Prepping for my CNBC appearance tonight forced me to dig into the housing bailout plan in a way that I might not otherwise have found time to do. I find this stuff really fascinating because it's at this beautiful intersection of several of my favorite disciplines: politics, economics and real estate. I majored in Government as an undergrad at Harvard, and studied Economics there as well, so I enjoy playing armchair economist and political theorist every now and then.
Here are my thoughts on today's announcement. And let me preface this by saying these are MY thoughts on the bailout plan, not Zillow's official thoughts. (Zillow officially doesn't have an opinion on this.)
First, today's plan will NOT turn around the housing market. It WILL somewhat reduce the number of new foreclosures (though I think many people are overestimating the reduction it will cause, considering the fact that it only applies to Freddie/Fannie loans which are only 60% of the market, and it only applies to people with a small amount of negative equity. And it's voluntary.) Reducing the tidal wave of foreclosures is good for home prices because it reduces inventory (or avoids further increases in inventory). This is why I applauded the huge drop in new housing starts announced today.
Foreclosure prevention will somewhat help the housing market stabilize, and it will obviously help the homeowners in question. But if you're looking for a REAL stimulus to the housing market, keep looking. The fact is that two things need to happen before home prices stabilize and start increasing:
1. We need to see stabilization in the labor market. Specifically, employees need to be able to stop worrying about lost wages from underemployment, and unemployment needs to return to the 5-7% range.
There were three pieces of big housing news today: 1) the Obama housing bailout plan, 2) the reduction in housing starts, and 3) the Fed put out a new forecast of unemployement for 2009: 8.8% by the end of the year. Frankly, this third piece of news which was the least reported is probably the most important of the three in terms of impact on the housing market.
2. Homebuyers have to feel confident that we're at or near a bottom. Zillow's research shows that a striking 70% of American homeowners think their home will increase in value or stay flat over the next 6 months. But buyers aren't walking the walk. Credit goes to Brian Brady for calling my attention to this point today. Too many buyers are sitting on the sidelines, not making offers because they don't want to buy too early. We're not going to have a housing market turnaround until those buyers start to make offers, and they're not going to make offers until they feel that we've already hit a bottom.
More specifically, here's what I like about today's plan:
- Donald Trump Jr and I agree on this much: it's a good thing that bankruptcy judges will now be permitted to rewrite the terms of mortgages in bankruptcy court. Corporate bankruptcy judges have always been able to rewrite material contracts when companies file for bankruptcy protection -- witness the countless labor contracts for bankrupt airlines that judges have ripped up in bankruptcy. It's about time that personal bankruptcy judges have the same latitude.
Some have argued that this will increase borrowing costs to mortgage holders in the future because the risk associated with a potential loan being able to be negated in court will have to be priced into all loans. Yes, I concede that in theory this is true. So what? It's true of corporate borrowing costs also, in theory, and life goes on. If an individual goes bankrupt, the contract detailing their single biggest liability -- their mortgage -- needs to be on the table for a bankruptcy proceeding to address.
- I like the incentive that the government is giving to loan servicers to try to work out troubled mortgages directly with borrowers. Alex Perriello gave a great speech at the NAR Convention in Orlando imploring the thousands of Realtors in the audience to spread the word among their client list: before you're foreclosed upon, please speak with your lender! Alex said that in between half and 2/3 of all foreclosures, the lender and borrower never even speak to one another. He pointed out that frequently borrowers are embarassed or confused, so they do nothing. The government's actions today -- offering a few thousand dollars to the borrower and servicer for each loan that is modified -- will definitely spark those conversations.
What I don't like about the plan:
- the part of the plan that I like least is the one that introduces enormous moral hazard on the part of borrowers: it basically rewards homeowners who fall behind on their mortgage by paying them a few thousand bucks to stay CURRENT on their mortgage. I think that creates strange incentives.
- To be honest, the whole dang plan is a little hard for me to swallow because I've always been a believer in free markets: if a foreclosure is meant to happen, or a company is meant to go bankrupt, then let it happen. It's impossible to hold back the tides. HOWEVER, we're living in extraordinary times, and my economic liberterianism is now outweighed by my pragmatism.
I also have to use this opportunity to point out that on March 23, 2006, I wrote the following post titled "The Tidal Wave Is Coming" on Zillowblog:
"I’m usually a pretty optimistic guy, but I’ve started to see some scary things on the horizon. And I’ve gotta pass it on. Check this out: 9.4% of all mortgage borrowers now have no equity or negative equity in their home, and 29% of new mortgages last year had no equity. $800 billion worth of mortgages owe more than their homes are worth, and that’s optimistic since it assumes no reduction in home values. One study estimates that if home prices fell by 10%, the share of 2005 homebuyers with negative equity would shoot up to 48%. Yikes! What happens when all those interest only mortgages flip from their low fixed rates to a much higher variable rate? A lot of homeowners who bought houses beyond their means a few years ago via low introductory rate ARMs are suddenly going to find themselves unable to pay their new higher mortgage. And guess what? They have no equity in their house. So they’ll have to sell and/or dramatically reduce their consumption. This is a disaster waiting to happen. This analysis says it all: 'Many homes were sold with Adjustable Rate Mortgages in 2003 and 2004. Now, we are seeing more than $2 trillion…of these mortgages coming up for a reset in their mortgage rates. My back of the napkin calculations suggest interest payments are going to eat up at least another $3 billion a month in consumer spending capacity over the next year. In a $12 trillion economy, this is not all that large, but it will suck almost 1/2 of 1% of consumer spending potential out of the economy.'
Sorry to be such a downer, but I’m worried about the impact that this will have on housing prices and more importantly on the overall American (and global?) economy."
Wow, sometimes I hate being right.