Friday, October 28, 2011

The Folly of Mortgage Forgiveness

Alan Blinder's editorial in the October 20 edition of the Wall Street Journal, How to Clean Up the Housing Mess, contains shockingly bad recommendations regarding America's housing hangover from the Greenspan era of easy credit.

For example, Blinder contends, in the opening paragraphs of his editorial,

"Sadly, however, we did almost nothing to stop the predicted foreclosure wave, which is now drowning us. The issue at this late date is how we can mitigate the damage.

One oft-repeated answer comes from the intellectual descendants of Andrew Mellon and Herbert Spencer: liquidate, liquidate, liquidate. Let the housing market find its natural bottom, and the chips fall where they may.

I beg to differ. Some of the reasons are humanitarian. Millions of foreclosures are ruining millions of lives and devastating many communities. We can do better than Social Darwinism."

Blinder refuses to acknowledge that the housing foreclosure mess and overbuilding involved borrowers getting themselves into loans which they should have declined, mostly for houses they could not afford. Simply declaring that they must be spared is a pipe dream. Liquidation of foreclosures doesn't necessarily mean evictions, but we must have an attribution of the loss of value to some party. And that party would, according to mortgage contracts, seem to be the borrowers. If they default and the lenders can't recoup all of their loan value, then they, too, will share some of the loss.

Next, Blinder makes a baldface misstatement,

By now, massive underbuilding during the slump far exceeds the overbuilding during the boom. So, by rights, a shortage of houses should be pushing up house prices, incentivizing home builders, and boosting growth in gross domestic product. Instead, actual and prospective foreclosures hang over the housing market like a wet blanket."

On Monday afternoon, two economists who were guests on Bloomberg television agreed that the recent rise in housing starts is bad news. That the US still suffers from a surplus of housing. So Blinder is wrong to claim that there has been a "massive underbuilding during the slump" that "far exceeds the overbuilding during the boom." If that were true, we wouldn't have a foreclosure dilemma, because demand would be supporting housing prices.

Blinder claims the following regarding federal mortgage relief,

"The first is money. Given the huge magnitude of the aggregate gap between house values and mortgage balances, a comprehensive anti-foreclosure solution requires hundreds of billions of dollars. (Note, however, that this money would be lent, not spent.)"

How does he know the money would "be lent, not spent?" Losses will eventually have to be realized, which means 'spent' money which artificially paid for value that just isn't there.

"The second barrier is a host of legal complications—stemming from such things as securitizations, second mortgages, and the like—that make it difficult to design and execute a comprehensive plan. The details would put you to sleep. But the bottom line is that most serious solutions entail modifying somebody's property rights—which is something we don't do lightly in America, and for good reason."

So Blinder doesn't take this lightly, but, what the heck, let's do it anyway. We'll just say, you know, that we 'didn't do it lightly.'

"The third barrier may be the biggest: politics. Apparently, many Americans view it as unfair to bail people out of unaffordable mortgages. Do you remember the famous Rick Santelli rant on CNBC in February 2009—the one that gave the tea party movement its name? Mr. Santelli was griping about President Obama's new foreclosure mitigation programs—the ones I just characterized as half-hearted. It would have been a brave politician indeed who pushed to make those programs larger and more generous.
Most economists see principal reductions as central to preventing foreclosures. That takes money, of course—plus ignoring the Rick Santelli rant. Perhaps the cost to taxpayers could be reduced by giving the government—or even private investors—some of the upside when house prices finally start climbing."

For some reason, perhaps because he's a liberal, and Rick Santelli is not, Blinder delights in demonizing the CNBC on-air staffer. Calling the process of saddling taxpayers with the losses of injudicious borrowers for homes they could not afford "politics" is a convenient way to disguise and endorsement of moral hazard, as well as bad policy.

"Many vacant houses could be converted into rental units by enterprising developers. The government could make such investments more attractive, e.g., by using mechanisms similar to what the Federal Reserve and the Treasury did during the worst of the financial crisis. Back then the government lent money to investors who were willing to buy mortgage-backed securities; this time it could lend money to investors who are willing to invest in certain rental properties."

Ironically, Lew Ranieri complained on CNBC earlier this year that such federal loan programs for small investors, which were a key part of the 1980s S&L crisis recovery, were not offered in the most recent mortgage-related crisis. Once again, though, one has to ask, who will have born the losses on these houses as they return to the market at lower prices?

Blinder is all for mandated loan forgiveness, forgetting that such losses will make banks take losses, further imperiling their capital adequacy. Large US banks wouldn't even be at the table discussing the issue, had the federal government not intimidated them with baseless litigation as the price of declining to join the talks.

As I explained to a friend the other day, housing value losses are a fact. There are only three groups which can absorb them- homeowners, banks and taxpayers. Blinder wants banks to absorb the losses. That will, as I have explained in this piece, cause capital adequacy issues, as well as reward borrowers for taking excessive risk. If homeowners are left to follow available legal options, including bankruptcy, then housing prices will fall to market-clearing levels and others who can now afford such houses will buy them. If the government, either directly or through GSE pass-through securities, assumes the losses, that means, in effect, taxpayers are bailing out homeowners.

That's no way to treat a private sector, nor to resolve the US housing problems. Blinder's ideas for dealing with the housing sector's woes and coming foreclosure boom should be ignored.


TallIndian said...

What many don't see or don't want to see is that the taxpayer bailed out the investors to the tune of at $200 billion and possibly several trillion dollars.

There was no federal guarantee on FNM/FRE paper (bonds or MBS). That was on every prospectus issued by either company since the 1970s.

Had George W. Bush shown any testosterone and allowed the free markets to function in 2008, FNM/FRE would have gone bankrupt, their debt and MBS holders left to fight over the remains. The taxpayer would have been completely out of it.

All the misdirection about Barney Frank and Jimmy Carter forcing the GSEs to make loans to minorities and how the brave, GOP was unable to stop these two is nonsense. No one forced the investors to buy FNM/FRE paper. They did so on their own knowing the risks.

Santelli et al ignore the fact that if not for the taxpayer bailing out FNM/FRE investors, the MBS would be trading $0.50 or less on the dollar -- not anywhere near the $1.08.

A massive subsidy from the taxpayer to lazy, ignorant investors who then lectures on the virtues of hard work and property rights.

Welfare Queens, indeed.

C Neul said...

Well, at least you're not entirely wrong.

I would agree that the true nature of the GSE guarantee by the federal government was never explicit until trouble hit in 2008.

Yes, it was not a good idea to make a specific guarantee to the Chinese, which is what happened.

But that leaves Bush as the bag-holder for two generations of bad federal policy in this area.

Regarding Barney Frank and, not Carter, but Kent Conrad and Chris Dodd, the last two, at least, Friends of Angelo, you are wrong.

What those members of Congress did was push GSE guarantees down to a level and type of borrower who never should have been owning a home in the first place.

I don't know why you drage Santelli into your rant. No, I'm sure he doesn't ignore the guarantee, and would be among the first to agree it should have been gone long ago.

Another way in which Congress screwed up was, while mandating loan guarantees to more low-income borrowers, it also allowed the GSEs to crowd out more private loan guarantees at the higher end by raising the mortgage size backed by GSE paper.

In closing, I think many of us do see that the taxpayer bailed out the investors and want that stopped ASAP.


TallIndian said...

I guess people no longer understand the meaning of such words as NOT and SOLELY


What Kent Conrad, Jimmy Carter (he's routinely blame by your GOP), et al did would have had consequence to the taxpayer if Bush had followed the rule of law.

Peggy Noonan in today's WSJ continues to the lies that somehow someone other than George W. Bush and Hank Paulson are responsible for the socializing of the losses.

All any GOP President had to do was simply read the line to the public from the prospectus.

If Barney Frank and Kent Conrad were forcing GSEs to buy bad loans, investors would have bailed out in a heartbeat.

George W. Bush failed his duty as President and his moral obligation to the taxpayer.

C Neul said...

I posted your second comment to allow you one final vent. You will see no others like it again here.

When I read phrases like "your GOP, " I know you are a presumptuous fool.

Do you know my party affiliation? If I even have a registered affiliation?

No, you don't.

Instead, your obvious liberal and Democratic bias- especially trying to muddy the issue concerning what Frank, Dodd and Conrad did- loses you any credibility you may have had.

To my other readers...this guy is wrong on essentially every issue but the salient fact which he enjoys trumpeting incessantly, i.e., GSE paper was never explicitly legally guaranteed by the US government. It was implied, but never really tested until 2008.

What TallIndian refuses to acknowledge is how loudly Democrats would have screamed, had Bush done what TI is claiming was so simply accomplished.

It was not so simple at that time.

It is, in fact, a far more complicated issue than TI admits.