It's the empty houses, stupid.
In case anyone has forgotten the core of the current economic crisis, here's a reminder: empty homes, both present and future. Empty homes are behind all the supposedly worthless mortgage-backed securities that no one wants to buy on Wall Street. Fear of the coming avalanche of empty homes -- what the Center for Responsible Lending calls the “tsunami of foreclosures” -- has made Wall Street’s mortgage-related paper nearly worthless.
It seems that filling those empty homes by dealing with foreclosures and stoking demand to buy homes should be the first order of business. So why -- as we discuss the most dramatic government intervention in nearly a century -- is there only passing mention of all these vacancies?
By every industry measure, foreclosure is a huge problem. Earlier this year, the financial services giant Credit Suisse estimated that there will be 6.5 million U.S. foreclosures during the next five years.
And even if you pay your mortgage on time, foreclosures will likely hurt you, too. Each time a family is kicked out of a home, there's collateral damage to the value of nearby homes. The Center for Responsible Lending says that the closest 50 homes lose an average of $3,000 in equity every time there’s a foreclosure. The organization estimates that 40 million families will lose nearly $350 billion in equity due to foreclosure collateral damage during the next five years.
The bleak outlook was published in April, which should make you wonder why Congress only became interested two weeks ago and then started acting with incredible haste. The crisis has been brewing for some time.
There are really two related but distinct economic crises facing America right now. There’s the liquidity crisis on Wall Street, which has us all breathlessly watching CNBC, and there’s the housing crisis, which is kicking 6,000 families per day out of their homes and is draining equity from the rest of the nation’s homeowners.
The liquidity crisis has superseded all other concerns in recent days, even the presidential campaign. Wall Street’s advocates, Henry Paulson and Ben Bernanke, generated enough panic that Congress appears willing to sign a check for $700 billion. For a while, those advocating for Main Street held out for a quid pro quo – immediate help with the housing market crisis -- but the resistance lasted less than a week.
'A game of chicken'
“This was kind of a game of chicken and I'm afraid it looks like the consumer advocates in Congress are the ones who blinked ,” said Adam J. Levitin, a bankruptcy expert at the Georgetown University Law Center.
Details of the not-quite-completed-bailout-plan are still emerging, but by all accounts it will not include the most obvious and direct tool to stem the empty house problem: adjustments to bankruptcy law that would allow judges to modify the mortgages of at-risk homeowners.
Such assistance could still materialize in Congress, but the Senate voted to reject the idea in April, spurred on by agressive bank lobbying. By agreeing to this bailout deal without fixing bankruptcy law, Main Street’s advocates have surrendered nearly all their leverage.
I understand the theory that giving banks more money to lend can ultimately help restart demand for housing by making it easier for consumers to get loans and, as demand increases, boosting housing prices. But isn’t that how we got here in the first place?
The proposal to help at-risk homeowners was simple: allow bankruptcy judges to rework loans (essentially, lower the mortgage principal and payments) to keep them in their homes and out of foreclosure. Sadly, supporters of the plan surrendered and instead focused on CEO pay -- a populist issue that's a distraction from the real problem of empty homes.
Critic sees bailout as 'unfair and ineffective'
"The only way to stop the free-fall of housing prices is to stop foreclosures," Kathleen Day, spokeswoman for the Center For Responsible Lending, warned. "If you don't do something for consumers, this is going to be unfair and ineffective."
The proposal to amend Chapter 13 bankruptcy law (the kind where debtors repay their loans, but buy time and get some discounts) is hardly revolutionary. Under Chapter 13, filers can rework all kinds of loans: car loans, vacation home loans, investment/rental property loans. But primary residence loans are exempt. Struggling homeowners face two choices in current bankruptcy law -- pay every penny or walk away. The limitation stems from a 1970s law that was intended to encourage banks to lend more money to would-be homeowners.
The simplest way to prevent the coming avalanche of additional empty homes -- and thereby make those asset-backed-securities have some real value -- is to prevent people from getting kicked out. It's stunning that $700 billion is about to change hands with no direct plan for keeping them in their homes.
There is the HOPE NOW alliance, set up by Congress this year to encourage at-risk homeowners and banks to renegotiate mortgages voluntarily. By all measures, it's been a failure. Banks aren't answering their phones when consumers call; trusts that service mortgages have perverse incentives in place that make foreclosure more profitable than renegotiated loans.
Allowing modification of home loans in bankruptcy would encourage banks to negotiate new terms, as it would allow the banks to avoid court costs and delays. Once bankruptcy courts set a few price points on modified loans, voluntary participation would likely follow.
The financial industry, which has long resisted modifying Chapter 13 bankruptcy, says that such a change would deal the mortgage-backed securities industry a body blow. Allowing judges to reduce the principal owed on a mortgage -- lenders call this a "cramdown" -- would lower the overall value of mortgage instruments, as a built-in bankruptcy discount would have to be applied, which would, in turn, harm consumers by restricting the flow of credit, banks say.
No sign of 'bankruptcy premium'
But Georgetown’s Levitin published a study last month that indicates that other loan markets are not adversely impacted by bankruptcy modification. There’s no difference in mortgage rates between primary residence loans and vacation residence homes, for example – and there would be if there were a “bankruptcy premium,” he said.
Levitin argues that proposed Chapter 13 bankruptcy changes would in fact be “market neutral.” Bankruptcy judges are well trained in determining consumers' ability to repay a loan, meaning many banks would get 50, 60, or 70 cents on the dollar, up to twice as much as they would realize after going through the costly foreclosure process, he said.
And neighbors would certainly agree that such a home loan modification would be preferable to another empty home.
"The contagion began on Main Street, and it has to be fixed there," said Day, from the Center for Responsible Lending. "You are not going to get at the root of this and really restore the economy until you stop all the foreclosures.”
Other empty home proposals
Even with the bankruptcy option, not all homeowners would be able to stay in their houses, and there are already millions of empty homes.
To address that problem, David Colander, a professor of economics at Middlebury College, has another idea. He wants part of the $700 billion bailout to go directly to U.S. consumers in the form of housing vouchers. The vouchers could be used to pay off loans, or even better, to persuade some renters to jump into the homeownership market. Nothing greases the housing market quicker than turning renters into owners, he said, calling it a "trickle-up policy."
"Unlike a tax cut, or a temporary stimulus fiscal package, this plan would have a directed effect on the housing market and hence on the mortgage backed securities market," he said.
If carried out in conjunction with a bailout of financial institutions, it would raise the value of securities purchased by the government because home values would rise as demand increases, Colander said.
To ensure the plan maximizes the purchase of primary residences -- as opposed to investment -- the vouchers would be income-based, under his plan.
Of course, such direct intervention into a market -- giving consumers free money -- contradicts long-standing free-market policies. But then, so does having the federal government purchase $700 billion in bad loans.