The Folly Of The Mortgage "Cramdown" Plan

It's been a while since Congress' mortgage "cramdown" plan has received a lot of publicity. As I write this, I'm looking at a Wall Street Journal piece from the March 14-15 weekend edition entitled, "Mortgage 'Cramdown' Plan Hits Turbulence."

And how.

There is a high level approach to this topic that involves discussing capital markets, the rule of law, contracts, and such. I had originally intended to write that sort of piece.

But there's another level of coverage for this legislation that focuses on the local real estate markets, and that's where this post is now going.

About a week ago, I happened across a good friend and former professional international squash player who is now a local realtor. We began discussing the local market and pending governmental programs to 'help' the situation. She was not happy.

Elaine told me that the $8K credit for first-time home buyers is doing nothing around here, because the house prices are still so high that few, if any, initial buyers can afford them. She said the better solution was to have given anyone buying a home the $8K credit.

Then we turned to the subject of Congressional 'help' for delinquent or about-to-be-foreclosed mortgages.

Elaine concurred with the findings of research into delinquencies which I have read in the press within the past six months. To wit, homes that have mortgages fall into delinquency, then are given temporary relief, have a very high probability of becoming delinquent again and, eventually, entering foreclosure within six months.

Essentially, people typically become delinquent on their mortgage because there has been a job loss. They don't usually decide to take a European or Asian vacation, buy a second home, or a new car, and, thus, skip paying the mortgage on their primary residence for a month or two.

No, such drastic nonpayment events are usually the result of a job loss which exhausts the financial means of the owner of a home. If given a few months respite, the owner isn't magically given a new job, too. Just more time to resolve their delinquency.

All too often, i.e., more than half of the time, the owner re-enters a delinquent state and, then, foreclosure.

This is why cramdowns are a bad idea. It simply allows someone who can no longer afford their home to enjoy a court-ordered, unilateral rescission of the mortgage contract, effectively cutting the price of the home by forgiving some of the principal, and lowering the interest rate, too.

But, as my realtor friend noted, all this does is make taxpayers subsidize the current owner while they enjoy a price cut on their home, while anyone who was waiting to buy the home out of foreclosure at a lower price is denied that opportunity.

When normal housing markets are allowed to function, then people who can no longer afford their home due to having bought what they cannot now afford, the homes are sold out of foreclosure at lower, market-clearing prices, to new buyers who can now afford those homes.

The current foreclosure experiences across the US are not, at root, housing problems, but merely the consequences of employment problems.

You fix the latter with unemployment insurance, not mortgage relief via local court cramdowns.

Because of the looming Congressional mortgage relief, Elaine told me that delinquent homeowners and/or others wishing to sell are maintaining artificially high prices, or simply not listing yet. The result is a clogged and frozen local residential real estate market in which willing, qualified buyers are being denied the opportunity to gain access to homes that should be sold at market-clearing prices.

The mere hint of federal mortgage relief has frozen prices and is keeping the supply of homes tighter than it would be, were normal lending and market forces acting. Banks would be foreclosing, instead of halting those procedures, under TARP-related threats of Congressional penalties.

Since brokers aren't paid until homes sell, Elaine told me that she and her colleagues aren't even participating in workouts of delinquent mortgages anymore, because the owners' expectations of prices are too high to promise a sale anytime soon.

In short, the simple expression of Congressional action and interest in doing other than allowing normal market forces and the legal system operate in the instance of current residential mortgage finance, i.e., allowing lenders to handle delinquencies and foreclosures as usual, has seized up the entire residential housing market and caused existing homeowners to expect a taxpayer-financed price and interest rate reduction on their current homes, while waiting buyers are forced to subsidize this situation, while being denied their chance to finally realize their own dreams of home ownership, albeit on better-funded terms.

Things sure are upside down in the American housing market, thanks to boneheaded federal meddling.