JustQuotes: Why Simply Reducing Rates Won’t Cure The Market’s IllsDecember 8, 2008
“Almost 53 percent of borrowers whose loans were modified in the first quarter of this year re-defaulted by being more than 30 days overdue…”
∙ Majority of Modified Loans Fail Again, Regulator Says [Bloomberg]
Comments from Plugged-In Readers
This is no surprise to those of us who have analyzed the mortgage market.
the problem in a nutshell was that easy credit allowed people to get into homes with mortgages that they have NO ABILITY to repay, due to the sheer size of the price to income ratio.
mortgage mods aren’t working because this isn’t an interest rate problem. it is an overleveraged (borrowing too much) problem. The ONLY way these loans work is if you have continual house price appreciation so that the “owners” can keep re-rolling the loans at teaser monthly payments. (these people can really only afford the teaser payments… they never expected to have to pay the true cost of “ownership”). of course the recession hurts too through job losses.
this is also why the 4.5% mortgage rate won’t solve the problem (it will help many people, but won’t solve the foreclosure problem), UNLESS it is paired with very loose lending guidelines AND teaser payments (in other words: payments that are less than interest accrued).
The loans modified in Q2 data looks about as bad (maybe slightly worse) as those modified in Q1.
worse: Alt A and the Prime mortgages are also performing more poorly than ever envisioned by our leaders. (although those of us who aren’t encumbered by kickbacks or political ideologies could see that Alt A is just as bad as subprime, and much of Prime not much better than that).
eventually when the 4.5% mortgages fail to ‘solve’ this problem I’d guess we’ll see “cramdowns” where lenders are forced to reduce the principal owed on a property. that will be interesting times!
“Foreclosures rose to a record in the third quarter as one in 10 U.S. homeowners fell behind on payments or were in foreclosure, the Mortgage Bankers Association reported last week.”
10% of homeowners behind on payments – yikes!
That means they’re probably not paying their property taxes, either. Or buying new dishwashers, washing machines, and cars.
If 53% of modified loans re-default, then better screening criteria are needed to determine who gets modified and who doesn’t. And I think a “foreclosure holiday” would be a big mistake because new buyers will not step up to the plate if they think prices are being artificially propped up, even with 4.5% 30-year fixed loans subsidized by the gov.
Does anybody know what percent of San Francisco homeowners are behind on payments?
I prefer to look on the bright side. A whole bunch of redefaulting borrowers got to live in their houses for a few extra months rent-free. It takes a while for the gears of foreclosure/modification to turn, and the smart trader will enjoy every minute of the free shelter being provided by the foolish taxpayer.
There’ll be more bailout/modification programs coming down the pike. Sounds like more scams to game!
It’s too bad of course for the people who actually have equity and/or put down large downpayments that they don’t want to “lose” (from a social justice point of view I guess – from a pure economics point of view, the issue is much more mixed). The programs are not available to them. They’ll have to wait until the market value of their home declines enough to convince them that their equity is truly and irretrievably gone, and then they will be able to default and get on the bailout free cheese line.
No kidding. How about a (positive) reward now for those who can pay, and have been paying mortgages and taxes before that cheese line becomes visable over the horizon…
It was a mania. Even the people who could afford properties at peak prices are likely to now reconsider. Prime might even turn out worse than subprime after the stagnation period that should follow prices snapping down.
Even if this program were 100% successful and if it reached an even larger fraction of the intended market it still isn’t clear the result would shift the market or even cushion the correction even a tiny bit. Prices are coming down and deleveraging is continuing.
When do the (apparently small minority) of us who saved diligently, took public transportation, actually believed in price-to-income importance get our bailout?
As a potential first time home owner, it’s a little hard not to engage in a bit of schadenfreude when we took the rather seemingly ridiculous step of saving a down payment, living a spartan lifestyle and paying attention to obvious market forces.
Seems to a admittedly bitter person such as myself that these ongoing parlor games continue to artificially keep the market from determining the true value of homes.
I certainly feel on a personal level for anyone in financial distress (been there before myself), but it’s hard not to be frustrated.
That’s a good point about prime, Mole Man. Prime borrowers could be expected to be more financially sophisticated and/or have more resources than other classes of borrowers (on average, of course). Credit rating should be less important, and anyway I would not be surprised at all to see the USG by diktat some time next year tell credit rating agencies to start ignoring real estate credit dings (or at least discount them), would you? All in the name of saving the system, of course, keeping the wheels of commerce moving….
I actually counseled two of my family members to cash out as much of the substantial equity out of their houses as possible in early-2007 (on the East Coast). One actually did, using an appraisal that was too good to be true. (No outright fraud, unless you count the general fraud of a maybe 80 IQ at best functionary “opining” on the value of a $1M asset that he knows he has to skew upwards in order to get paid by the lender.) That family member is pretty happy right now, and I think we might see a rash of strategic defaults. Just another unintended consequence when government institutionalizes moral hazard.
I had assumed that Hillary would win in a walk througout 2007, so that worries about recourse/refi issues should have been the last thing on any borrower’s mind. I expect Obama will be even more generous 🙂 And, the IRS gift of no tax owed on the forgiveness of debt after short sale or foreclosure? A wonderful, unexpected gift for many. It’s almost as if the policy makers went out of their way to make every mistake in the book during this entire bubble. (That’s assuming of course this mess was unintentional. When you look at the ease with which government power and control is being expanded – just as in the Great Depression BTW – even nonconspiratorialists have to question that assumption :)) And they’re not done yet.
I don’t think the regulators think they can stop foreclosures at this point. The best I think they are hoping for is to try and slow the rate of deflation in prices and maybe engineer some kind of 3-5 year period of flat or minimal declines of 1-2%.
Frankly as a guy with some cash on the sidelines, Id rather they just let the market correct quickly so I can buy.
Bear markets only end with periods of massive overcorrection. No period of over correction means the bear market goes on and on and on…so dumb.
“When do the (apparently small minority) of us who saved diligently, took public transportation, actually believed in price-to-income…”
I love the non-sequitur pathos in “took public transportation”. Yes, pilgrim, you have suffered greatly. 🙂
Anyway, I think hypersavers will be rewarded somehow, but we will have to wait until after Jan 20 to see exactly how. Patience!
I suppose if you have a cast-iron stomach you could “enjoy every minute of the free shelter being provided by the foolish taxpayer.” But I imagine that for most of those about to face foreclosure this is a period of desperation and anguish that they wouldn’t wish on anyone else.
How odd that people who are not in this situation apparently wish that they were.
Well Salarywoman i think the reason is we restrained ourselves when we saw crazy prices in real estate and elsewhere. Sure it would have been fun to buy a 2 million dollar house and flip it for a 50% profit with a no doc loan but I prefer not to live my life like that.
In my normal business I am a big risk taker. But the house I do own –is a 30 year fixed rate and I put 20% down. I don’t understand people putting this variables rate mortgages and other crazy gimicks to live short term in a home. if people are doing that stuff-they never really owned the home.
so on our side of the equation we look at people who now have the potentail to get bailed out with big principal reductions a la the us tax payer. and we go–geez we were the fools for not playing the game right.
at least sometimes I feel that way sometimes.
Loan mods normally have a 50% failure rate.
Interest rate reductions do not address the incentive to default for those with underwater mortgages. One solution is to reflate home prices through inflation. If you read Bernanke’s speech on how to address deflation from 2002:
you’ll recognize all the alternatives to physically printing money the Fed is currently implementing. I’ll add that the Fed buying illiquid mortgages (that are probably worth not much) is really like dropping dollar notes from a helicopter.
non-sequitur pathos! That’s a darn fancy way to deride my musings cooper :-)…Point taken though, I guess like Salarywoman I feel like a sap sometimes for naively not jumping on the bandwagon.
Perhaps someday it will be worth it, but I’m not getting any younger and I’d sure like my own place some day. Let the market work! It’s brutal, but at least it’s honest. Not like this seemingly endless game of 3 card monty whose rules keep changing under us….
If “big principal reductions a la the us tax payer” are really going to happen then I can sort of see your point. But I’d rather be in your situation than anxiously waiting to see if this is actually going to happen. Sure there are some cold, calculating speculators out there who will be just as happy to walk if there is no bailout or if the bailout somehow excludes their particular situation. And sure there are some people who will always land on their feet even though logic and reason say they shouldn’t.
But first of all I doubt very much that big principal reductions are going to become a reality. I may have to eat my words on this but it’s a politically infeasible solution that would end up creating more problems than it solves. It might be tried. But if so my guess is that it would quickly be abandoned.
And second, most of the people who are in trouble are not speculators but ordinary people who made bad choices, as so many of us do. Or people who made sensible choices but lost their jobs. Or retirees who had their savings vaporize. I just don’t understand how helping people like this could make you feel like you were a fool “for not playing the game right.”
You did play the game right. You are in a much, much better position, financially and psychologically, than the vast majority of the people that you seem to, sometimes, envy.
It depends, if you put 20% down on something and are being foreclosed on, I’d be surprised if you didn’t come out ahead with either and outright bailout or a de facto reduction in principal.
If you get some deal where you are paying 4.5% on your mortgage and it’s stretched to a 40 year repayment which I can totally see them doing..boy look out. If they add on principle reduction? wow I wish I had some of these bad loans.
Now there is talk of them using eminent domain to actually force total renegotaion of these morgages (one step below Putin).
So the game for the borrower is to hang on as long as possible to gain visibility into what the new administration will do. it’s likely going to freeze foreclosures in an ad hoc fashion.
that means–try and get your lender to give you even 2-3 months. or scrape together enough cash to last that long. unless you committed utter and total fraud you are gonna keep your house.
Now–why does that piss me off? I could have bought a 3 million house and just waited this January to start my default process to get my loan totally renegotiated for half the rate over 40 years. by the way, when you lower the rate on a loan it’s just like a principal reduction. they are all multiple sides of the same coin
Ha! “principle reduction”.. Honestly, I can’t wait.. When this country thinks it is necessary to give a principle reduction to the most irresponsible folks in America, it will be beautiful day for all the academics who promote this daily.. A principle reduction for a small percentage of the mortgage holders in this country equals a waterfall of defaults that no professor or economist or some “know it all” newscaster will input into their “mathematical” equation. Who really thinks a responsible and prudent neighbor will stand by and watch someone else get a principle reduction and smile and say “isn’t that sweet” they refinanced their house multiple times and bought all those wonderful toys and now my tax dollars will bail them and I will just continue to give and give and be charitable, all for the greater good… Little do these academics and Washington folks who never get out understand, this move will not only bankrupt America financially but it will be the last straw and bankrupt America morally. I would call this “wipe out” of anything that may be left in this country we might call good, charitable and responsible. I just dare the government to do this. At least we will be able to add to the dictionary what a “modern day revolution” definition will look like.. I guarantee anyone it will not be pretty. And to think they are worried about the financial health of this country. Can you imagine what this country will look like with the highest crime rate in history?? Of course not…
Go ahead… “Make my day”!!! Give those homes away… Just dare ya…. You can bet I will figure out how to take advantage of the deal of the century someway, somehow…
I understand and share your frustration.
For anybody who is waiting to buy, I think these statistics are ultimately good news. Policy makers can say, “We care about you troubled owners. We tried our best to help you save your home. But look at the facts: these loan modifications just don’t work.”
At least that’s what I HOPE they’d say. It’s one thing to ignore economic theory, it’s another thing to be proven wrong and continue down a disastrous path nonetheless.
Obama says he wants to make policy decisions not based on political ideology, but rather on facts. I also think the Republicans and Libertarians aren’t vocalizing their bailout outrage too loudly, because Bush is still in the White House, but the volume will crank up once Obama enters takes over. Especially if his administration pursues paths that have already proven to fail.
All these programs–Help for Homeowners, possible 3-6 month foreclosure holidays–do is delay the inevitable: foreclosure and continued decline in housing prices.
And lowering the interest rate is not like a principle reduction, because when you sell you still owe the principle. Your property taxes are still calculated based on the principle. The FDIC is giving some home owners rates as low as 3% for 5 years PLUS the interest is based only on a portion of the principle–that’s effectively a 1% or 2% interest rate. Wouldn’t that be nice?
The Comical had a good summary of 3 different loan modification programs on the front of yesterday’s business section:
And while it seems unfair that people who (in most cases) never deserved these homes or mortgages are getting bailed out, there are either loan limits ($550,440-$729,750) and means testing. For instance: must have good payment history, must be 90 days delinquent, certified financial hardship, did not purposefully default, cannot have active bankrupcy, etc).
So, yes, you could have bought a $3 million dollar home, but you’d only be bailed out on a small fraction, if at all.
And if they invoke eminent domain, I’m moving to Russia…
This notion of using eminent domain is interesting, but it will never happen. However, if the govt did invoke this, it would be bring home prices down faster than just about anything else.
The notion is that the govt could seize homes facing foreclosure and sell them back to the homeowner at the fair market value with some new cheaper mortgage. The lender would then be paid that low fair market value as “just compensation” for taking the home. This is most likely an unconstitutional use of eminent domain. But if invoked, it would result in a large number of homes being re-assessed, and those new appraisals would quickly set the new, low market value which is all other sellers could expect. This is the exact opposite of the intended effect (geez, maybe they’ll try this after all . . . )
I don’t get how these are the most irresponsible folks in America. Some people wanted a house, paid the market rate just like they stupidly pay marked big box retail for pretty much everything, and only later found out they were screwed. Reducing the principle helps them and the banks. If you can really find examples of how this turns out to be a windfall for people who grossly overpaid then that might be used to stop the insanity. In most cases the reduced principle is barely relevant, and the fraction of loans having principle reduced is arguably not even significant.
The worst is yet to come when Mozillo and friends come to collect their winnings from RTC 2. The good thing is that this correction story should have a mostly happy ending with house prices back down where they should be and banks regulated such that the worst of this fraud can’t be easily commited again, at least not for a little while.
I can tell you guys for a fact the obama adminsitration is considering invoking eminent domain based on the public interest. they believe the lenders (the ones tehy can find) are not modifiying loans quickly enough and sometimes are unreachable. they are in fact actively considering it and i think it’s actually more likely than not they will do it if the foreclosure stats continue to worsen.
@ Mole Man, please tell me a little more about Mozillo and RTC 2: “The worst is yet to come when Mozillo and friends come to collect their winnings from RTC 2.
As for the use of eminent domain, keep in mind that:
”The Fifth Amendment to the Constitution says ‘nor shall private property be taken for public use, without just compensation.’ This is a tacit recognition of a preexisting power to take private property for public use, rather than a grant of new power.”
So I agree with Trip that invoking eminent domain would actually cause house prices to cascade downward because “just compensation” would be a market rate lower than what was paid.
Plus, who owns the house: the home “owner,” the bank, or the investor holding a small fraction of the mortgage back security?
Also, I would argue this doesn’t meet the “public use” threshold, however in 6/23/05 the Supremes extended “public use” to include urban planning projects. Basically, if Starbucks brings in more tax revenue, that’s a better “public use” than a senior citizen’s private house. Outrageous.
Before Obama could invoke eminent domain, the Supremes would need to rule this as constitutional, and I just can’t see this happening. I wish Sandra Day O’Connor were still on the high court.
The just compensation is pretty simple. With the forced “adjustment” the loan will have a higher net present value than if it goes into foreclosure. Since there are so many lenders that can’t even be located in time, the argument will be no compensation is needed since the lenders get more.
The point that has been made a few times but I would like to reemphasize is the fact that any solution out of the mess, which could involve the free market or any of the range of governmental solutions proposed, has to avoid making homeowners who currently can afford to make the payments on their current mortgage feel like someone else is getting a deal they don’t have access to.
If the government can use eminent domain to force lowered mortgage principal amounts, then the government may as well just own every building in the US. It will require fewer piles of paperwork and will be more effective at preventing price declines.
@ Cooper, trying to apply eminent domain is a really interesting (desperate?) idea. In your example, who would ultimately own the loan? Are you saying the government would force banks to sell them defaulted loans? So the property to be confiscated is the loan, not the house? Doesn’t eminent domain pertain to real estate, not all asset classes (loans)?
And how would “just compensation” be determined? If the government used market rates, house prices would go down further. If the government paid above-market prices, then that’s not just compensation. Not only would this be rewarding the so-called predatory lenders by overpaying, but taxpayers would probably revolt. Taxpayers are already bailout fatigued.
I don’t see how keeping a defaulted home owner in place has a higher net present value when 3 out of 5 modified loans fail in the first 8 months. I’m trying to understand your rationale, but keep in mind today’s re-default statistics will only get worse with additional layoffs and wage deflation.
Points for creativity. Still, no matter how far I try to stretch this idea, I can’t fit it in to the eminent domain bucket, without throwing away our Constitution.
yeah it is upsetting :/
just to be clear i don’t support any of this crud. i think its a waste of time and we should let the market clear. get a huge over correction so buyers start to come in naturally.
The Obama administration might use eminent domain to make loan modifications but I doubt that it would be used to make principal reductions. I agree with CC here. The reaction would be catastrophic.
Loan mods won’t keep everyone from foreclosing, but they will cushion the blow somewhat. There are people out there who have seen the interest rate on their loans go as high as 12%. Yeah, they were dumb to sign the docs in the first place. But that still doesn’t justify 12%.
Sheila Bair makes a good point regarding this number:
“The lack of detail makes it tough to distinguish “re- default rates of sustainable modifications versus cosmetic modifications that by their nature are more likely to re- default,” said Bair”
That said, any modification program is likely a temporary measure. At some point these houses will probably sell (either by the homeowner or the lender) for much less than they were purchased.
I can, however, see value in a modification program for some homeowners. Especially where a mortgage broker convinced the homeowner to refinance into a neg am loan based on the monthly payment amount. In some cases the broker neglected to mention the details and collected a YSP (encouraged by the lender). Both of which are inconsistent with a broker’s fiduciary duty.
@ DataDude – if you want to play around with NPVs try the FDIC’s spreadsheet.
I’m guessing you’re getting this eminent domain junk from some fringe website? Probably one that also says the personal income tax is an unconstitutional scam?
cooper’s suggestion that eminent domain might be used is not as absurd as some might think. It is more likely that the government would use another tool.
Regardless of the tool, however, a legal challenge to any such legislation would almost surely include a violation of the takings clause. The USSC has defined “property” broadly enough to encompass include any of the bundle of rights in property ownership. The “property” doesn’t even have to be real estate (“property” includes such things interest income in IOLTA trust accounts and trade secrets). The government might counter that there has been no “taking” as there is still an economically viable use of the property where a modification results in a higher NPV than foreclosure. But even if that argument were to fail and the legislation held to be a taking, the USSC has made clear that “public use” is met in virtually every taking (see e.g. Hawaii Housing Authority and Kelo).
If the government creates any legislation regarding modifications, I hope they restrict it to homes that are currently occupied by the borrower (as opposed to at the time of origination). It is probably a good idea to also enact an outright ban on investment or rental modifications. We will probably see some sort of forced modification program or at least some very strong incentives to modify from the new administration. California has already created a pretty strong incentive to modify with SB 1137.
Rubicon- I did not get it from a fringe website. It was on CNBC. I don’t get why ya think it’s all a stretch for them to threaten to do this.
They are already encouragin people to alter with stuff like fees…first they will try raising the fees. If that don’t work…they’ll take out the big stick.
This has been a really interesting discussion, everyone.
Like Cooper, I’m not in favor of all these modifications, but hopefully the FDIC et al will learn from this first round of tweeks and come up with better screening criteria for which home owners get modified and which terms lead to success.
I never thought the American vocabulary would have the word “re-default” added to it’s vocabulary. What’s next? The re-strike out in baseball. The re-double fault in tennis. The re-fourth down in football. As basketball John Wooden said, “Do it right the first time.” What’s wrong with that?
And I predict next year a new word will enter our vernacular:
Like Cooper, I’m not in favor of all these modifications, but hopefully the FDIC et al will learn from this first round of tweeks and come up with better screening criteria for which home owners get modified and which terms lead to success.
Unlikely. when one thinks through the problem you see that there is no simple solution.
-there are a huge amount of delinquent mortgages. Many of them have no or little (or erroneous) documentation.
-mortgages are going delinquent too rapidly to process.
-because they are coming too quickly to process, nobody can process them so more and more actually default.
-These defaults put downward pressure on housing prices which makes it more and more difficult for mortgage holders to refinance, thus more go delinquent
So to stop this cycle one must either refinance the delinquent mortgage holders, or modify the loans.
but as we stated above, there are too many to process.
thus, we have a choice:
EITHER process the modifications fully using good documentation and verification. This will reduce the re-default rate, but takes too long to “solve” the problem given the rapid rate of people going delinquent.
OR we must ram through modifications trying to stall the problem, but the only way to do this is to do less vigorous processing. but then the re-default rate is high.
@ ex SF-er: If there aren’t enough people to process modified and re-modified (and re-re-modified) loans, maybe this is a solution to our high unemployment rate?
Retrain laid off employees to process mortgage modifications to speed things up and improve screening and documentation.
The question is whether a laid off Circuit City shelf stocker can do the job. Laid off engineers would probably be better candidates, but this would be a pay cut and wouldn’t look good on the resume.
there is no question that this would be a sensible thing to try.
we could retrain many of the ex-mortgage industry employees (brokers, etc) to do the mods.
there are still a few problems
1)the time it takes to train in these people and the lack of people who know how to train them in.
over the bubble years any deal got done any way possible. the true people who knew risk management were “in the way” of the dealmakers, and so the risk managers were let go and replaced with yes-men and those who don’t know anything.
that knowledge is now to some extent lost. that said, it is a good idea to try to get these programs up and running again.
2) when one processes loans for modification the “correct” way, one quickly sees how bad the borrowers tend to be.
we’re not in this situation because a few people got a little over their head. We had significant over-leveraging, and also massive amounts of fraud and deception (both ways) with substantial numbers of people who have no possible way of paying off their mortgage. Modification simply isn’t possible for them.
this is what happens when you put people in homes that cost 7-10x their annual gross salary. it can ONLY work if you have continual home price appreciation.
Publius, glad to hear from you! How is Sacramento? As you’ve no doubt read, big law in SF is a tumultuous field these days.
Using eminent domain in this fashion would go way beyond Kelo and I don’t think this new Supreme Court line-up would find a “public use” here. Besides, the lenders will find a sympathetic court (probably the 4th Circuit) to enjoin this and it will be moot before it ever reached the high court with the passage of time. Obama is a con law professor (and appears to respect the limits of executive authority, unlike Bush) and has surrounded himself with basically free-market types. I don’t think he would ever take this counter-productive step even if he legally could.
Well, Trip, I don’t disagree with your characterization of Kelo. Or, the idea that a public purpose “takings” justified mainly on tax revenue would have to be stretched beyond recognition to accomodate a taking that results in the borrower – an individual – enjoying the same property that was supposedly taken for “public use” (whether directly, or constructively by seizing and reworking the mortgage).
But I have to question the characterization of Obama as a con law professor. Maybe a lecturer or special purpose appointee for his work at U of C, or maybe you are referring to a different sort of “con” 🙂
Anyway, as to whether he would stretch the Constitution like this? As an extension of the new New Deal, I have four words for you: NLRB v. Jones & Laughlin Steel. The legacy of the switch in time that saved nine, as we all learned in those dark days of 1st year con law….
Good to see you as well, Publius! I hope everything is great for you and your family in Sacramento (I changed my tag).
LMRiM, yes, the Jones & Laughlin “switch in time certainly could be reprised if the USSC again thwarted legislative and executive attempts to stimulate the economy and help workers. But I don’t think we’d see any sort of similar ultimatum with a homeowner bailout. The difference is that the New Deal programs the USSC kept striking down in the 30s as outside of Commerce Clause powers — unionization, minimum wage, etc. — were wildly popular with the public. But these recent bailouts have been contrary to public opinion, and I think that individual homeowner bailouts have been among the least popular ideas of all — for the same reasons voiced on this board; the vast majority of us lived within our means and were not so stupid as to get ourselves in the position of paying way more for a home than it could ever be worth or we could ever afford.
Jones & Laughlin also came only after 7 years of a serious downturn. So sure, if the USSC repeatedly put the kibosh to some popular spending programs, I could see a renewed court-packing threat. But it won’t come from a program like that discussed here.
Last point — I work with two U of C grads who had Obama for a professor. I know nothing of Obama other than what I’ve seen and read the last 2 years. But I respect the intellect and judgment of my two cohorts tremendously, and both give him high praise for intelligence and depth of knowledge and comprehension of con law issues. I’ve seen nothing that brings their judgment into question even if I may disagree with some policy moves that I’ve seen.
Points all taken, Trip, about the law and Obama’s competence as a professor. You know, I was a rough contemporary with Obama in law school, but I was at the “rival” law school in Connecticut, and you know how competitive the silly Ivies are…. Looks like Obama’s moved on to bigger and better things, but I’m still living in the past 🙂
I’d like a bailout on my 49er season tickets, please
This is why anyone that thinks there’s a near-term recovery to the housing market is misjudging what’s happening in the economy right now. This isn’t just another recession like 2001, or even 1992.
This time, the American consumer is tapped out. They have little to no savings, are leveraged to the hilt in debt, and don’t have anywhere near the borrowing power that they used to – that’s provided a bank is even able or willing to lend to them.
For a real estate market to revive, it will require a broadbase turnaround in the overall health of the consumer. It’s going to require a substantial rise in average savings (the days of 0-10% downpayments are gone), substantial reduction in average debt loads (the average American has around $8K+ in credit card debt alone), a substantial improvement in the job market to make them feel confident about making the biggest investment of their lives, and substantial reduction in home prices to bring them back down to earth.
Until a majority of those things happen, expect to see the market for real people (read: non-millionaires) to continue to deteriorate. Millionaires are irrelevant to the broader housing market recovery.
I do not agree the consumer is tapped out. He is tapped out at the high prices he has been paying (with debt) in the past 10 years.
But most of the consumer goods have very low manufacturing costs (Chinese mostly) and huge marketing/administrative/engineering overheads/markups.
All sellers need to do is lower prices and regular people will go back to buying stuff using real cash this time. Just like Real Estate.
Thanks Trip! I could only stay away from SS for so long. Sacramento has been a lifestyle change for sure, and as is usually the case, there are pros and cons. Missing SF in a lot of ways (went to Union Square with my two-year-old who had a blast. He wasn’t quite ready for ice-skating though). Yes, the SF biglaw market has been interesting to follow for the last few months. I’ve been following that train wreck on ATL. I hope you’re in a good “recession proof” position.
I agree that eminent domain is not the most likely tool. I believe the more likely tool is another legislative instrument. The legislation is likely to be based upon NPV calculations similar to what the FDIC has been doing for the last six months. I expect to see laws that mandate a modification if the NPV of modification is greater than the NPV of foreclosures, lenders (or really the servicers ) will be required to offer modifications.
Services are now required to make a good faith effort to explore foreclosure avoidance measures under CA law. The downstream effect of the legislation is still uncertain.
My argument is not that the government will use eminent domain as a positive tool. Rather, my argument is that any kind of “forced modification” legislation would face a takings clause challenge. As I pointed out in my previous post such a program would almost certainly be determined to affect “property.” The closer questions is whether there has been a taking (if the property remains economically viable there is no taking – as with rent control and zoning ordinances).
Apparently we only disagree on the application of the “public use” doctrine. Granted, its has been a few years since I took Con Law, but it was my favorite subject and I aced the class. When was the last significant USSC decision that held the taking was not public use? I can’t remember one. The USSC has made it very clear that the legislature, not the courts, make that determination. I could be wrong, but I am interested to see what happens in the next six months with this issue.
@LMRiM – It’s good to see you back as well. As is probably the case with many other long-term followers of this blog, I was able to determine your “true” SS identity in fairly short order. I’m still wading through some of the book suggestions you have made on this site. Perhaps I’ll be ready for my career as armchair economist in a few more months.
Good to hear that you are well. I often think I’d like Sacramento better because of the proximity to skiing and the Sierra generally (I hope you ski!), but I’d probably opt for Incline to avoid CA income taxes 🙂 (I wonder if the Incline Village SFH rental market is as distorted as the Bay Area’s, since so many Bay Aryans “tax dodge” out there? I’d imagine there are plenty of underutilized properties….)
And I’m glad to hear that your armchair economist studies are progressing. I came across a blog recently that has a current post (Dec 7) “Hoover’s heirs at work” that has a good application of Rothbard’s Depression arguments to what is going on right now:
I hope SS sees some econ forecasts and analysis fom you soon. I can almost guarantee you that you will do better than the eminence grises of the econ world who almost to a one completely failed to call this credit wipeout until it was a Cat 5 storm right over us (Roubini and a few cranks excepted).
Publius, we’re litigation-heavy (my area as well), which is counter-cyclical, so we’re busy right now, especially the bankruptcy and employment groups. The corporate (esp. M&A) groups are pretty dead, but that’s a relatively small part of our make-up. The big deal firms are going to be laying off lots of associates and staff. I’m going snowboarding in Tahoe over the holidays assuming there is any snow (LMRiM — you don’t still ski since the snowboard was invented, do you?) and then spending New Years with our friends in Sacramento. As I’ve told you, they moved there from SF 6 years ago and love it there.
I actually agree with you on the “public use” issue, except I think that the Roberts-Alito additions to the Court might change the outcome on this hypothetical.
I think ex SF-er hit the nail on the head on the likely scenario a couple months back. It doesn’t matter whether or not there is any legal basis for loan modifications. The govt owns the banks now (at least de facto) and can tell them to do whatever the govt wants them to do in exchange for continuing life support. I just read this morning that Sheila Bair of the FDIC demanded, and got, an agreement from Citi to participate in a mortgage relief program as a condition of the latest bailout. It will be interesting to see how much the hedge funds and other investors in the secondary markets push back — that is where any resistance will come from. And as I mentioned earlier, these bailout programs, including those targeting homeowners, are terribly unpopular and a core of reps/senators may actually listen to their constituents.
Trip – The practice areas you identified are probably extremely busy right now. That’s a good place to be if you like those practice areas.
You are probably right regarding the current make-up of the USSC. But this would represent a pretty big change in policy on this issue.
You mentioned one thing that I totally agree with right now, but that I believe will change in the near future.
“these bailout programs, including those targeting homeowners, are terribly unpopular”
I am politically fairly moderate, but tend to lean pretty heavily to the right most of the time (for instance I opposed both the bank and auto bailouts). However, the more I learn about the practices of lenders and brokers in the last ten years, the more I am becoming a consumer rights advocate on this issue.
For instance, I have now dealt with three borrowers who were taken advantage of in the worst way. All of them over 65 years old and all of them minorities. I have found that most brokers don’t understand the meaning of a fiduciary duty or simply ignore it. All three of the individuals were convinced to refinance a decent loan into a neg am loan (or a pay-option arm) based on how much the monthly payment would be and how much cash they could pull out. Remember these loan products have only been used frequently in the last ten years (I can’t remember the exact number but these loans went from somewhere in range of 5-10% of all loans to 30-40% of all loans).
Sometimes the broker would tell the borrower that they would not charge anything for the refinance or at least a very low rate (like a half point). They then got the borrower into a loan at a much higher rate than the borrower would ordinarily qualify. The lender then paid the broker what is called a Yield Spread Premium. I have seen payments as high as $30K from lenders to the broker. Yes, it was disclosed in the fine print, but was never explained to the borrower. At best this is practice is misleading and at worst outright fraud. And it certainly does not meet the broker’s fiduciary duty. In one case, the borrower could neither speak nor read English and no Spanish translation of the loan documents were provided.
Imagine if an attorney did something like this. If discovered, it would likely be grounds for discipline if not disbarment. This is the reason I support sustainable modifications (meaning fixed interest rates for a 30 to 40 year term) for some borrowers that can prove a consistent source of income. The lenders are defending this practice vigorously and claim that they owe no duty of care to the borrower. They also count on the fact that most borrowers do not have the resources to engage in litigation. That is not to say that every lender and every broker is a bad actor. The problem is really that is too little supervision by brokers over dubious employees (most of which are not even licensees). Many times the broker would not even review the loan documents.
The public is going to hear more and more stories through the media regarding some abhorrent behavior by mortgage brokers and lenders. I think a program targeted to remedy some of these bad acts may not only become popular, but demanded by voters.
Thanks for the interaction, I enjoy your posts. Have fun in Sacramento for New Years!
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