( - promoted by Philip Bump)
Here’s what we know from the Great Housing Debacle of the Aughts: The housing bubble drove up the price of housing as people rushed to buy their segment of the American Dream. The more the prices of housing rose, the more people were forced to use creative financing mechanisms because the monthly payments on traditional 30 year amortizing mortgages were too high for many borrowers. The more people accepted exotic mortgages, the more banks and financing entities took crazy risks. The more risks banks and financing entities took, the more people could buy overpriced housing. The more people could buy overpriced housing, the more overpriced housing became.
In other words, when the housing bubble finally popped, many people realized that they spent way more money on their home than it is currently worth. The fancy financial term for this is underwater. As of November 2009, 25% of borrowers are underwater. But what does this mean? |
Supposedly, people are throwing in the towel and walking away from their properties because their home is currently worth less than what they owe. However, to be able to just “walk away,” a homeowner has to have cash on hand to pay for other housing options. Most people probably don’t have thousands of dollars sitting around in the bank that would allow them to secure new housing and move. On top of that, defaulting on a mortgage is pretty bad for people credit scores, so it’s probably hard to find a landlord or bank that’ll give them a new place to live.
Still, anecdotes about abandoned homes are scary. The more people who walk away, the more homes will be in foreclosure, and the lower prices will fall. Then more people will be underwater and at risk of walking away. To encourage people who can pay their mortgages not to walk away, some advocate that the Obama administration push lenders to forgive principal on loans. The thinking is that if people don’t have to pay more than their home is currently worth, they’ll stay in their homes. There are two problems with principal forgiveness, though. The first is that the market will, one day, recover. If people ride out this dip in the market, the value of their homes will increase again. It seems fair, then, that people who later sell their homes don’t get to keep the profits from future sales. If the tax payers are underwriting this principal reduction (because banks sure aren’t going to eat the loss), then I think there needs to be a restrictive covenant placed on the property that caps the profits an owner can make. The rest goes to pay back the government coffers.
The second problem is that principle reductions artificially inflate the market. We actually need the market to crash a bit to make housing affordable to a wider segment of Americans. If prices don’t return from their unsustainable levels, the only way people will be able to buy homes in the future is through exotic mortgages. Of course, that puts us right back where the problem began.
In thinking about how to preserve the American Dream of Homeownership, we need to be sure that we don’t perpetuate its problems. Principal reductions can help, but only if they are done carefully. |
