Medication for Middle-Class Mortgage Mania

Everything old is new again….

Between 1634 and 1637, tulips became all the rage in Holland. The record of exactly what happened is sketchy and perhaps apocryphal in part, but at one point a particular kind of tulip bulb could be traded in the marketplace for about 12 acres of land. This is one reason why the history of this phenomenon is often labeled the “tulip mania.”

In America between 2005 and 2008, real estate became all the rage. Remember all those infomercials, like “Anyone Can Make a Million in Real Estate with No Money down?” The real estate “bubble” had many forebears. Wall Street profits, insidious and complex mortgage products, and easy money all contributed to the problem, but the overriding reality is that everybody in America, except those at the very top or the very bottom of the economic ladder, wanted to get into the real estate game. McMansions became very popular among people who had formerly been thought of as middle-class, and suddenly many people who were certainly not “rich” started buying houses “on spec,” particularly in places like Florida and Las Vegas. Builders could get easy money too, turning out those spec houses in record numbers.

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It’s not unfair to call this a bubble, but I think it’s more accurate to call it a mania. Always popular, real estate suddenly became the express elevator to the penthouse of the American dream—everybody tried to get on. When you look back at other “bubbles”—the Internet bubble of only a decade ago, for example—you will see that a much smaller number of individuals, and a relative handful of companies were involved. Painful as it was, it pales in comparison to the number of individuals, banks and investors around the world who were affected, often dramatically affected, by the real estate mania. Just ask anyone who used to work at Bear Stearns or Lehman. Also, the dollar amount of the losses engendered by the Internet companies is nowhere near the amount lost in American real estate. No one thought that the entire financial system was threatened by the collapse of 100 or so overpriced but very sexy cyber-startups.

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Now that the debt ceiling faux-crisis is behind us, stock markets have stabilized a bit, and Athens is not yet auctioning off the Parthenon to pay its debts, perhaps we have time to focus on the most abiding problem (other than the oxymoronic “jobless recovery”) of the American economy—foreclosures.

The scope of the problem is breathtaking, even if you believe the numbers you read, which I don’t. “H.A.R.P,” the Home Affordable Refinancing Program, enabled only about 800,000 homeowners to refinance and is already experiencing a woefully high rate of post-refinancing default. It is estimated that another 4 million Americans are “in or near foreclosure,” which means that they’ve missed at least a couple of payments. But what about all those folks who are only late; who struggle every month to meet the mortgage payment on a vastly overpriced home; who used to be part of the great American middle class, when there was one; and who, without some assistance in the form of a market rebound or a sudden increase in income—both of which are extremely unlikely—will sooner or later fall into the foreclosure class?

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The Solution? »

Image: Tim Schapker, via Flickr.com

The Solution?

In the next two weeks, President Obama has promised a plan to solve, or at least assuage, the foreclosure crisis that is now entering its fourth year. The Administration has sought and received numerous proposals from the private sector and other institutional and educational sources as to exactly what should be done. Glenn Hubbard, Chairman of the Council of Economic Advisers under Bush 43, and some of his colleagues at the Columbia Graduate School of Business have proposed a comprehensive and worthwhile refinancing program for so-called GSE (government-sponsored entity) mortgages which include those issued or guaranteed by Fannie Mae and Freddie Mac, as well as the FHA and VHA.

The Columbia proposal, and many others, strike me as interesting blueprints to overhaul the entire mortgage industry in the U.S., rather than simple steps that can be taken quickly to ameliorate the impending doom so many Americans see looming on the horizon. The Columbia proposal may well form the basis for the drastic overhaul the system genuinely needs, but, alas, it shares one weakness with every other proposal that I’ve seen, although I’m sure I haven’t seen them all. The flaw is that it deals only with GSE mortgages. While GSE mortgages are certainly a large (if not the largest) part of the problem, they don’t include an entire significant subset of beleaguered borrowers. In fact, recent evidence suggests that smaller loans and those made to relatively less affluent people are not the problem.

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GSE mortgages are generally limited to those with an original principal balance of less than $417,000 in most cases, and $729,750 in the so-called “high cost” areas. Because the craze evolved into an epidemic, spiraling prices quickly left those long-established figures in the dust. In the years following 9/11 until the very beginning of the crash, most Americans didn’t think of themselves as “rich,” simply because they believed, however incorrectly, they could afford a house worth $465,000 with a down payment of $47,000, or a house worth $830,000 with a down payment of $83,000 (ah, those heady days of only 10% down). The illusion of affordability was created and perpetuated by alluring teaser rates, and/or negative amortization plans that initially kept the lid on monthly payments.

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Let me make it clear that I am by no means suggesting a bailout for the rich. I’m not suggesting a bailout at all. But we do need to find a way to restructure mortgages of this type, because these so-called “nonconforming” or “jumbo” loans were not limited to the truly affluent. The numbers, which are not easily available, suggest that default and foreclosure rates are as bad—or worse—among these nonconforming buyers as they are among those with GSE loans. Moreover, there is virtually no data publicly available as to just how many people are “on the edge;” i.e., those who are not “in or near foreclosure” but who are obviously struggling and would certainly make any lender’s watch-list.

I have often said that foreclosure is a contagious disease—one foreclosure can ruin the resale value of a block, and a slew of them can undermine the value of every home in a given neighborhood. Just as we don’t want foreclosures to ruin a decent neighborhood of $200,000 homes, it is equally toxic to allow a torrent of foreclosures to significantly devalue wealthier neighborhoods. These are extraordinary times and extraordinary times require public and private sector utilization of extraordinary measures to solve societal issues. This issue cannot be properly addressed piecemeal. If we are to preserve the fabric of our society, it must be addressed whole cloth—not just patched where GSE financing is involved.

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