“Letting Prices Fall” Versus Resetting the Housing Market

http://news.firedoglake.com/2010/09/12/letting-prices-fall-versus-resetting-the-housing-market/

“Letting Prices Fall” Versus Resetting the Housing Market
David Dayen
Sunday September 12, 2010

This week, an argument broke out in the blogosphere and the traditional media over whether “we should let housing prices fall.” Tyler Cowen sums up the argument:

Should we let housing prices fall?

Many smart people say we should. It seems increasingly clear that we must. For how long can the government prop them up? Are we never to have a private market in mortgages again?

Yet what happens if we let them fall? Arguably many banks would once again be “under water.” Enthusiasm for another set of bailouts is weak, to say the least. Our government would end up nationalizing these banks and it still would be on the hook for their debts. The blow to confidence would be a major one, especially if along the way we saw a recreation of a Lehman or Bear Stearns or A.I.G. episode.

I’d like to know what “let” means in this context. Because the government’s actions, with their light touch, avoidance of principal write-downs and handing over of discretion to the banks, have stopped working to prop up the market. Basically the only policy that succeeded in that context (though it was a pure tax giveaway to people who didn’t need it) was the homebuyer’s tax credit, which won’t be coming back. Everything else has neither stabilized housing prices nor kept borrowers in their homes. Rates are near all-time lows and home sales are near all-time bottoms, while foreclosures are at record highs.

The only way to fix this is for everyone to recognize the way out. Joseph Stiglitz explains.

In short, government policies to support the housing market not only have failed to fix the problem, but are prolonging the deleveraging process and creating the conditions for Japanese-style malaise. Avoiding this dismal “new normal” will be difficult, but there are alternative policies with far better prospects of returning the US and the global economy to prosperity.

Corporations have learned how to take bad news in stride, write down losses, and move on, but our governments have not. For one out of four US mortgages, the debt exceeds the home’s value. Evictions merely create more homeless people and more vacant homes. What is needed is a quick write-down of the value of the mortgages. Banks will have to recognize the losses and, if necessary, find the additional capital to meet reserve requirements.

This, of course, will be painful for banks, but their pain will be nothing in comparison to the suffering they have inflicted on people throughout the rest of the global economy.

By contrast, “letting prices fall” just massively increases the number of homeowners with negative equity and accelerates the problem. And while some of the other ideas on refinancing and short sales may help at the margins, without principal reductions we’re still basically on the margins. You need to reset the market, not allow it to work its “invisible hand” magic that will result in destruction for millions of borrowers.

This latest Administration foreclosure plan would require principal reductions, in exchange for the refinanced loan getting government backing. But again, this comes at the discretion of the investors who hold the mortgage. This amounts to a wish and a hope that investors will make the right decision for borrowers and take the hit rather than foreclosing. And the funding for this, in the form of incentive payments to servicers, totals only $14 billion, maybe enough to reach 300,000 of the 11 million underwater homeowners in the country (a Neighborhood Stabilization Program out of HUD, which would redevelop vacant homes and resell them to low- and middle-income families who get down payment assistance, tacks on just $1 billion more).

The National Community Reinvestment Coalition has the right idea. CEO John Taylor thinks the White House needs to mandate loan principal reductions:

“A civilized country cannot embrace an economic policy that ignores human suffering. We can’t just turn away from the millions of families who are facing foreclosure for reasons beyond their control,” said Taylor, who has been advocating for mandated loan principal reductions since 2007.

“In the past four years we lost $6 trillion in real estate values. Somebody has to eat that, and it shouldn’t be the people who had nothing to do with creating the economic crisis in the first place. We need big solutions for very big problems, not half way measures and certainly not intentional neglect,” said Taylor.

The HAMP program, incidentally, has produced modifications which lower principal for just .1% of all its successful borrowers, which amounts to a grand total of 400 loans.