Economist Stan Liebowitz says in this WSJ op-ed that “most government policies being discussed to remedy woes in the housing market are misdirected” because they are based on a misunderstanding of “the actual causes of the mortgage crisis.”
Using real (and readily available) data Liebowitz shows that most of the causes of the housing crisis being promoted by the media and the political class — subprime mortgages, so-called “liar loans,” poor creditworthiness, unemployment, upward reset of interest rates, and under regulation — are only contributory factors rather than the meat of the matter.
To avoid future problems, it is important to correctly understand the basic causes of the crisis. Implementation of all of the “suggestions being put forward by the administration and most media outlets -- more stringent regulation of subprime lenders -- would not have prevented the mortgage meltdown regardless of their merit otherwise.”
The central issue in the current foreclosure crisis is people having no skin in the game. That is, they owe more than their property is worth. Much ado has been made in some corners about people that are “upside down” on their mortgage. It turns out that this is not only a major problem; it is THE major problem. Yet none of the remedies being offered address this matter.
Liebowitz asserts that a “significant reduction in foreclosures will happen when and only when housing prices” reach true market levels “and unemployment stops rising.” He asserts that “current [home] prices are approaching their long-term, inflation-adjusted pre-bubble level,” but he warns that many of the policies aimed at helping could actually derail this natural progression and exacerbate the problem.
In his final sentence, Liebowitz cites “fictitious causes that fit political agendas and election strategies” as the basis for most of the policies presently being advanced as solutions to the housing crisis.
When dealing with political matters it is essential to understand that politics has its own economy. It is the nature of that economy for politicians to publicly hide behind a mask of altruism while responding to political incentives. Political maneuverings are chiefly designed to increase the power of the individual politician or select groups. All the better if this can be done while simultaneously promoting (or appearing to promote) an ideological agenda with which the politician or group is aligned, or while increasing the power of political allies.
Wise citizens should gain a healthy appreciation for the political economy. They must realize that it is necessary adroitly work within this system — though often unpleasant — to advance their own causes, even when those causes are just. The trick is to pull that off while remaining unsullied.
"The trick is to pull that off (working within the political economy to advance just causes) while remaining unsullied."
I think the key to pulling that off is an enormous degree of personal integrity. I only wish there were a way to reliably and consistently identify people with that kind of integrity who also have the capacity to work on issues as complex and nuanced as the federal government deals with.
I've come to the conclusion that the mortgage system is based on a flawed mathematical model. The mortgage system has people leveraging off the equity off their property rather than building equity.
David's comment about integrity is interesting. The real heart of mortgage financing is the integrity of the people engaged in the process.
One is able to completely undermine the system if they change the integrity of the people in the system.
The media created a flip-this-house mantality about home buying. The mantality was one that encouraged people to take great risks. They would reap the rewards if the market rose, but would externalize the costs of failure on the system at large.
This creates a systemic fault in that there is now an artificial pressure that magnifies the peaks and valleys of real estate cycles.
Being upside down is solely a function of current market prices. And as long as you can make your payments, it doesn't really matter if you are upside down.
The problem is that there are many who for a variety of reasons cannot make their mortgage payment each month. Two of the larger reasons for this is loss of employment coupled with no savings, and a mortgage payment that increased due to an adjustable interest rate. In some cases, like that of my neighbor, it's a combination of both at the same time.
No doubt that a combination of factors are in play here. However, Liebowitz contends that without people essentially having no ownership in the property, the current crisis would not exist.
It is also important to realize that home prices are trying to adjust to normal market rates. Unless the financial and political elites manage to successfully create another bubble, it will be a generation before home prices reach the dollar amount that some of these people currently owe on their loans.
Being upside down on a home IS a problem because you know that you are in essence not the owner. You're just paying rent. Moreover, the areas where the vast majority of foreclosures are occurring (only four states) all have laws that provide few consequences if you decide to just walk away from the house and the loan.
When the penalties for walking away are low and your payment is high, the incentive for walking away is significantly increased, even if you can afford the payment. If finances are getting tight for one reason or another, that increases the incentive even more.
Kevin (y-intercept at comment #2 above) has proposed a more shared ownership system that he suggests will make sure that both the homeowner and the lender have more skin in the game, as it were. It's an interesting idea.
I'm still not sure how much incentive there is to simply walk away from a house you're paying for just because the market price is down. Pretty much everyone who has ever financed a car purchase has been upside down in that scenario, yet we don't have wholesale car abandonment. It seems like there would have to be some sort of financial incentive to do so, ie you can no longer afford the payments.
Though I suppose if you had a large down payment on that house you would be less likely to walk away and more likely to find some way to save the home. In some ways, without skin in the game, as you put it, homeowners take on the same mentality as home renters who can leave just about any time they want with little repercussion.
I once worked as a loan collector. It wasn't a pretty job. But I saw a lot of different situations where people weren't paying their loans on everything ranging from musical instruments to cars to homes to farm equipment.
Many people didn't have a problem paying on their car loans when they were upside down on the loan because for most of these people, the car they were driving was quite new. However, there were a lot more problems when people were upside down on older cars, especially when they carried a high debt ratio.
If such a car experienced mechanical problems, a significant number of these folks would just stop paying their loan. "Why should I pay for something that doesn't run?" they would think. If we came to repossess it, they'd have no problem letting us take it away, despite the consequences of having a repo on their credit rating.
It was different with homes. I rarely saw people that were upside down on loans. Back in that day, almost nobody got an interest only loan in hopes of flipping the house and turning a tidy profit on increasing home values.
Perhaps it comes down to those that are intent on 'owning' a home as opposed to 'holding' a home for speculation. I'm not sure if any data can effectively delineate between these two groups. My guess is that speculators would be more likely to walk away from an upside down mortgage than owners would.
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