Immediately after Treasury Secretary Geithner announced the framework of the new bank bailout program the stock market sank hundreds of points, as I hope he expected it would do. The plan fails to address the real banking problem and fails to fully acknowledge the real housing problem.
The plan includes a variety of programs and provisions that will help lower mortgage rates on new purchases, make it possible for many borrowers to refinance into mortgages with lower rates, and for some borrowers to be able to restructure their mortgages to avoid foreclosure. Lowering home owners’ mortgage payments by lowering their interest rates will have a significant stimulative effect on the economy and will reduce the number of families forced into foreclosure by some marginal amount. It will not solve the core problem and may actually make it worse.
There are two foreclosure crises going on right now. The first crisis is hitting speculators, many of whom look like very normal people, like you and me, and who would not consider themselves speculators. But they were. Any family that used an adjustable rate mortgage or any of the other specialized tools to buy more house than they could afford with a traditional 30 year fixed mortgage was speculating that the price of their house would continue to increase and that they would be able to sell for a profit before their rates started increasing. When the housing market peaked, these people found themselves unable to sell and they are the ones who have been getting picked off by the adjustable rate mortgages in droves. To a degree this phenomenon has happened all over the country, but it has only happened in crisis proportions in a few places. California and Florida had the most upside speculation and have had the worst downside losses. Nevada’s and Arizona’s populations have soared as people have retreated from the untenable California housing market, which created mini-boomlets in these communities, which now have also collapsed.
For every one of the families that has taken a loss on a speculative real estate investment, remember that another family took a profit earlier. In fact, very often the families that were able to parlay a series of houses into bigger and better houses through market forces rather than the sweat of their brow, are the same families that are now being forced into the reality of what their money should have been buying them all along. We should have minimal sympathy for people who took profits on the way up but are now screwed on the way down.
The second foreclosure crisis is a result of the recession created by the credit crisis that sprang from the first foreclosure crisis. Michigan and Ohio have been hit particularly hard by this crisis as unemployment has soared. With the deepening recession and spiraling job losses, there will be more of these foreclosures and they will be distributed more evenly around the country. While they don’t feel any better or worse for it, these are the “innocent bystanders” of this mess. These are the people who mostly bought homes they could afford, financed with jobs they had every right to expect they could keep, and who have been caught in a crossfire that never should have happened.
Here’s the problem. These two foreclosure crises are qualitatively different but the solutions on the table only apply to one of them and may aggravate the other.
The main thrust of the mortgage relief program is a variety of ways to lower mortgage interest rates. When rates are lower, payments are lower, and the line between keeping your house and losing it moves so that a marginal number of people get to stay in their homes who otherwise wouldn’t have. When rates are lower, houses also become comparatively better investments. They may not be as good an investment as they were several years ago, and they may even just be a less bad investment than they were last year, but either way, since their competitive position improves compared to other investments, their prices will either go up a little or, at the very least, fall less. This will have a dramatic impact in California, Florida, and other markets where the primary cause of the foreclosures is the real estate bubble.
Around the rest of the country, where foreclosures are happening because of job losses, no amount of restructuring or changing interest rates is going to make up for a catastrophic loss of income. The only solution in these parts of the country is getting everybody back to work. In fact, the prospect of increased housing demand in parts of the country where demand is only depressed because of a poor economy will, what? That’s right… it will create an artificial increase in housing prices which will likely lead to a whole new batch of dislocations further down the road.
The answer? If we are so screwed that we have to accept that we have no choice but to make speculators whole for their bad investments… we should limit that to those markets where the most speculation occurred. Around the rest of the country, we should take whatever funding is going to go into lowering tens of millions of home owners interest payments and put it toward economic stimulus that will benefit the entire economy, including renters.