Barack Obama became the latest politician to call for a moratorium on foreclosures. It's rather obvious why such a populist proposal would have political juice. Furthermore, given McCain's own populist mortgage bailout he would have little room for criticism of Obama's proposal. Still, what makes for good politics doesn't always make for good policy. A moratorium on foreclosures is the exact sort of counter productive idea that will further deepen this crisis. Here are the three reasons why.
1) What will happen after the moratorium.
In order for someone to be in foreclosure their mortgage is as little as six months behind. They maybe nine and twelve months behind before a foreclosure action is taken. Does this sound like someone that can catch up? Barack Obama can propose all the moratoriums he wants but what will happen afterwards? If someone is in foreclosure all a moratorium does is delay the inevitable. Meanwhile, that person continues to live in said property without making any payments. How does such an action help anyone including the person the moratorium is supposed to help?
2) We have a liquidity crisis and now banks are forced to continue to hold onto bad paper indefinitiely.
The people that are behind are NOT going to be able to refinance and they likely won't be able to sell. Most of them owe significantly more than the property is worth. As such, adding another six months before a bank can foreclose means that there will be another six months where a bank doesn't receive any payments. Yet, we're in a liqudity crisis. Banks need money. A foreclosure takes time but once the property is sold they are infused with cash. All a moratorium on foreclosures ends up doing is making sure that for another six months or nine months or a year they continue to receive no money. All that would do is deepen the liquidity crisis. Banks need money in order to lend. The government and the central banks can continue to pour more and more money into these banks and raising the specter of inflation down the road, or these banks can find the money from their own portfolios. Foreclosing once and for all on bad borrowers is a way for banks to get the money themselves. A moratorium bars that for another six months to a year.
3) In order for housing to stabilize, bad borrowers must be removed from the market
One of the main reasons that housing is plummeting is because the market was built, during the boom, on irresponsible loans to irresponsible borrowers. Now, the market only allows for loans to responsible borrowers with plenty of down payment. As such, we have significantly more potential sellers than buyers. Forcefully keeping people in homes by forbidding foreclosure may seem like a way to stabilize the market, but in reality it only prolongs the agony of the market. These borrowers will sooner or later default. The best thing to do is to make it as soon as possible. Delaying the inevitable only goes to continue the uncertainty of the market. Short of giving these borrowers the property free and clear, there is little the government can do to make sure they won't go bad on the loan. Any new loan, even if the terms are signficantly better, will likely eventually be defaulted on as well. These people are simply irresponsible. They should have never received a mortgage in the first place, and forcefully keeping them in their homes only delays the inevitable and continues the downward spiral of the housing market.
Yeah, I would concede this "foreclosure moratorium" is somewhat a political gimmick. However it's a sort of pre-counter to whatever political gimmick McCain is going to pull next. It's not near the ridiculousness of McCain's last gimmick, having taxpayers buy *all* bad mortgages at inflated prices, which most economists left to right agree is an absurd plan. Obama's proposed moratorium is only for 3 months, so it wouldn't have the kinds of negative impacts you are talking about, even if implemented.
ReplyDelete...and I have criticized McCain's mortgage bailout significantly worse than this proposal by Obama.
ReplyDeleteThank you for stating the obvious. Typical of Obama to toss a benefit to one group that will be paid for by another.
ReplyDeleteI'm a small businessman. How about a 6 or 9 month salary and rent moratorium for me? How will my employees and landlord survive? Not my problem. I'm sure Obama will take care of them, too.
My concern is that the economy will stay bad until there is liquidity in the housing market.
ReplyDeleteMost of the proposals I see to address that try to help people keep prices at the last sale value
which is artificially inflating prices over the current market clearing amount. The Economist
had an article on this:
http://www.economist.com/finance/displaystory.cfm?story_id=12470547
which cites Luigi Zingales - Plan B paper.
http://faculty.chicagogsb.edu/luigi.zingales/research/PSpapers/plan_b.pdf
It not only has a proposal based on things that have been done before, to avoid foreclosures
while lowering house prices to the market rate, but also addresses the connectivity risk
between banks and other financial institutions.
Anyone interested in thinking carefully about future economic policy should read Zingales' Plan B.
I can think of only one good reason for a short moratorium on foreclosures … to allow time to come up a REAL plan for helping people facing foreclosure and, just as important, a REAL plan to stabilize home prices.
ReplyDeleteCan people in foreclosure be helped? Some CAN be helped, but obviously not everyone. Lets not be so cynical, and condemn everyone as a slacker. Bank policies had a lot to do with this problem.
And is there a way to stem or slow the slide in home prices? I think there is, with a minor change in the tax law.
Summarized below are two proposals for addressing the foreclosure problem, and helping the banks (and everyone) by stabilizing prices. The first step is to pursue Proposal 1 and, if it doesn’t work for the homeowner, the last resort is Proposal 2. If both proposals can’t be implemented, then perhaps neither should. But this is a crisis … why not both? We need to help, as much as possible, both homeowners AND banks, and every homeowner.
Proposal 1:
This proposal DIRECTLY addresses the plight of Americans impacted by foreclosure. The concept is to move people who may soon lose their homes (or have already) into another foreclosed home they can afford.
To make this happen, the banking industry in areas with high rates of foreclosure (such as many communities in Florida, California, and Nevada) would form local review committees. Federal, state, or local government can provide “limited” support and oversight to these committees, as discussed later.
Each committee would compile a consolidated list of foreclosed, abandoned, and mortgage default homes in their area. Homeowners who have lost (or may lose) their homes would be contacted and, with their input, a decision made as to a monthly payment they CAN afford, and the size/type/location of a home that meets their needs. Based on this information the committee would search for an existing foreclosed home that meets the criteria. Obviously this will be a lower priced home, with a lower monthly payment, property taxes, etc. The homeowner would be shown the home (or homes, if more than one).
At this point the homeowner has two options. The homeowner controls what happens. They can proceed with a foreclosure on their current home, or agree to move to a new home and assume a new, lower cost, mortgage.
There are a variety of ways committee members can encourage people to move to a lower cost home including: (1) allowing the homeowner to transfer the equity (paid down principal) accumulated on their old home to the new home, (2) subsidizing all or part of the moving cost, and (3) telling homeowners that moving (versus foreclosure) will preserve their credit rating plus allowing them to continue enjoying the many benefits of home ownership.
Proposal 1 enables banks to establish a new mortgage approximating the original mortgage on the 2nd home, substantially reducing bank losses versus selling the house to an investor in today’s depressed housing market. Banks also have the option of folding unpaid house payments on the original home into the new mortgage, spreading the payback over many years. Banks clearly have a vested interest in making Proposal 1 work, versus Proposal 2. Proposal 1 should be pursued before Proposal 2. Banks will control the homes released for sale under Proposal 2.
From the homeowner perspective, their new mortgage will probably exceed the actual market value of the home in today’s market. This should not concern the homeowner because (1) they avoided damaging their credit, (2) can live in a home they can afford, (3) will likely (over time) see the value of their new home increase, and (4) after foreclosure, it may be years before they can purchase another home due to credit damage.
Note: This proposal requires no change in the tax laws, or any other laws I can think of. But I do believe government can play a positive role. Government oversight on this proposal should restrict the use of an ARM, excessive home equity lending, interest only mortgage payments, and other discredited lending practices. They can also mediate the natural competitiveness between banking companies, who may find it difficult to cooperate in resolving this crisis because banks with the highest foreclosure rates will benefit the most from this plan.
Note: Mortgage payments for homeowners in trouble should not simply be reduced, even temporarily. This approach is not fair to their neighbors who continue to meet their mortgage obligation, and is the reason many oppose the concept of a “bailout”. Proposal 1 avoids this criticism.
Proposal 2:
Reduce or eliminate capital gain taxes on homes purchased by investors as rentals. The exemption should be limited specifically to foreclosed homes (held by banks). It should not include regular residential home sales and the sale of rentals such as apartment houses, duplexes, and investor owned home rentals. Changing the law will spur private investors to purchase the glut of vacant homes that burden the banking industry. The proposal is relatively easy to implement … a minor change in the tax code (which already exempts most primary resident homeowners). I believe this proposal might even be supported by the banking industry (even though most foreclosed homes would be sold at a loss to the banks) because it will help stabilize declining home prices … a serious concern of the banks. This is a temporary “fix” and should be implemented in phases … such as a 100% exemption the first six months, a 75% exemption the next six months, and so on until the exemption is phased out. For example, an investor who buys a foreclosed home within six months of the exemption taking effect, would owe zero capital gains when they sell the home years later. Phasing will spur investors to act promptly, helping reduce the glut of vacant homes quickly rather than taking years.
You have put the exact same comment into two posts.
ReplyDeleteYour second proposal is a good idea however it won't help anyone in a foreclosure or near one.
Your first proposal is a mess. You want to massively expand the power and scope of government in order to play musical chairs with people in foreclosure.