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What to think of Obama's housing plan
The ever-worthy Mark Thoma rounds up reactions and analyses, including some critical remarks from CalculatedRisk and some praise from Felix Salmon. Willem Buiter is negative (worth a read). Simon Johnson says it's not enough. WSJ surveys a few reactions as well. I'll add some observations:
1. Housing prices ought to be lower, and as quickly as possible. So aiding homeowners cannot be justified on the grounds of propping up prices, which is difficult to accomplish anyway. Such aid has to be justified in some other way. The main argument is that our ex post procedures for foreclosures are not what we would have chosen ex ante, had we known that such a severe housing and financial crisis could be possible. That opens up some room for beneficial intervention, but a good plan it still hard to pull off.
2. When it comes to refinancing the Fannie and Freddie loans, and expanding those agencies, how many foreclosures will this avoid? We should be reducing the size of the mortgage agencies rather than putting another $200 billion into them.
3. We should not be helping people stay in their homes if their mortgage payments are at 43 percent of their income. (The bill requires banks, in such cases, to lower interest rates until monthly payments are at 38 percent of income. The government then steps in to lower payments to 31 percent of income.) I don't feel moral outrage (although it is morally outrageous), I just don't think it is a good use of money. I also wonder how it works when your income is quite variable year to year. Are they sure there is no way to game this?
It will in the short run prevent some (enough to matter?) foreclosures. But it won't keep up the long-term price of homes or prevent eventual foreclosures when the home has negative equity. It adjusts interest rates on the payments, not principal on the loans (thank goodness).
Most of all it is a bad precedent which we will live to regret. It is a significant move away from the idea of commercial decisions based on contract.
One source, by the way, suggests that lenders will have veto rights over these "renegotiations" by choosing to foreclose instead of accepting the lower payments. But foreclosure is quite costly for the bank, so I don't feel so much better.
By the way, aren't we trying to help the banks?
4. Sellers receive various bonuses for modifying eligible mortgage loans. This is ideally a Pareto improvement if more of these contracts could be modified than is currently the case. My doubt is whether the subsidy will affect many modification decisions; so far I don't see that lenders are putting a lot of effort into renegotiations. Here is a good article on when modifications work and when they do not. I doubt if an extra 1k will make much difference.
5. Guidelines for modifying eligible mortgage loans are established. Ideally this could give more scope to the Coase theorem, but see my reservations under #4.
Felix Salmon, who likes the plan, nonetheless offered up a scary bit:
But really nobody has a clue how much it will cost: that's entirely dependent on whether or not the plan succeeds in arresting the fall of house prices.
The bottom line: #3 is a deal-killer for me. Just say no, and you don't even need a moral hazard argument (they are overrated, anyway) to see why this is troubling. I'd like to see the plan's proponents predict how many foreclosures it will forestall and be willing to take their lumps if they are wrong.
Posted by Tyler Cowen on February 19, 2009 at 07:09 AM in Economics | Permalink
Comments
In California, where most of the losses are, the $1000 incentives are trivial. Also, most of the loans during the bubble were non-conforming, so they won't be helped by the Fannie and Freddie action. A note on CR says they won't be helped by the 38-31% reduction either.
The cramdowns on the other hand, will probably come into play in California and elsewhere, since bankruptcies are going to be pretty common as ARM payments adjust. This has to complicate securitization of mortgages going forwards, and drop the values of the current set of MBS.
Posted by: MichaelG at Feb 19, 2009 7:18:34 AM
Two comments,
1. Concerning your main argument (#1), now I can understand and more important justify why my Minnesota Vikings lost their first SuperBowl.
2. You say "I don't feel moral outrage (although it is morally outrageous)". This must be a new definition of sangre de horchata (if you don't know the term, ask a Mexican).
Posted by: E. Barandiaran at Feb 19, 2009 7:39:43 AM
"Are they sure there is no way to game this?"
It's not a question of whether there is a way to game this but how many ways there are to game this. Given the level of fraud in the mortgage market over the past few years, I can only imagine the level of fraud we will see in this "bailout".
Posted by: Highgamma at Feb 19, 2009 7:39:45 AM
why 'as quickly as possible'? because you don't have enough popcorn?
Posted by: babar at Feb 19, 2009 7:40:23 AM
It is obvious now, especially in a broad downturn in the midst of a housing bubble crash, that a foreclosure is not meant to be applied generally. It is a nuclear option intended not to be used.
Why wouldn't banks want to renegotiate? I would think that they would prefer to renegotiate on a case-by-case basis. That preserves the threat of foreclosure and selects for the most desperate and motivated borrowers.
Wouldn't renegotiating to a 50 year mortgage at similar rates preserve the present value of the loan for the bank while improving affordability for the borrower, thus not hitting the value of the loan and improving the uncertainty around loan performance?
Posted by: Andrew at Feb 19, 2009 7:50:37 AM
Oh, and if the banks want to renegotiate, then don't we simply need the gov't to coordinate the un-slicing and un-dicing of individual mortgages so the mortgages can be renegotiated?
Posted by: Andrew at Feb 19, 2009 7:56:37 AM
I wonder how many foreclosures are for households that can reliably make a 31% of income mortgage payment but can't handle 43%?
Posted by: liberalarts at Feb 19, 2009 7:56:43 AM
I wonder how many foreclosures are for households that can reliably make a 31% of income mortgage payment but can't handle 43%?
Posted by: liberalarts at Feb 19, 2009 7:58:59 AM
"Most of all it is a bad precedent which we will live to regret. It is a significant move away from the idea of commercial decisions based on contract."
I'm sure they also said that about manumitting the slaves. The issue is the same: some people think human values ought to trump economic values.
Libertarians raise this same point very frequently for all sorts of day-to-day issues such as bankruptcy law. Let's go back to the good old days of debt bondage!
The simple fact is that our commercial system is created to act as a sort of sandbox: businessmen can play relatively safely in the security of the sandbox. But when one of them takes off his pants and poops in the sandbox, the children are lifted out until the sandbox can be cleaned.
Posted by: Mike Huben at Feb 19, 2009 8:08:09 AM
"some people think human values ought to trump economic values"
Those people don't understand economics. And sometimes they don't waste the time of those who aspire to. Economics is human action. I wonder, WTF do these people think someone like Tyler is defending when he defends contract?
Posted by: Andrew at Feb 19, 2009 8:20:32 AM
Mike Huben--
"The issue is the same: some people think human values ought to trump economic values."
Yes. And in my case, I didn't buy a house here in NoVA because prices were too expensive for me to afford. And now the government is trying to prop up prices so that I still won't be able to afford them. My "human value" is that I'd like to be able to buy a home without having to go into debt so much that I'm dependent on the goodwill of banks and the government saving me. When house prices go up to unaffordable levels, how is the solution to keep them that high?
House prices ought to go down "as quickly as possible," babar, because that's the only way to start getting the houses sitting empty to be sold, and to get the housing market functioning again. Also the only way to get people to be willing to sell and willing to move. If house prices are going to fall, it does no one any good to have it drag out as long as possible with sellers unwilling to lower prices so that they'll sell, and buyers unwilling to buy until the prices lower. That just leads to empty, abandoned houses.
No one is talking about debt bondage. Neither bankruptcy nor foreclosure results in debt bondage.
I feel moral outrage because I'm a renter who chose to rent because I couldn't afford a house, and I thought that they were overpriced. Now I'm going to foot the bill for everyone that I thought was foolish for buying a house that they couldn't really afford, expecting to refinance because "prices always go up." Not only am I going to pay for it with my taxes to bail these people and their lenders out, but the government is trying to step in to assure that prices always go up.
Posted by: John Thacker at Feb 19, 2009 8:25:48 AM
Looks like it will work on a modest scale: how modest nobody knows.
Foreclosures are costly for banks. This plan seems to have been figured out to make the margin in which it pays a bank to renegotiate and not foreclose wider. It is therefore helpful to banks; and also to the problem of the toxic mortgage securities the better slices of which which will now become somewhat easier to sell or price.
Some households hit by unemployment will certainly be better able to weather the storm. House prices will not prevented from falling because in most markets there will still be a hefty surplus of houses on the market.
Maybe there will be a way of gaming the rules; if there is Californians will find it. If that threat can be kept in check, this looks a good use of a modest amount of money; but I do not expect that the headline numbers will ever be spent.
Posted by: Diversity at Feb 19, 2009 8:41:44 AM
All these really smart guys do not seem to understand there are two different situations.
In Ohio and Michigan, where foreclosures have been high for several years, there never was a bubble, just a declining job market.
Will a California solution work in Michigan? Not likely.
Posted by: save_the_rustbelt at Feb 19, 2009 8:42:41 AM
Ability to make a contract and confidence that the contract will be enforced is tremendously valuable. Introducing additional uncertainty into the deal will make contracts more expensive and more difficult to execute.
I forget who made the comment, but what is the tragedy if someone who used to rent bought a house he could not afford, and goes back to renting?
Posted by: Rich Berger at Feb 19, 2009 8:44:26 AM
As housing price fall more people can afford housing. Marginal housing will be left vacant in some communities. But housing will return to the point where the average family in a community can afford the average housing in a community.
People who lied on loan applications should get zero help from the government. People who were trying to flip houses should get zero help. ( I would define this as people who purchased more then one home in the last four years, except for job transfers.) People who took out second mortgages to tap the equity of their inflated home prices should get zero help. I would not help anyone stay in a house where the value of the home is 25% above the mean value of the community.
I'm not sure that leaves many people in trouble.
I am outraged that I will now subsidize people who live in bigger more luxurious homes then I own, people who can only maintain that lifestyle with government help.
I was prudent and refused to spend more then 25% of my income on housing. Instead I increased savings to prepare for the future. I have lost large amounts on my investments. Do I get help from the government on my Bank of America stock, a company the government coerced into bad investments?
Group A invested most of their portfolio in highly leveraged real estate. Group B invested their portfolio mostly in the stock market. Why is the government coming to the aid of group A but not group B?
I can understand helping the poor, the maimed, the mentally ill. I don't understand government help to people living in McMansions with built in pools.
Posted by: DanC at Feb 19, 2009 8:50:47 AM
I'd like to see Buiter debate Simon Johnson, since Buiter thinks Johnson is full of it in almost every way on this issue.
Posted by: TA at Feb 19, 2009 9:00:14 AM
So its o.k. for the FED to try to pop the bubble, but it is not o.k., once the bubble has popped naturally, to let it stay popped?
This seems to be a weird intersection.
Posted by: stephen at Feb 19, 2009 9:23:30 AM
I don't think the securitization structure is the major impediment to renegotiations (they've always had provisions for servicers to renegotiate terms), the major impediment is that too many people's only means of paying the mortgage (even on a zero interest rate loan) was through rising asset prices. There's not much to renegotiate when one's income doesn't cover 1/360th of the principle balance (even if the rate were adjusted to 0).
Posted by: nelsonal at Feb 19, 2009 9:25:33 AM
Simply outrageous. Like many other commenters, I too held off on buying a place here in DC because the prices were so ridiculous. Now my prudence is being punished.
Why do we need a public policy response anyway? The market is already addressing the problem. Housing construction is down and first time buyers are starting to enter the market (anecdotally I have two friends -- first time buyers -- that have each put in bids in the past 5 weeks). Lower supply and new demand will prop up housing better than anything Obama could come up with.
And $200 billion more for Freddie and Fannie, the same two who helped stoke the crisis in the first place? The mind boggles.
Welcome to the consequence free era. In the minds of many in government no one should suffer from their actions. For all the paens to sacrifice and hard choices from the president, the reality is that we are willing to do anything but. How is digging ourselves further in debt with this $275 billion plan a bold move? It's gutless.
Obama is quickly making the profligate Bush look like a miser. These are some unreal times we are living in.
Posted by: Colin at Feb 19, 2009 9:39:20 AM
I second what DanC said! Help the truly poor let the rest fend for themselves. I believe that capable middle class people will not, in this day an age, end up begging bread and so do not really need Gov. help. They can move to smaller homes. Hopefully for a good while now housing will be treated as an expence and not an investment, this may be a needed adjustment because in about 50 years if trends do not change population will stop growing reducing upward pressure on land prices.
Posted by: Floccina at Feb 19, 2009 9:40:04 AM
1. The solution to the problem of people over their heads with a variable rate loan is to give them a new government-sanctioned variable rate loan? For most, that just means that foreclosure will happen in 5 years not this year, after everyone has spent thousands deferring the inevitable.
2. IIRC, by far the largest number of adjustable rate mortgages will not reset until 2011. This program does little if anything in anticipation of the disaster-in-waiting when those float to market rates, rates that will undoubtedly be much higher due to the increased risk involved in lending after government intervention.
The Law of Unintended Consequences at work, I think. The one law never passed by Congress, yet the one that is almost always discovered to be a rider contained in the mass of verbiage contained in any congressional legislation.
Posted by: RW Rogers at Feb 19, 2009 10:10:36 AM
Clusterstock headlined it best. "Government bails out reckless borrowers, hoses renters."
Posted by: MHodak at Feb 19, 2009 10:24:30 AM
How about they let me deduct what I pay on rent from my income tax like interest payments on mortgages? I see the government spending hundreds of billions on everything but somehow I never manage to see any of it coming my way. Maybe I should start being an irresponsible citizen, get over my head with debt, start a bank get money from savers, lend it to me and open a car company, hire thousands of people and promise them huge benefits when they retire.
Posted by: Joen at Feb 19, 2009 10:33:44 AM
The current housing situation has been brewing up for over a year in most places. The only action left in most real estate agencies are people trying to invest when houses are going for half what they would have in mid-2007. I believe that the policies we use to help the housing market should step away from our ongoing desire to help the present without researching and foretelling the future.
Like Tyler mentioned, the way that we handled foreclosures before thinking about possibilities of such a downward spiral did not take into account the future, nor did it have any risk management aspects, much like the sub-prime loan situation created by banks. In order to execute the plan correctly, I believe the policy should not be blasted out into practice like our recent bailouts have been delivered, but need consideration and thought about the future prior to launching another failure of an idea.
Posted by: SkeeWCU at Feb 19, 2009 10:37:38 AM
The current housing situation has been brewing up for over a year in most places. The only action left in most real estate agencies are people trying to invest when houses are going for half what they would have in mid-2007. I believe that the policies we use to help the housing market should step away from our ongoing desire to help the present without researching and foretelling the future.
Like Tyler mentioned, the way that we handled foreclosures before thinking about possibilities of such a downward spiral did not take into account the future, nor did it have any risk management aspects, much like the sub-prime loan situation created by banks. In order to execute the plan correctly, I believe the policy should not be blasted out into practice like our recent bailouts have been delivered, but need consideration and thought about the future prior to launching another failure of an idea.
Posted by: SkeeWCU at Feb 19, 2009 10:38:40 AM
