Obama’s Mortgage Solution: What’s In It For Me?
By AUSTIN NELSON
There is considerable controversy as to the wisdom of the new measures introduced by the Obama Administration to stabilize the housing market: Will they work? What does it even mean for something like this to work?
While there are strong arguments on both sides, let’s look specifically at who Obama’s plan will definitely help and how that could in turn help the economy.
According to the White House’s official release on the Homeowner Affordability and Stability Plan (HASP), upwards of 9 million homeowners will be helped in their struggle to stay afloat. Even assuming that the administration is inflating these numbers a little, that’s still a lot of families. Each of these families could potentially be given a lifeline, a way to stave off the foreclosure of their homes.
In a plan estimated to cost $275 billion, HASP aims to achieve the lofty goal of slowing foreclosures by:
1.Reducing and subsidizing monthly payments for troubled borrowers
2.Incentivizing servicers and banks to modify loans
3.Instituting clear and consistent guidelines for loan modifications
The argument has been made that the plan rewards those who made poor financial decisions at the expense of those who did not. In some ways, this is true, but there could be effects of these measures beyond the families who are directly helped.
Most importantly, slowing foreclosures can prevent the downward spiral of home values that results when a number of homes get foreclosed within a single neighborhood. In fact, the White House claims that “the average homeowner could see his or her home value stabilized against declines in price by as much as $6,000 dollars.” While the exact modeling used to figure out such a specific number is unclear, the fact remains that preventing foreclosures will stabilize prices, particularly in neighborhoods with high rates of foreclosure.
Notice that I said that staving off foreclosures will STABILIZE prices, not that it would put an end to price declines. The underlying forces involved in the current home price correction go well beyond foreclosure activity. Prices will correct—indeed they must correct before the economy improves–and no foreclosure prevention plan can stop those fundamentals. The key is to make sure that the market doesn’t over-correct and cause unnecessary damage to the economy as a whole.
In a pattern we here at Cirios have seen many times over, a flood of foreclosures can cripple a neighborhood in a matter of weeks. The greatly increased supply caused by newly foreclosed properties coming onto the market results in price declines in the entire neighborhood. Additionally, foreclosed homes often sit on the market for months, largely because they are improperly priced and the bureaucracy involved in their sale is staggering. While on the market, these homes gradually fall into disrepair, decreasing the value of every home on the block simply by their ugly presence. The resulting decrease in home values leads to more homeowners going underwater and in turn even more foreclosures. And the spiral continues, feeding back on itself. By slowing the flow of foreclosures, it is theoretically possible to stabilize this cycle and remove the feedback mechanism.
The bubble that formed from 2001-2006 in the residential real estate market was unprecedented in its scope and magnitude. At the national level, median home prices climbed to more than 30% beyond historical trends. In many areas that number was twice that much.
As you can see in the graph below, a previous bubble (blue arrow) in the late 1980s (a time period where prices climbed above historic trends) was followed by a prolonged trough (red arrow) where prices fell below the trend. The same could be said for the late 1970s, but the bubble was much less severe.
In fact, the size of these “bubbles” and the length of following “troughs” have increased substantially. If the same pattern were to follow the currently deflating bubble, we should expect to see a trough that lasts on the order of fifteen years. With the current plummeting trajectory of home prices, that trough could be even deeper than the historical pattern would predict.
Source: Economagic, analysis by Cirios Real Estate
On the right side of the graph, I’ve placed a few projections of trajectories for housing prices. One represents a deep trough, which would result from a large “overshoot” in housing price declines. The other represents a “soft landing” for home prices which could result from breaking the foreclosure spiral. Note that the difference between the two projections is two-fold: depth and duration.
In other words, how bad will it get and for how long.
The variance between the trajectories is a 12% difference in low price and a five year lag in home prices’ return to historical trends. In the interest of scientific rigor, I have to say that there is no factual basis for either one of these scenarios. I have not run any models or even evaluated any data in a quantifiable way. But what I am trying to show is that the difference between a scenario where the foreclosure fueled home price spiral continues and one where it is attenuated could have drastic consequences for real estate markets and the economy as a whole.
Our fictional 12% difference in home price means well over $1 Trillion dollars in lost home equity. A five year lag in housing recovery means five more years of expensive and destructive foreclosures. The drag that both of these factors would place on the economy would certainly slow any eventual economic recovery we could hope for.
Only time will tell if HASP will have the desired effect on the housing market. As I’ve said, it certainly won’t be a magic bullet to “solve” the economic problems that currently face us. At best it only addresses a symptom and not the disease. But spiraling home prices are a symptom that we cannot afford to ignore. That HASP simultaneously provides a positive solution to a lingering problem while directly helping millions of families most strongly affected by the economic downturn is reason for praise.
That it helps a select few more directly than others is unarguable, but the overall effect on the housing market and the economy should be positive. Whether it is the best possible plan or merely the result of political expedience is a matter for debate, as are the moral implications that such a socialistic policy represents. But now is the time for action, and this plan strikes a powerful blow.
Tags: foreclosure, HASP, home price, mortgage, Obama, recession