On October 1, the government kicked off an element of a housing relief bill passed last summer termed “Hope for Homeowners”. The program allows borrowers who are currently owe more than their home is worth and who are spending more than 31% of their income on mortgage to swap their mortgage for a more affordable loan. To qualify, borrowers must have completed their loan on or before 1/1/08 and have made 6 payments in 2008.
Unfortunately, the program puts participation in the hands of lenders, not borrowers, with the lenders deciding to participate. In a sense, this puts them diametrically opposed broader trends and the intent of the broader bailout package. The incentive as a profit-maximizing lender in this situation is to maximize the value of the loan by withholding concessions until the borrower manifests that they are at immenant risk of default, at which point the lender should offer the minimum conscession necessary to keep the borrower from defaulting. To the extent that negotiating with one borrower establishes prescedent, the cost to the lender of negotiating with a borrower extend beyond the individual question to their broader protfolio who could ask for consessions, further reducing the incentive to negotiate peicemeal.
On the other hand, the lending industry has pushed for a bailout package that essentially lets them offload troubled mortages as quickly as possible without the same value extraction mechanism. This approach does have merit in terms of restoring some stability to the market as quickly as possible, but it does reflect a fundamentally different approach.
Unfortunately, for all their merits, both programs fail at one of the key criteria necessary to putting the crisis behind us–finding the market bottom in housing prices. One thing that is clear at this point is that there is a massive overhang of customers who are in houses that they cannot afford under most interest rate scenarios, with recent US Census housing studies putting this rate at 38% of mortgage holders spending more than 30% of income on mortgage servicing. If this guidline proves accurate as an indicator of future default, the prospect for future defaults and housing price declines is great. For this reason, discussions of propping up housing prices are potentially the most misguided policy suggestions of all as this would preserve a situation where many buyers cannot afford the homes they live in, a fact that was revealed as the bubble’s pop laid bare the unreasonable appreciation expectations that formed the basis for many purchases.
Therefore, the fundamental policy question is not how to price troubled bonds in the secondary market or even how to let lenders negotiate individually with borrowers, but how to get to a market-clearing price as efficiently as possible (without the high transaction cost of foreclosures). Only once the bottom has been reached will the housing market normalize with consumers able to once again afford the homes they live in.
Let us hope that this point does not get lost on policy makers as they work through current and future solutions and that they expand their view of “bailout” to include a broader mechanism for helping housing prices find a bottom and passing this value through to the homeowner.
Tags: GoalSpring, Lending Industy
