Fix Congress's Housing Fix

The bill before Congress reflects how good government intentions are perverted by interest group.


The once-in-a-century housing boom of the first half-dozen years of this decade has now turned into a bust. Home prices are down between 15 and 20 percent from their peak in 2006. Many experts predict as much as an additional 15 percent decline before the pricing bubble is undone.

Falling home prices have made it difficult for borrowers who have trouble meeting their mortgage payments to refinance or sell their home, leaving many with foreclosure as the only alternative. Some 10 million homeowners are haunted by the phantom of negative equity, whereby they owe more in mortgage than the value of their home. In part, this reflects mortgage loans that were made for virtually the total purchase price, when lenders and borrowers saw home prices soaring and did not worry about the burdens of meeting the schedule of repayments. They thought homes could be sold at any time, often at a hefty profit, a reasonable assumption since home prices had jumped an average of nearly 9 percent from 2000 to 2006, after rising an average of less than 3 percent in the 1990s. A typical home that was worth $150,000 in 2000 was worth $252,000 in 2006, instilling the optimistic view on the part of lenders, borrowers, and investors that credit risks could be washed away by rising equity.

Just as they acted rationally when they believed prices would always rise and they couldn't lose, they now see that prices are sinking fast while their mortgage debt isn't, and they don't believe prices will rebound anytime soon. No wonder they are prone to see that the most rational course is to mail in the keys, especially if they bought the property as a rental investment. The incentive to default is that mortgages are generally nonrecourse loans—i.e., creditors can take the home of someone not meeting the obligations but cannot seize other assets or wages. That has led to a new class of homeowners called "walkers," who have walked away from their mortgage debt.

Downward spiral. Mortgage delinquencies and mortgage foreclosures have risen from historically low levels at the end of 2006, picking up speed in nearly every quarter since then. According to the Census Bureau, over a million homes were in foreclosure at the end of the first quarter, and the portion of loans at least 30 days overdue climbed to a record 6.35 percent.

Foreclosures that began in the subprime mortgage area have now pulled more and more borrowers with higher incomes and good credit down in the undertow. Falling home prices have also made it more difficult for borrowers to tap their home equity loans, a form of second mortgage popular with homeowners looking for a cushion against future cash needs. These are now susceptible to elimination by the lenders on the grounds that declining home prices have reduced the home value ratio to unacceptable levels vis-à-vis the loan amounts.

The compounding loan defaults and the resulting foreclosures accelerate the downward spiral of home prices. It becomes a self-reinforcing process without any visible stopping point, given many sellers and few buyers. This comes at a time when the supply of new, unsold homes is at twice the typical level of a healthy market—an 11-month supply versus five to six months.

Hardly surprising, therefore, that housing is big news in both boardroom and bedroom. The housing bust represents the greatest strategic threat to the American economy, having already subtracted at least 1 percentage point from economic growth in the past quarter. It is the largest asset in the balance sheet of the average American family, and its decline in value has forced many to begin saving out of income instead of out of asset appreciation. This means consumer spending will be depressed at a time when higher gas and food prices are cutting deeply into purchasing power. Consumer confidence has fallen to a 16-year low. Foreclosures also have transformed tax-paying properties into tax-eating properties, creating a big problem for municipalities who not only lose the real estate tax revenues but also have to send in the police, fire department, and sanitation officials to prevent homes from being looted or vandalized, because empty houses attract squatters and drag down the value of entire neighborhoods. The result is that foreclosed properties often plummet in value.