Friday, December 12, 2008

Megan on Foreclosures

I caught Maxine Waters on CSPAN Wednesday gassing at treasury flacks about how they aren't spending any of the $700B on bailing out homeowners. But Megan writes:

How easy it is to address foreclosures, however, depends on what the reason is for the foreclosure. Are people missing payments because changed circumstances mean that they can't afford them, or are people missing payments because they don't want to make payments on a house that was worth $500,000 when they bought it, but is now worth $300,000?

That's actually a complicated question, because many people bought a house they couldn't really afford on the assumption that rising markets would give them the equity to refinance into a mortgage they could afford. This turned out to be a bad bet.

But people with ARMs are not, by and large, actually in the position of having suddenly seen their interest rate jump by double-digits. They're in the position of having seen their interest rate go from a low teaser to a still pretty low adjustable rate. The interest rate indices generally used to set ARM payments are actually quite low right now, though of course, the rates are often lagged. Still, the problem is not that people got caught out by surprisingly high rates.

That leaves us with two questions: how low a rate are we willing to provide in order to produce a workout? And what if the problem is, as even some liberal commentators are arguing, that people don't want to make payments on a house where the value has dropped by half?

I don't think that the US government can provide price protection against falling home values, for several reasons. The first is the moral outrage. It's one thing to help people who got caught out by bad life circumstances by reducing a crushing interest rate, especially when the government has, as now, such low borrowing costs. It is quite another thing entirely to simply give someone tens of thousands of dollars in home equity on an unaffordable house they bought without any substantial downpayment. Are those people going to be allowed to profit from their heavily subsidized houses if the market recovers?

People who bought homes they could afford, or people like me who rented because they thought housing was in a bubble, won't stand for it. Especially since propping up those peoples' home values will not only require substantial tax contributions from me, but also make it harder for me to buy a house.

Megan also writes that we can't afford it: given historic trends, our housing is still overvalued by anywhere from 15 - 40%. Assuming, as Megan does, that the true overvaluation is 25%, and that housing prices must sink by this amount from where they are today, then homeowners must split a further $3.5T drop in equity. Sorry, but the Chinese won't give us that much money. Not anymore.

1 comment:

Max Ray said...

people with ARMs are not, by and large, actually in the position of having suddenly seen their interest rate jump by double-digits. They're in the position of having seen their interest rate go from a low teaser to a still pretty low refinancing rate. I don't think that the US government can provide price protection against falling home values, for several reasons.