right stage in life to buy a house, but at the wrong time ?
I bought my house to live on it, 3 years ago, in a decent neighborhood, not terribly inflated prices; I’m probably way underwater (don’t even want to look :).
For me, it is not terribly important (got a fixed rate mortgage, have a stable job, am living in the house), but I bet you many people who bought their houses 5 years ago or so are now underwater, whether they were irresponsible or not :)
“The failure of the Obama administration so far to come up with a working solution to the problem of mass defaults and foreclosures…”
I’m not sure what you mean here by ‘solution’. Do you mean they should somehow pretend it is OK or they should give these people money… or what? The implication of your comment is clear: you think action can change the facts. I don’t think it can.
I wouldn’t pretend to know whether this will work. Does seem like an uphill battle, but for pete’s sake its about the only idea I’ve heard. Other than the sound of shrugging shoulders!
Proud to have a congressman with a brain and guts! I suspect (have no idea) Mr. Miller conferred with a local who gives a #am$: http://www.responsiblelending.org.
Hillary Clinton and Roubini were pushing for a new HOLC back in mid-2008 and earlier.
Wouldn’t it just be better to nationalize all real estate and be done with it?
Decree that all houses get (x) deducted from the original principal amt. X is either a % or a $ amt. This will reduce mortgage payments and allow mortgage payers to pay off debt or actually buy stuff (like gold). The mortgage owner gets (x) as a lien on the property if it ever sells for more than the new, lower value. If you own your property outright, oh well.
Government stimulus w/o taxpayer debt, housing prices reset lower, banks lose but have the potential to get some of it back, responsible people get rewarded.
Comments?
Sounds like TARP, no? If someone can’t sue District Court and get the TARP law nullified as unconstitutional, well we don’t live under a Constitution anymore.
I’m not kidding Professor Johnson; all the oversight and machinations at watching TARP are hiding the real big elephant in the room… that the TARP gives no authority that Paulson and Geithner have used.
The law is not “flexible”, nor “broad”, nor “vague”.
FEBRUARY 24, 2010 – Naked Capitalism – excerpt
Martin Wolf is Very Gloomy, and With Good Reason
“Martin Wolf, the Financial Times’ highly respected chief economics commentor, weighs in with a pretty pessimistic piece tonight. This makes for a companion to Peter Boone and Simon Johnson’s Doomsday cycle post from yesterday.
Let us cut to the chase of Wolf’s argument:
Now, after the implosion, we witness the extraordinary rescue efforts. So what happens next? We can identify two alternatives: success and failure.
By “success”, I mean reignition of the credit engine in high-income deficit countries. So private sector spending surges anew, fiscal deficits shrink and the economy appears to being going back to normal, at last. By “failure” I mean that the deleveraging continues, private spending fails to pick up with any real vigour and fiscal deficits remain far bigger, for far longer, than almost anybody now dares to imagine. This would be post-bubble Japan on a far wider scale.”
http://tinyurl.com/yl8d24s
If one wants to interfere with with market, this is one of the better ideas. However, I prefer stoppin’-the-proppin’ and letting the market do its magic. Let the foreclosures proceed and let prices come down to a truly affordable level generally.
If this proposal is given serious consideration, I see two major hurdles:
1. “The idea would be to take market data about mortgage prices and force banks or trusts…”
With no employment in sight, and an economy that is going to continue to deteriorate for years, market data will only be accurate for the moment. What happens when the home that was rewritten falls into default, or when it’s upside-down again?
2. There is no way in hell the banksters will let this go through unless the plan in packed with goodies for them.
Screw that.
All the folks that took too good to be true loans need to eat crow so the housing market can return to sane pricing, and the banks need to be left holding the (now far lighter) bag.
HAHAHAHAHAHA, you expect bankers to abandon the system that allows them to grip us by the short and curlies? Won’t happen! Well, not without full collapse of the current system, at any rate.
All those people in upside down mortgages are not going to default. As one person above mentioned, he/she is in an upside down mortgage, but can afford it, and will continue to hang onto the property. Pride and history will keep them in. The market has always turned around, and fortunes made from owning real estate. No one will become a renter if they can help it, unless they want to increase their geographic mobility. The critical factor is income. If employment rises, the default rate will decline. And the vultures waiting will have missed their opportunity to pick the last bones bare. The market in my area is down to what it was about 3 years ago, and those were sluggish years with little appreciation, and depreciation the last year. So those that bought with small, or no down payment, have mortgages currently under water, but it doesn’t take growth long to wipe that away. So, historically, hanging on if you can is prudent. Making possible more people hanging on, via a large scale jobs bill, would save lenders, businesses, and society a lot of pain, and would only starve the vultures a bit. Doing as some above suggest, letting drown those that dared dream of becoming middle class, will turn this country into a mean, and dangerous land. Perhaps, that would be a good thing. With the government having just fed the rich and starved the poor, the have nots might become less controllable, and leaders again will decide to swing the pendulum in the opposite direction to keep from being overthrown, as they did in the `30s when farmers were showing up with shotguns to protect other farmers from being foreclosed upon. In a way, that is what lawyers and politicians are doing now by advising people to stay in their homes unless the lender can come up with the original documents, and cops refusing to enforce eviction notices unless said documents are produced.
Writing down mortgages to what a property is currently worth and letting the current debtor keep the house if they can make mortgage payments based on the new loan amount would be less expensive than going through the foreclosure expense and time, and then selling the house for 10% below the market at the end of the foreclosure proceedings, which is the average in my market for corporate owned properties. Of course, some would try to game this reality. So lenders would have to determine that the debtor cannot fulfill the original agreement. If the debtor can, but will not, fulfill the original agreement, then only a fool would accommodate them.
I am a happy renter. I do not purchase inflated assets, so my own net worth has steadily grown every year for the past ten. Anybody could have done (or do) the same.
I refuse to purchase an overpriced house. I will buy a house when prices become sane (we are not there yet) and when I can pay cash for it.
Now, your proposal is to use the power of the state to transfer my savings to people who bought (and continue to buy) overpriced real estate by taking out loans for 10-20 times their net worth?
Oh yeah, I have some comments for sure. But they are not suitable for polite company.
Agreed – wait till commercial realestate bursts. That bubble will be messier, and it will get huge government intervention, since many o fthe TBTF’s are also heavily invested in commercial properties.
Oligarchy anyone?
economies of scale – small banks have t band to gether and pay a lot of money to get the same lobbying effect as TBTF institutions. B of A, for instance, has the ability to field dozens of lobbyists a day to Capitol Hill – can your community bank do that?
How is US support of the GSEs different from owning mortgages? I read that Freddie Mac lost $26 bn last year and things aren’t looking up. If taxpayers have to cover these losses, what is preventing us from keeping people in their homes? These, by definition, if I’m not mistaken, are not sub-prime, so one assumes that we would not be rewarding irresponsible borrowers.
Why not remove the property tax exemption for the foreclosing entity? That might encourage them to deal.
Thanks for a remarkably clear and straightforward post. When the housing market started to unravel the clamour for “help” always was carefully phrased to cut out “speculators”. Guess what? That nice family down the block with only one owner-occupied property were speculators in any reasonable view in that they could only “afford” there house if prices kept moving up – even in that case I scratch my head a little on how they expected to get off the treadmill. Folks paid too much for houses. So what? I paid too much for any number of stocks and am satisfied to live with the results. Don’t tell me a house, bought with a purely speculative motivation (“I’ll have $75K of equity in 3 years!!!!”, should be thought about differently. And with rents falling and vacancies climbing, foreclosure isn’t even much of a hardship. If Obama doesn’t care, well at least he got that one right!
Orlando, categorizing borrowers as responsible or irresponsible shouldn’t even be a consideration. Right now the rage is that the government should help folks who are upside down on their mortgage. But think about it: upside down-ness is simply a reflection in a drop in (notional) value of property. This exact same thing has happened to the neighbor who owns without a mortgage and to the mortgaged neighbor who still has equity. Why would the nation select only the upside down guy to give “help” to? In fact it is quite reasonable to view the upside down guy as being in the best shape as he/she still has foreclosure out there as a financial “option”. Again, I am not fundamentally interested in characterizing folks as irresponsible so as to justify dening them help – it’s just that nothing bad in particular is happening to them that isn’t happening ot millions of others, who would potentially be asked to foot the bill for helping out.
JS, I follow exactly what you say about the logic of writing down mortgages. So why does it seem that writing down mortgages seems to be off to such a slow start? You mention that some might try to game the system. I think there are some geographies where underwaterness is so pervasive that every rational borrower would game the system if they discovered that writedowns were being offered….i.e. you are not doing the right thing for youself and your family by continuing to pay, even if you can do so. So this has lenders hesitant – maybe for every foreclosure and 10% undermarket price they take they think they are helping keep 3 or 4 more current by stonewalling. Another possibility is that lenders, being rational, have heard the clamour for federal government action. They would feel pretty stupid if they wrote off 20% of the loan value of 30% of their portfolio if 3 months later the government agrees to fund writeoffs at 90%. There are definitely places in California, Nevada and Florida where this scenario (or even more extreme) is possible. An unambiguous statement from Obama or Geithner that principle reductions are never going to be funded by the government should actually speed up consideration of principle reductions.
My latest update is highly relevant. See http://www.bobgreenfest.wordpress.com or http://ow.ly/1biC8 for additional insight.
Eminent domain shmeminent domain.
Call it whatever you want, the mechanism is not important. The political will is. And it ain’t there. The government will not force the holders of those non performing mortgages to sell them for a reasonable price. Not gonna happen.
Reality is that the power of the state has been and is being used to transfer your savings to the oligarchs. Reality is that the bought and paid for gov’t may yet force you to purchase health insurance. Reality sucks.
Nobody was forced to buy a house. Many people that have bought houses did so as a place to live rather than an investment, overpriced or not. And if you read the above closely, it costs you nothing. The (x) principal is taken away and attached as a lien. Cost to taxpayer = free. It is NOT paid off, just basically that debt turns into to equity. It might even lower rents, and should if you have a landlord with integrity. It might also be the tipping point that finally kills the zombie banks and purges debt from the system, and changes the political status quo.
Since the gov’t is probably going to decree another stimulus anyway, one that costs the taxpayer nothing is a better option than what they will eventually ram through.
Is this optimal? No. Is it a better option than throwing more money into the squid’s beak? I say yes, if only because my grandkids will not have to pay for it.
Shudda wudda cudda’s won’t close pandora’s box.
Exactly. The home mortgage market has been Nationalized with taxpayer dollars and no Congressional debate. The Commercial real estate speculators are about to be bailed out by us next.
Lee S.
Why can’t we trade a future real estate appreciation lien to the banks for a principal write down today? Allow anyone who chooses to reduce a principal payment down to the traditional 30% of true and honest income in exchange for the bank getting paid back through future asset appreciation when the property sells down the line.
These future appreciation values could even be securitized today to allow banks to cash out early. Also to ensure final and full payment back to the banks we could demand a life insurance policy with the borrowers that would make up any potential shortfall in appreciation.
The US Treasury could bring back all the sliced and diced mortgages to enact this plan at a very low cost relative to a full bailout. Indeed virtually zero US taxpayer dollars are required to enact this plan.
In the meantime the homeowner has more discretionary income to spend or save since they are not plowing all their money into an underwater mortgage.
Home prices are going to get back to a level that reflects true income levels eventually — why not do this overnight and be done with it. Perhaps those that played “by the rules” could get a one time tax benefit as a reward.