Negative equity: a housing time bomb
Part 1: Will Obama's mortgage plan work?
By Jack Guttentag, Monday, April 6, 2009.
Flickr photo by Umberto Fistarol.Editor's note: This is Part 1 of a three-part series. Read Part 2.
Most of the small print about the Obama administration's plan to help beleaguered mortgage borrowers is now available. In my view, it is coherent and well thought out, but disappointing in its limited scope. The program is designed to provide benefits to owners who deserve to be helped, rather than to reduce foreclosures and stabilize home prices.
The limited scope of the program is why its cost is estimated at only $75 billion, or less than the amount required to bail out AIG. The systemic impact will be correspondingly small.
The major limitation of the program is that it does not attack the problem of negative equity -- mortgage balances larger than the value of the homes securing the mortgages. Large and growing negative equity underlies the sharply reduced values of mortgages and mortgage-related assets on the books of the financial institutions holding them. These reductions in asset values have eroded the capital of these institutions, which the government in case after case has had to replenish to prevent failures.
The new program is focused entirely on the capacity of borrowers to make their monthly payments. Indeed, this is evident from the program name, "Making Home Affordable" (MHA). The major tool for reducing the payment is rate reduction, with balance reductions only a last resort in cases where rate reduction and term extension can't get the payment low enough to be affordable.
This approach flies in the face of evidence that balance reductions are critically important in avoiding subsequent re-defaults. A recent study by Roberto G. Quercia, Lei Ding and Janneke Ratcliffe found that "Among the different types of modifications, the principal forgiveness modification (i.e., balance reductions) has the lowest re-default rate. We believe that this is because it addresses both the short-term issue of mortgage payment affordability and the longer-term problem of negative equity. The results indicate that households with negative home equity are more likely to redefault over time, even when a modification has initially lowered the mortgage payment." (Loan Modifications and Redefault Risk, Center For Community Capital Working Paper, March 2009).
MHA has two parts. Part one is directed toward increasing refinance opportunities for borrowers whose loans are owned or guaranteed by Fannie Mae or Freddie Mac, and who don't have more than 5 percent negative equity on their first mortgage. Borrowers with negative equity greater than 5 percent don't qualify.
The second part of the program encourages payment-reducing contract modifications of mortgages that are endangered by adverse events affecting the borrower -- such as a job loss or a pending rate increase. As noted, the major tool for reducing the payment is rate reduction, with balance reductions only a last resort. ...CONTINUED
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Submitted by Robert A. Hulme on April 6, 2009 - 4:21am.
We should focus more of our attention on jobs.
Robert A. Hulme
Realtor, GRI, e-PRO
Prudential Utah Real Estate
Loan Officer
Mortgage Xpress
www.chandlerazrealestate.us
www.mesaazrealestate.us
Submitted by Jack McCabe on April 6, 2009 - 5:02am.
I'm glad to see Dr. Guttentag has reached the same conclusion. It's about time more experts started calling for demonstrative change, as the current housing stimulus plan only delays the inevitable.
For more information on principal reductions to end the foreclosure crisis and stabilize prices, see;
http://www.heraldtribune.com/article/20090204/ARTICLE/902040363/2055/NEW...
http://www.heraldtribune.com/article/20081222/ARTICLE/812220370/-1/NEWSS...
http://www.sarasotalandandhomes.com/sarasota-real-estate-blog/?p=107
http://www.furniturestyle.com/BlogPost/Housing-market-update--the-Obama-...?
Submitted by Doug Wolfe on April 6, 2009 - 5:53am.
The professor has hit the nail on the head once again.
I wonder if there are any statistics on the percentage of refinances that are for the purpose of paying credit card debt. And, should that be allowed, or should it be prohibited?
Doug Wolfe, GRI
Long and Foster Real Estate, Inc
Phoenix, MD
410-667-1900
www.dougwolfe.com
Submitted by Tim Johnson on April 6, 2009 - 6:03am.
Makes sense, but I fear any success at forestalling some foreclosures will be outweighed by alienating the people out there who don't need a modification. If you and your neighbor bought your home at nearly the same price, and your neighbor gets a principal reduction, and you're 30% upside down, you might feel you just got another reason to walk away from your mortgage. I hear a lot of people talking about just walking away and taking a hit to their credit report (the effect might not be so bad if lots of other people are doing the same thing).
Relocation.com
Submitted by Larry Whited Sr. on April 6, 2009 - 6:38am.
I respectfully disagree with the professor.
Investors as well as Wall Street created an artificial market bubble that drove prices 20-30% higher than they should have been.
That forced real home buyers to pay premium prices just to house their families.
The investors and Wall Street should not be bailed out.
The real home buyers should be helped with loan modifications so they can stay in their homes until the negative equity is recovered by market improvement.
Granted this may take 5 years or more but they stay in their homes until it happens. That is a win/win for everyone in the long run.
Larry A. Whited, Sr., CRB, CRS, GRI
President & Founder
www.maxUnet.com & www.WebMLS.net
A Virtual Real Estate Franchise System
** Virtual Is the Future **
P.O. Box 757
West Chester Ohio 45071
Direct - (513) 543-2727 Fax - (513) 297-7497
Submitted by Ed and Cindy Knight on April 6, 2009 - 6:47am.
Great article. Way too many went out a thin limb and should have never bought. Their lack of financial responsibility is drastically effecting the neighborhood. Yet the govt offers them programs and most will not even use them.
Where as their neighbors did nothing wrong, want to keep there good credit and either refinance or move but there are No programs for them. Yet these are the folks that will help our RE markets and our economy get back on track.
As for the investors not being helped this too is wrong. We are the ones that will be renting to the ones who foreclose. If we are not helped we can not pass it along to the renters.
Something needs to change.
Cindy Knight
Submitted by Jon Astaris on April 6, 2009 - 8:13am.
Maybe the professor or someone with weight and authority should really say what needs to be said about these "rescue" plans. They are designed with a single purpose in mind: to create the impression that "we really care" and "we want to help you" and as in all cases where the government comes to help, RUN.
There are and will be many millions of empty homes strewn across the land, resulted from the CRA and other misguided GOVERNMENT ACTIONS which allowed anyone with a heart beat2 to buy a house. The builders slapped them together as fast as the banks said YES and the world applauded the great american capitalist system.
Now those millions of homes are going back to the banks and the government is going to take them off of their hands. Unless you can get half of canada or a quarter of Mexico to come up and buy them, you'll have to buldose them or use them to grow chickens in them.
Submitted by William Metzker on April 6, 2009 - 8:17am.
Well said, Dr. Guttentag. But what I'm interested in knowing is the extent to which human behavior affects the economics of this. Example: Within the past couple of weeks, I saw some abstracts of home owners in a couple of fairly large neighborhoods with LTVs of 120% to 150%--pretty upside down. Yet, none of these homeowners were in default, and none were listed for sale.
Maybe the hammer hasn't fallen, yet. Or, maybe these folks are like others who aren't upside down--they'll just make their payments in the hopes the market will improve in the next year or two.
Submitted by Sean OToole on April 6, 2009 - 8:41am.
1. Price declines cause foreclosures, not vice-versa. Stopping foreclosures will NOT stop price declines. We still have demand for homes, but only at prices people can afford to pay. And without interest only and neg am loans, that price is lower than it was 2 years ago.
2. I'm amazed how everyone is ok with bailing out banks, and bondholders who made stupid loans, but not ok with bailing out homeowners who took stupid loans. Has all that corporate lobbying worked so well that we fundamentally care more about Bank of America, JP Morgan and the other rentiers then our friends and neighbors?
3. Stimulate jobs all you want Robert, but this economy is NOT going to recover while 20% of US, and 30% of California households with a mortgage have negative equity. Add on top of that the ridiculous amounts of auto, boat, and credit card debt carried in the US and it is clear that we have a debt hangover of unprecedented proportions and there is zero chance of this country getting back to the party until we work that excess debt out of our system.
For now foreclosures and short sales are the ONLY things that effectively deal with the core problem of negative equity. Foreclosures are unnecessarily painful, and short sales are currently far harder to complete than they should be. Its time we stop playing the blame game and figure out the most efficient way to clean up the negative equity with the least moral hazard. We are failing hard on this front right now.
Sean O'Toole
Founder / CEO
ForeclosureRadar.com
ForeclosureTruth.com
Submitted by chis eliopoulos on April 6, 2009 - 10:13am.
THIS IS MADNESS.
The whole mess is because we use credit and we got our selves in dept.All these programs are costing money and will put us in MORE dept.The solution is simple let everything go wherever far down it can go.Yes many people will loose but they are the one that took the gamble of ownership.Many banks will go under but many banks will emerge.It is NOTHING wrong with total failure.The system the last 30myears is running on fumes.How an economy can be healthy if is not based on DISPOSABLE income? So far no expert has the answer to that, maybe because there in none.
How crazy actually is to buy a house for investment, borrow any equity you have in it and spend it?
People were spending borrowed money,that's not an economy thats a pyramid.
The feds WONT fix the problem (they never have).
The best financial advice is PAY OFF ONE'S DEPTS.
Forget the tax perks and incentives.
The average dept is about 12% interest,there is no investment on this planet that will constantly give this return and peace of mind.Period.
Submitted by Annie Zaic on April 6, 2009 - 10:41am.
Tremendously saliant information Dr!
So, what to do about it, seriously...the whole "logical" country seems to agree with your position...how do we get DC to get it? My recent conversations with lenders seems to uncover the issue...IRS Tax Rules. Apparently, lenders can right off losses on foreclosures over 5 years but principle reduction rewrites do not get as favorable treatment. If congress passed a temporary rule passing on similar tax benefits, I understand that lenders would jump in. I'd love to hear your opinion on this, Dr.
Bob Hamrick
CB Premier Realty
Las Vegas, NV.
702-460-8090
bobh@cbvegas.com
Submitted by Lane Bailey on April 6, 2009 - 12:28pm.
I couldn't disagree more. I'm not a Professor of Economics at Wharton, but it is pretty obvious that the problem is that spending got out of hand. It got out of hand on the personal level, business level, and the governmental level.
Increasing spending will NOT fix a problem brought about by too much spending. It will only create more debt.
Rewarding the participants, whether they are people, businesses or financial institutions won't solve the problem. And yet... that is exactly what the government is trying to do.
Oddly, many of the first wave markets have started to resolve... BEFORE the government was able to really wind up and get involved. And as soon as the government started talking about "helping" those same markets started to become unstable again.
How many TRILLIONS of dollars would be saved if we let some institutions fail? And how much of an anchor on our future have we chained with the repeated bailouts?
Submitted by Lenn Harley on April 11, 2009 - 2:00am.
Finally a few with platforms to present common sense have reached the right conclusion.
Negative equity is a sleeping giant. There are millions upon millions of home owners in this country that, while not facing foreclosure, are held hostage by a mortgage balance that prevents them deprives them of job mobility, consumer power, school choice and many of the normal benefits of home ownership.
They are prisoners of their mortgage balance which is often twice the market value of their home.
The real estate industry will continue to falter until the normal "move up" buyer returns which is not going to happen with for home owners with negative equity. Many will not submit to short sale, foreclosure or bankruptcy remedies, they will simply continue to devote a disproportionate percentage of their income to make their mortgage payments waiting for home value appreciation to return and free them from the mortgage millstone around their necks.
The smallest family emergency can put them in foreclosure or bankruptcy because they have no savings with every dime going to pay the mortgage on a home with half the value of their mortgage.
I've written of this many time and without exception get comments about "bought homes they couldn't afford" from readers in the housing industry. This knee jerk reaction of so many who should know that the consumer relies on the so called "experts" ignores the fact that the consumer is not in a position of power when making a loan application. The consumer merely applies for a mortgage. The experts make the loan, fund the loan and put the lien on the property that is not choking the financial blood out of American home owners.
The "experts" are fine. They have TARP money. The American home owner with a mortgage twice the amount of the market value of their home can only work every day and make their mortgage payments, hoping for a better day.
Lenn Harley
Broker
Homefinders.com
http://www.homefinders.com