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Lower home prices can fix what government can't

Monday, March 29, 2010
By Caroline Baum, Bloomberg


NEW YORK -- Thud! Four years after the peak of the housing bubble, home sales are slumping... again.

New home sales, which lead the complex of housing indicators, fell to an all-time low of 308,000 in February, the fourth consecutive monthly decline. For existing home sales, it was the third consecutive drop after last year's tax-credit- driven bounce.

Homebuilder sentiment has rolled over. Housing starts are bumping along the bottom, with new construction too low to accommodate normal growth in households, according to Michael Carliner, a Potomac, Maryland, economic consultant specializing in housing.

Alas, all the Fed's purchases and all the government's men can't put the residential real estate market together again.

Between them, the federal government and central bank can lower mortgage rates, modify mortgages, use its power to get private lenders to modify mortgages, and create incentives to move inventory, such as the first-time homebuyer's tax credit.

What they can't do is manufacture enough artificial demand for an asset that was artificially inflated to begin with. Prices will have to fall, which is how supply is allocated in a market economy. (An occasional reminder is in order given the current spend-money-to-save-money mindset.)

The Federal Reserve will complete its purchase of US$1.25 trillion agency mortgage-backed securities at the end of this month. Its efforts on our behalf have driven 30-year fixed-rate mortgage rates to half-century lows of sub-5 percent, “which should have been more stimulative than it was,” Carliner says.

Flawed Model

Those who rely on econometric models — the same models that did so swimmingly well in assessing risk and anticipating the financial fallout from the housing crash — said the Fed single-handedly reduced mortgage rates by as much as 1 percentage point.

Ex-Fed, mortgage rates will probably tick up. The Obama administration's Home Affordable Modification Program has been a disappointment, even to the Treasury, according to a report by the Special Inspector General for the Troubled Asset Relief Program. (The Treasury used US$50 billion of TARP money as part of a US$75 billion program to incentivize borrowers and lenders to modify mortgages.)

One year into the program, 168,708 mortgages have received permanent modifications, according to the SIGTARP report. Aspects of the program make it “particularly vulnerable to re- defaults,” including a failure to consider a homeowner's other debt, an unaffordable second mortgage or the inability to meet increasing monthly payments at the end of five years.

Repeat Offenders

The recidivism rate among defaulted borrowers who get modified loans is high even in good times. These are not good times.

More than 11.3 million homeowners owed more than their homes were worth in the fourth quarter, according to First American CoreLogic, a provider of mortgage data and analytics in San Francisco. Borrowers may decide “it makes more economic sense for them to walk away from their mortgage notwithstanding the lower payments,” SIGTARP says.

And that's the government's outlook.

Perhaps another solution is in order. A novel idea not yet tried would be to do what other industries do to rid themselves of unsold merchandise. They hold a sale. Let prices fall until the goods find a buyer.

I'm all for charity and doing what makes sense. If a lender decides it's in his self-interest to reduce the loan balance on underwater or delinquent mortgages — if modification is cheaper than foreclosure — that's between management and shareholders.

Bubbles Are Good?

With government programs, those who lived within their means, who bought a home they could afford, are being asked to pay for the mistakes of others. Bankers and insurance companies weren't the only ones who were greedy.

In 2007, Newsweek's Daniel Gross wrote a book entitled, “Pop! Why Bubbles Are Great for the Economy!” His thesis was that asset bubbles leave behind a usable infrastructure and are a net positive for the economy.

Even then he was straining to fit the housing bubble into his bubbles-are-good framework.

“The bubble achieved a goal that billions of federal dollars, and 30 years of good intentions, could not: gentrification and renewal in formerly some of the most wretched spots of the cities.”

The bubble achieved another goal: it turned vast tracts of suburban housing into rotting wasteland.

Economics is about the allocation of scarce resources. Investors overpaid for resources that were underutilized, in some cases for years. Money went into housing because prices were rising, financing was cheap and, as an added bonus, you got a roof over your head.

'Reward the Reckless'

Now we're stuck with a glut.

The percentage of loans that were seriously delinquent — more than 90 days overdue — rose to a record 9.67 percent in the fourth quarter, according to the Mortgage Bankers Association. Rates rose in all categories of loans, including subprime, prime and government-backed loans. Those numbers aren't adjusted for seasonal variations.

Almost one-quarter of all residential properties with a mortgage were underwater in the fourth quarter, according to First American CoreLogic.

What's done is done. Throwing bad money after good makes no sense. The government can't save housing without sapping something else of needed capital.

The government's efforts are “not only ineffective but counterproductive,” Barry Ritholtz writes on his Big Picture blog. “They reward the reckless and punish the responsible, and create a moral hazard.”

Worse, Ritholtz says, “they penalize middle America for the sake of giant Wall Street banks.”

Help bankers? Now there's an angle that should energize the masses.

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