Louise Story has an article in the NY Times today about pending "homeowner bailouts."
"Arizona is one of five states that, with money from Washington, hopes to help at least some of these people hold on to their homes. Under a new, federally financed pilot program for the hardest-hit housing markets, state officials will decide who will get a homeowner bailout, and who will not.
The idea is as controversial in Washington as it is here. Do the neighbors next door who lived beyond their means — the ones who, say, bought that house they could not afford, or who binged on home equity loans to buy new cars and flat-panel TVs — really deserve to be bailed out with taxpayer dollars? Do they deserve to have some of their debts forgiven? And is that fair to the cautious ones who paid their mortgages?"
Well, my position is clear on that question: the answer is NO. But let's not get bogged down in an idealogical battle: if you believe that homeowners who borrowed and spent beyond their means should be bailed out, we really have nothing to discuss - I strenuously disagree. I do, however, ask those who are pro-bailout to refrain from using the "hey - banks were bailed out, why shouldn't we be bailed out too?" argument. After all, we all learned by age 5 the old adage: two wrongs don't make a right.
There is also a key point that lots of people seem to gloss over when talking about homeowners who are having trouble paying their mortgages: there are millions of others on the sideline waiting, saving, and hoping to prudently buy houses of their own! For every imprudent borrower we aid, we are impeding a prudent saver from buying a home they can afford - because we are keeping home prices inflated, and preventing house prices from falling to affordable levels where new savers can finally purchase them.
Since the NY Times gives us some actual data, let's look at one of the troubled homeowners who had to throw in the towel before this bailout program:
"Ms. Carter, at 4344, arrived in 2005, as the bubble was inflating. She took out tens of thousands of dollars in home equity for repairs and other items, and by this year, she was underwater on her mortgage by $86,000. A single mother, she moved out this month, days before her home was sold in a short sale, which meant her mortgage lender allowed her to sell for less than the value of her mortgage and the lender took the loss."
I'm a compassionate guy, but if you expect me to sympathize, I don't (and to her credit, I don't think she's asking for sympathy - as we'll get to in a minute). The Times, in the attached graphic, gives us some more data on Ms. Carter:
original mortgage: $207,920
current mortgage: $307,000
purchase price: $259,000
current value: $221,000
It seems that the "tens of thousands of dollars in home equity" that Ms Carter withdrew from her home is closer to $100,000. Her current mortgage is $86,000 underwater. If she hadn't spent her paper profits (perhaps on the Mercedes and the expensive lawn we'll encounter in a moment?), she wouldn't be underwater!
Now, I don't mean to pick on Ms. Carter, in fact, she is honest about her situation:
"Years ago, she considered filing for bankruptcy but then changed her mind. She said she was accountable for her actions and was making what amounted to a business decision to leave her home.
“I had to take emotion out of it,” said Ms. Carter, 36. “If I had a business, and every single month I was losing money, would I keep on paying? No, I wouldn’t.”
Sitting at her dining room table, before a large tank of fish, she recalled how she had made this a perfect home. It is one of the few on East Montgomery Road with grass in the yard, an expensive proposition in the desert. A Mercedes sits in the driveway.
She said she did not feel she deserved to have her debts forgiven, but added that if her mortgage had been lowered, she would have tried harder to stay."
This "homeowner bailout" program will certainly be difficult to implement morally. The director of the program is quoted in the article as saying:
"he was reluctant to help homeowners with “self-inflicted wounds,” like those who overspent or cashed out the equity in their homes during the bubble years. He wants the banks to match the public money being used for debt forgiveness, and he is focusing on people whose incomes have fallen but who still hold jobs."
And here is the key epiphany that I've been marching toward: guess what - this isn't really a homeowner bailout at all. It's ANOTHER bank bailout! Remember - just like Ms. Carter made the "business decision" to leave her home, banks can make the business decision to adjust the outstanding mortgage balance (lower) on borrowers who cannot pay and will otherwise default and induce foreclosure. There's one huge problem with that, though: I've written at length about the deadly game of extend and pretend we're playing with our debts. The banks are carrying so many of these mortgages at the full loan value, even though they know that in reality they will not be getting the full mortgage value back. If they do a mortgage principal writedown (reduce the amount the homeowner owes), however, they have to write down the value of the loan too - and take a loss.
What's the solution? Extend and pretend... close your eyes and pretend the losses don't exist by refusing to acknowledge them. That's why you see articles like this from Calculated Risk, describing home "owners" who haven't made a payment for three years and still haven't been foreclosed on!
Think about it - the banks know that the real estate market sucks. They don't want to take your house from you and have to sell it themselves - that is expensive, AND it requires them to take the actual loss on their books. On the other hand, they don't want to lower the mortgage balance to an amount the borrower can actually pay, because that ALSO requires them to take the loss on their books. So, they just delay and pray.
Which brings us back to the "homeowner bailout." Do you see, now, who the end beneficiary is? Homeowners don't need a government subsidy - what they really need is for banks to make sensible business decisions and write down mortgages to levels where homeowners are willing to pay (side note: of course, the banks could also foreclose, but that's more expensive for the bank. Despite biases individual bystanders may have on homeowner responsibility, it's probably a better business decision for the banks to do a principal writedown than a foreclosure). As we've just established, if banks do these principal writedowns, they have to recognize losses which further decimate their already fragile (insolvent??) balance sheets - so they avoid the writedowns.
Solution? The government comes in and essentially subsidizes the writedown! The government could send the money to the bank on behalf of the homeowner and get the mortgage balance reduced accordingly, which would be a wash for the bank, or it could allow the bank to keep the mortgage balance as is (also a wash for the bank), and aid the homeowner directly. Either way, banks avoid the reality of marking their bad assets (mortgage loans) to market.
Mr. Traylor, the director of the Arizona housing department, said that he wants banks to match the public money. We will have to wait and see how the program actually plays out, but either way, the banks are getting a subsidy here.
disclosure: short XLF