San Diego Housing Bubble News and Analysis

This plan may be the best of a bunch of awful plans. As believers in the rule of law, capitalism, and personal responsibility, we are all appalled at the steps the government has taken and will continue to take to "fix" this problem.
The virtues of this program are that it is efficient--gets the breathing room directly to the idiot borrowers, stabilizes the housing market which may otherwise overreact on the downside in a viscious circle, and whacks upside the head the equally dumb lenders with a quick principal reduction.
It is efficient because it avoids the waste of foreclosures, trashed houses, empty & idle housing stock sitting and deteriorating, and family upheavals.
Let's face it Piggs, the government is going to waste a lot of our money no matter what. You want revenge? It'll cost you. Let's get this boondogle over as quickly and cheaply as possible.

Foregive me if I am wrong, but wouldnt this bankrupt our lending services just the same?

Our whole problem is Banks cant get their money back from past loans. If they loose too much money, they go under. This plan just forces them to take the loses now under, instead of over time as people default.

Minus the social costs, I dont understand how this fixes the problem. Again the only option is for the GOV to willingly take it in the shorts and have taxpayers foot the bill by overpaying in the ED takeover and then underselling the loan back. Otherwise our banks go under and stop lending for fear of not being repaid as weak banks die in the forced ED takeovers. Companies die due to no lending. Unemployment shoots up. Stocks dive as companies fail. Etc etc etc. It is no different.

We have two choices.
1) taxpayers foot the bill for the banks looses and everyone pays for the bubble, even the responsible who did not partake. Considering the size of this bubble, the cost is far higher than anyone wants to admit.
2) Banks foot the bill, weak ones go under, lending tightens, weak companis go under, and we go into a recession that punishes overly risky lending/borrowing (and some good unlucky ones too)

Currently we are doing both.

EconProf I see absolutely no merit in this plan with respect to selling the home back to the original homeowners.

I agree with the first part of the plan which would be to take the home away from the homeowners using emminent domain.

However in no way whatsoever should the home be "given" back to the homeowner on any terms. The home should be sold on the open market. If the current homeowners want to buy it then they can compete with anyone else.

The rate of recidivism with regard to rampant consumerism is quite high. I work with so many people who are SO qualified with respect to gainful employment, strong downpayment money, who have simply elected to be prudent over the past few years. These people would form a much strong base to the homeownership pyrmaid rather then current overburdened base owner.

I am very disturbed by this "family upheaval" that everyone keeps writing about. Renting a home is not an upheaval. I don't like it but it is not the end of the world and to sensationalize it is crazy. Pity the poor homeowner who HELOCd himself to foreclosure so now he has to suffer through the upheaval of foreclosure so he has nowhere to park his boat.

So yes, I like the first part of the idea but a much stronger implementation of what to do after the home is taken should be considered. If the home is taken through emminent domain then the deal with the original owner would be they get to walk with no ding to the credit and if the home sells for more then they owe then they get the profit.

The better lesson for them will be that they learn to live within thier means. What a treat.

If we all agree on a few preliminary assumptions:
That our goal should be to minimize the government's costs, to hit the bottom of the market sooner rather than later, and to punish the irresponsible lenders, and...
That the government's actions so far, and into the future, promise to be wasteful, reward the wrong people and lenders (such as by buying underwater mortgages at face value), and take too long, and...
That the possibility exists for the RE decline to feed upon itself, forcing the bottom to be below trend line or "fair value" historically and putting underwater many people who now have 10% to 30% equity in their homes, thus doubling or tripling the taxpayer's costs, then
this approach merits a closer look.
It gets ahead of the curve (assuming it could be implemented quickly, which I think is its biggest problem), and at a lot lower costs. It only keeps the borrower in the house if they have the liklihood of paying the new, lower mortgage. Yeah, I'd also like to not reward those who can stay with a lower principal, but the current and future programs are going to shower the undeserving FBs with a lot more than this program would at much greater cost to us.
As to the "social costs", I'm not including solely the disruption to the family that is forced to move, but the external costs imposed on the neighborhood, the erosion of the property tax base and resulting hikes in other taxes, the overshooting of the price decline, and the inherent waste of perfectly good houses boarded up for many months or years.

With respect to minimizing governments costs, there can be no argument about selling on the open market being cheaper.

Let me ask you this, how can one actually determine the true market value without putting the home on the market itself? An appraisal is just that, only an appraisal. Thus it is quite intuitive to me that not putting the home on the open market is actually reducing the potential for profit.

Honestly it does not matter what the trend line is, or if there is an overshoot due to massive inventory. Rather, this is the expectation with a huge influx of inventory. However it is simply a matter of rolling the program out in stages to help reduce that issue. In fact inventory can actually be controlled down to a local market level if this is done correctly. Similarly with the rate of recidivism being what it is, the cost to keep a homeowner current, then do it again in 6 months or a year is not trivial. Moreover, you have not addressed all of the other defaults that most people who have fallen behind incur including county taxes, hoa, and/or mello roos. Again, it seems to me that the current homeowner being bailed out of these defaults in addition to the mortgage does not make sense. Once more, it seems obvious to me that the free market should be tested to see who the new owner should be.

As for the erosion of the property tax base, this is a huge problem. How can it be legal for someone to live in a home that has been revalued at a much lower price then the assessed value? Any astute homeowner will indeed be petitioning a lower tax based on the true value of the home. The government is paying the default AND accrued interest penalty to catch the buyer up as well right?

If the house is put on the free market and sold why would the house be boarded up for many months or years?

As for punishing irresponsible lenders... that is not my goal. I don't care about irresponsible lenders. The government has already been abundantly clear that they are going to bail out lenders, not punish them. As for my approach, once the home is on the market and sold, the government is out of the picture. The buyer found a lender and bought the home at market rate with a TRUE MARKET determined mortgage, not some government subsidized rate.

Those who view the current problems with foreclosures and mortgage backed securities need to stop calling those in foreclosure idiots who bought houses they could not afford. There might be some in that category that as stated above would lose their house if they can't afford the new payments.

The current financial crisis has many distinct problems that this plan can address efficiently.

For instance, homeowners who don't have upside mortgages will not lose equity in their homes due to foreclosure sales below market value. So even if you are not in foreclosure the foreclosures in your neighborhood will affect your property value. No one is untouched by this crisis.

Let's assume you did everything right and are living within your means. Your job requires you to move to another state recently. The value of your house however has decreased over 30% which basically forces you to chose between losing your job or losing lots of money on the sale.

This plan would take care of the upside mortgage problem for anyone who submits a request. This includes all those borrowers who are upside down on their mortgage whether in foreclosure or not.

Wall Street will also benefit from this plan because all of those risky loans held as securities would be paid off to the investors. Right now, they don't even know what, if any return they might get from these Securities.

Under the plan,the refinanced mortgages could then be re bundled at their true value and sold to investors. This will also solve the liquidity issue as the funds will continue to flow through each of the processes.

I am sorry but I disagree. As I said the first part of the plan is fine, that is the repossession of the homes due to emminent domain. The second part of the plan which is simply subsidizing the homeowner is not good. A plan of this manner will not determine the true value of the home. A plan of this manner takes no contingency into effect for recidivism. A plan of this manner will not be able to easily discriminate between fraud.

What is the huge moral crime against asking people to live within thier means rather then bending the rules and accomodating the means to fit thier budget or lifestyle? The alterations I provided remove all arbitrary facets of the plan. They allow the absolute true value of the home to be determined. They provide a new homeowner, or in some cases the old homeowner, who will be requalified and is much more well positioned to pay the loan properly. Finally the sale of the home itself will become a TRUE comp, rather then a HIDDEN comp and it will serve to help the entire housing market adjust faster and in a more true manner.

Yes, this plan would cause all the financial institutions to fail at the same time. Isn't this how they do it in the Banana Republics?

I agree with SD Realtor on this one. It seems to me that instead of trying to minimize foreclosure and "keep people in their homes", the government should be: 1) trying to streamline the foreclosure process by helping the current cash-strapped occupant transition to a much more affordable rental (thereby freeing-up their cash and increasing their economy-supporting consumer spending power, by the way), and 2) aiding banks in turning around all their newly foreclosed-on properties for sale on the open market.

These steps could be accomplished by providing first months rent/security deposit loans or assistance for foreclosed-on people, for example, and also funds to help banks clean up trashed properties (not including granite counter top upgrades!) in preparation for quick sale on the open market.

It seems like keeping financially-strapped people in underwater houses is bad for both the people themselves and financially responsible people waiting patiently to buy a realistically-priced house.

I can't for the life of me understand the continued backlash on the borrower when it is the responsibility of the lender's Underwriters who were supposed to make sure that the borrower could afford the mortgage.

The system was and is broken because neither the Lender nor the Broker had any incentive to make sure the loan was sound and that the borrow was qualified. IN fact, since it was not their money on the line, they could care less.

Was There a Loan It Didn’t Like?
By GRETCHEN MORGENSON

Ms. Cooper’s biggest regret, she says, is that she did not reject more loans. “I swear 60 percent of the loans I approved I was made to,” she says. “If I could get everyone’s name, I would write them apology letters.”

Do you know why they didn't care if the borrower could pay or if the transaction was fraudulent??

I will tell you why, because it didn't matter to them, they got paid either way for the full amount of the Note. Which leads me to another point, just who is entitled to foreclose on the home?

The Bank you thought was the Lender has been paid in full for your loan and is now called a Servicer making an additional 2.5% on your monthly payment.

The owners of the Mortgage backed Securities are the true owners of the Note, but in some cases the same Note has been sold into 3 different pools. In addition, some of those Notes were insured by AIG which protected the investor who in that case would have also been paid on your Note.

So at the time your home is getting foreclosed, your Note could have been paid in full twice and they also are going after the house as well. Does this sound like a system we should have any sympathy for??

My question is, what happened to all of that money paid to the supposed Lender who sold the Note to the Investors to be bundled as securities?? That was free money, where did it go??

"I can't for the life of me understand the continued backlash on the borrower..."

Maybe it comes from this scenario being repeated over and over:

1. Media presents sob story of FB who laments how they were deceived, bamboozled, etc.
2. Housing bloggers do the 15 minutes of research that the writer of the piece should have done in the first place and quickly discover (choose one or more from list):
A) Borrower refinanced multiple times to fund purchases completely unrelated to housing.
B) Borrower was a Carlton Sheets disciple who also bought 17 pre-construction condos in Las Vegas.
C) Borrower lied blatently on loan application and/or turned a blind eye to obvious fabrications made by the broker on their behalf.
D) Endless variations on this theme.

It would be nice to think these are abberations. But I know better. I remember the cocktail parties and water cooler conversations where I had to listen to these people drone on about their real estate investment savvy.

The vast majority were speculators. They got high snorting granite countertop dust and watching HGTV and bought into the greatest housing bubble in history. And now they want to be bailed out.

Which isn't to say that the lending industry and used house salespeople didn't do their part as well -- they did. But the borrowers were, by and large, complicit in the whole affair.

I would have to agree with Lyra. Indeed both parties have heavy burdens to bear. Shame on the lender for being foolish enough to do the lending but personal liability of the borrower trumps that card in my book.

Neither the buyer nor the lender should be bailed out. If the system would be allowed to work its way out then both foolish buyers and lenders would be washed out with the tide.

Amen, Lyra and SD Realtor!

For years, I have been putting the lion's share of the blame on the lenders (and their associates), as they well knew these loans would never be paid back. I defended the borrowers, as many of these people really were naive (and painfully STUPID!!!! -- yes, they were), and had little experience with the mortgage industry.

All that being said, it was never my impression that FBs should be kept in the banks' houses, but that **a most generous GIFT to them** would be a non-recourse loan, where the bank couldn't go after them if they foreclosed on them.

They should also receive a negative mark on their credit reports because they DID default on a **very large** loan. People, like many Piggs here, have worked hard to stay out of debt and made many sacrifices that the FBs refused to make, and our credit reports should reflect the vast differences between these very different types of borrowers. Seriously, these idiots (yes, they are IDIOTS), couldn't figure out that $50K per year would not afford a $500K+ house????? What they need, more than anything, is a lesson in finances and personal responsibility.

My family (and many others on these blogs) has been renting for years because we refused to overpay for a shack. We've always lived within our means and stayed out of debt.

Please explain why we should have to pay for the over-encumbered idiots to stay in a house that **they could not afford.** If we can live in a rental, so can they. It's not the end of the world, and would teach them a well-deserved lesson.

If we bail out the specuvestor-idiots, they will be back next year looking for more bailouts. What happens if prices drop more, do we continue to renegotiate their mortgages all the way down?

Who will buy these loans (reworked loans and future mortgages) if they know the govt can come in and change the terms at the drop of a hat?

Bad idea, all around.

This is the most thorough analysis of the mortgage meltdown I have found. While it does include "Speculators", I left them out of the extractions below because the author ultimately concluded that they were just using the system made available to them to try to make a buck.

Anatomy of a Train Wreck
Causes of the Mortgage Meltdown
By Stan J. Liebowitz

October 3, 2008

The last defense of banks trying to defend themselves against charges of engaging in biased mortgage lending appeared to fall when the Federal Reserve Bank of Boston (Boston Fed) conducted an apparently careful statistical analysis in 1992, which purported to demonstrate that even after controlling for important variables associated with creditworthiness, minorities were found to be denied mortgages at higher rates than whites.

In fact, the study was based on such horribly mangled data that the study’s authors apparently never bothered to examine them. Every later article of which I am aware accepted that the data were badly mangled, even those authored by individuals who ultimately agreed with the conclusions of the Boston Fed study. The authors of the Boston Fed study, however, stuck to their guns even in the face of overwhelming evidence that the data used in their study was riddled with errors. Ex post, this was a wise decision for them, even if a less than honorable one.

The winds were behind the sails of the study. Most politicians jumped to support the study. “This study is definitive,” and “it changes the landscape,” said a spokeswoman for the Office of the Comptroller of the Currency. “This comports completely with common sense,” and “I don’t think you need a lot more studies like this,” said Richard F. Syron, president of the Boston Fed (and former head of Freddie Mac). One of the study’s authors, Alicia Munnell, said, without any apparent concern for academic modesty, “The study eliminates all the other possible factors that could be influencing [mortgage] decisions.” When important functionaries make quotes like these, you know that the fix is in and that scientific enquiry is out.

My colleague, Ted Day, and I only decided to investigate the Boston Fed study because we knew that no single study, particularly a first study, should ever be considered definitive and that something smelled funny about the whole endeavor. Nevertheless, we were shocked at the poor quality of the data created by the Boston Fed. The Boston Fed collected data on approximately three thousand mortgages. Data problems were obvious to anyone who bothered to examine the numbers. Here is a quick summary of the data problems: (a) the loan data that Boston Fed created had information that implied, if it were to be believed, that hundreds of loans had interest rates that were much too high or much too low (about fifty loans had negative interest rates according to the data); (b) over five hundred applications could not be matched to the original HMDA data upon which the Boston Fed data was supposedly based; (c) forty-four loans were supposedly rejected by the lender but then sold in the secondary market, which is impossible; (d) two separate measures of income differed by more than 50 percent for over fifty observations; (e) over five hundred loans that should have needed mortgage insurance to be approved were approved even though there was no record of mortgage insurance; and (f ) several mortgages were supposedly approved to individuals with a net worth in the negative millions of dollars.

When we attempted to conduct a statistical analysis removing the impact of these obvious data errors, we found that the evidence of discrimination vanished. Without discrimination there would be no reason to try to “fix” the mortgage market. Nevertheless, our work largely evaporated down the memory hole as government regulators got busy putting the results of the Boston Fed study to use in creating policy. That policy, simply put, was to weaken underwriting standards. What happened next is nicely summed up in an enthusiastic Fannie Mae report authored by some leading academics (Listokin et al., 2002).

2. Relaxed Lending Standards—Everyone’s Doin’ It

Within a few months of the appearance of the Boston Fed study, a new manual appeared from the Boston Fed. It was in the nature of a “Nondiscriminatory Mortgage Lending for Dummies”3 booklet. The president of the Boston Fed wrote in the foreword:

The Federal Reserve Bank of Boston wants to be helpful to lenders as they work to close the mortgage gap [higher rejection rate for minorities]. For this publication, we have gathered recommendations on “best practice” from lending institutions and consumer groups. With their help, we have developed a comprehensive program for lenders who seek to ensure that all loan applicants are treated fairly and to expand their markets to reach a more diverse customer base.

Even the most determined lending institution will have difficulty cultivating business from minority customers if its underwriting standards contain arbitrary or unreasonable measures of creditworthiness.

The document continues:

Management should be directed to review existing underwriting standards and practices to ensure that they are valid predictors of risk. Special care should be taken to ensure that standards are appropriate to the economic culture of urban, lower–income, and nontraditional consumers.

Credit History: Lack of credit history should not be seen as a negative factor. Certain cultures encourage people to “pay as you go” and avoid debt. Willingness to pay debt promptly can be determined through review of utility, rent, telephone, insurance, and medical bill payments. In reviewing past credit problems, lenders should be willing to consider extenuating circumstances. For lower–income applicants in particular, unforeseen expenses can have a disproportionate effect on an otherwise positive credit record. In these instances, paying off past bad debts or establishing a regular repayment schedule with creditors may demonstrate a willingness and ability to resolve debts. Successful participation in credit counseling or buyer education programs is another way that applicants can demonstrate an ability to manage their debts responsibly.

Obligation Ratios: Special consideration could be given to applicants with relatively high obligation ratios who have demonstrated an ability to cover high housing expenses in the past. Many lower–income households are accustomed to allocating a large percentage of their income toward rent. While it is important to ensure that the borrower is not assuming an unreasonable level of debt, it should be noted that the secondary market is willing to consider ratios above the standard 28/36.

Down Payment and Closing Costs: Accumulating enough savings to cover the various costs associated with a mortgage loan is often a significant barrier to home ownership by lower–income applicants. Lenders may wish to allow gifts, grants, or loans from relatives, nonprofit organizations, or municipal agencies to cover
part of these costs. Cash–on–hand could also be an acceptable means of payment if borrowers can document its source and demonstrate that they normally pay their bills in cash.

Sources of Income: In addition to primary employment income, Fannie Mae and Freddie Mac will accept the following as valid income sources: overtime and part–time work, second jobs (including seasonal work), retirement and Social Security income, alimony, child support, Veterans Administration (VA) benefits, welfare payments, and unemployment benefits.

Credit scores. While credit scores can be an analytical tool with conforming loans, their effectiveness is limited with CRA loans. Unfortunately, CRA loans do not fit neatly into the standard credit score framework . . . Do we automatically exclude or severely discount . . .loans [with poor credit scores]? Absolutely not.

Payment history. While some credit-score purists might take issue with our comments in the preceding section, payment history for CRA loans tracks consistently close to the risk curves of conforming loans . . . In many cases, purchasing a home puts the borrower in a more favorable financial position than renting. It is quite common for a first-time homebuyer using a CRA loan to have been shouldering a rent payment that consumed 40 percent to 50 percent of his or her gross income.

When considering the credit score, LTV, and payment history, we put the greatest weight by far on the last variable . . . Payment history speaks for itself. To many lower-income homeowners and CRA borrowers, being able to own a home is a near-sacred obligation. A family will do almost anything to meet that monthly mortgage payment.

Where do most payment problems occur? Usually, the problems stem from poor upfront planning and counseling. Hence, one of the key factors we look for in a CRA portfolio is whether the borrower completed a GSEaccredited homebuyer education program. The best of these programs help the individual plan for emergencies that can arise with homeownership.

There are two points that need to be kept in mind. First, preliminary evidence (Mian and Sufi, 2008) indicates that the recent increase in defaults has been dominated by those areas populated by poor and moderate-income borrowers. Further, figure 9 (Share of Speculative and Subprime Loans by Census Tract Income), which will be seen later in this report, and the discussion surrounding it show that poor and moderate-income areas had the largest share of speculative home buying, and speculative home buying will be seen, later in this report, to be the leading explanation for home foreclosures.

Thus the evidence is that the foreclosures are disproportionately a problem of the poor and moderateincome areas, which is entirely consistent with the weakened underwriting standards discussed above. The fact that foreclosures among poor and moderate homeowners are not receiving the greatest amount of newspaper attention doesn’t mean that they are not at the epicenter of the foreclosure problem.

Second, although the original mortgage innovations were rationalized for low-and middle-income buyers, once this sloppy thinking had taken hold it is naive to believe that this decade-long attack on traditional underwriting standards would not also lead to more relaxed standards for higher-income borrowers as well. When everyone cheers for relaxed underwriting standards, the relaxation is not likely to be kept in narrow confines.

3. Empirics of the Current Crisis
The immediate cause of the rise in mortgage defaults is fairly obvious—it was the reversal in the remarkable price appreciation of homes that occurred from 1998 until the second quarter of 2006. Since then prices have sharply declined. The housing price bubble can be easily seen in figure 1, which shows inflation-adjusted housing prices since 1987.

If relaxed lending standards allowed more households to qualify for financing, basic economics also says that housing prices would have risen as the demand for homes increased. Some portion of the housing price bubble, perhaps a large portion, must have been caused by the relaxed lending standards.

Of course, relaxed lending standards, or underwriting innovations as it is euphemistically put, were so successful that standards were loosened across the board so that even a prime loan applicant could avoid making virtually any down payment by taking out a piggyback second mortgage to cover the down payment required by the first mortgage (often both mortgages were made by the same lender).

4. Problems with the Subprime Bogeyman Hypothesis

The bogeyman in the mortgage story is the unethical subprime mortgage broker who seduced unwary applicants out of their hard-earned, sacredly treated assets. This subprime bogeyman charged usurious rates for his mortgages and bamboozled his clients with artificially low teaser rates that allowed them to purchase homes that were unaffordable at realistic interest rates. This character has been pilloried by all manner of politician and pundit. Although a convenient scapegoat, this character does not actually appear to be responsible for the main part of the mortgage meltdown. This is not to say that there are not lying and cheating mortgage brokers—there are. But every profession, including economics, has its share of liars and cheaters.

There is an important problem with the hypothesis that evil subprime lenders caused the mortgage meltdown. That problem is the fact that subprime loans did not perform any worse than prime loans.

So, if there is no subprime bogeyman on whom the mortgage meltdown can be blamed, what’s a politician to do?

6. Conclusions

The “mortgage innovations” that are largely the federal governments responsibility are almost completely ignored. These “innovations,” heralded as such by regulators, politicians, GSEs, and academics, are the true culprits responsible for the mortgage meltdown. Without these innovations we would not have seen prime mortgages made with zero down payments, which is what happens when individuals use a second mortgage to cover the down payment of their first. Nor would we have seen “liar loans” where the applicant was allowed to make up an income number, unless the applicant was putting up an enormous down payment, which was the perfectly reasonable historical usage of no-doc loans (which require minimal financial documentation).

The political housing establishment, by which I mean the federal government and all the agencies involved with regulating housing and mortgages, is proud of its mortgage innovations because they increased home ownership. The housing establishment refuses, however, to take the blame for the flip side of its focus on increasing home ownership— first, the bubble in home prices caused by lowering underwriting standards and then the bursting of the bubble with the almost catastrophic consequences to the economy as a whole and the financial difficulties being faced by some of the very homeowners the housing establishment claims to be trying to benefit.

Hindsight is the best sight, they say. Unfortunately, the housing establishment and our political leaders seem intent on not learning from the past. Hopefully this report can help move the debate in a direction that will allow for more productive learning.

*Stan J. Liebowitz is Research Fellow at the Independent Institute and the Ashbel Smith Distinguished Professor of Managerial Economics at the University of Texas at Dallas. Anatomy of a Train Wreck is included in the forthcoming Independent Institute book, Housing America, Building out of a Crisis, edited by Randall G. Holcombe and Benjamin W. Powell(http://www.independent.org/store/book_de...).

SD Realtor and Lyra,

You are spot-on. Thanks for speaking up for people who act, and acted, responsibly. We are a minority.