Facing Foreclosure

More

The other day, Ryan Avent had a good post on who is actually defaulting on their mortgages.  Though you commonly hear the discussion framed as a question of when interest rates reset, Ryan points out that this isn't really accurate.  The problem is not principally people who can't pay their mortgages because their interest rates have reset--people will cut back on a lot of other things to keep their house, and if you can't afford a 1% rate increase even with drastic lifestyle cuts, you probably have too much house.  Rather, the main problem is people who have an income shock.  Normally, if you lose your job, and you can't afford your house, you're eventually forced to sell it.  But when the market drops 20%, if you're a recent homeowner, or if you did a cash-out refi, you can't sell it, because you'll end up owing money at the closing.  Obviously, if you had tens of thousands of dollars to hand over at closing, you wouldn't need to get out in the first place.

This has tricky policy implications.  The supply of credit--for which interest rates are usually a good proxy--has huge effects on home prices in this world of majority mortgage financing.  We've pushed interest rates down as far as they're going to go, but that's not going to reinflate the bubble.  So huge numbers of people who have income shocks are going to end up in foreclosure unless their bank allows a short sale.

But what's the alternative?  Huge write-downs to the mortgage principal of everyone who gets in trouble?  They'll still have to sell the house in a lousy market.  And it makes the banks more fragile, while unfairly handing a giant subsidy to those who happen to lose their jobs.

On the other hand, it does mitigate the claim that this is about irresponsible borrowing--at least in a lot of markets.  In places like California and Florida, where prices of large houses have dropped 30-50%, the most sensible downpayment policies wouldn't have kept people from going underwater.  Though to be fair, highly insensible downpayment policies helped inflate the bubble, and a lot of people with tiny downpayments are getting themselves in trouble.

Jump to comments
Presented by

Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

Get Today's Top Stories in Your Inbox (preview)

The Time JFK Called the Air Force to Complain About a 'Silly Bastard'

51 years ago, President John F. Kennedy made a very angry phone call.


Elsewhere on the web

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register. blog comments powered by Disqus

Video

Adventures in Legal Weed

Colorado is now well into its first year as the first state to legalize recreational marijuana. How's it going? James Hamblin visits Aspen.

Video

What Makes a Story Great?

The storytellers behind House of CardsandThis American Life reflect on the creative process.

Video

Tracing Sriracha's Origin to Thailand

Ever wonder how the wildly popular hot sauce got its name? It all started in Si Racha.

Video

Where Confiscated Wildlife Ends Up

A government facility outside of Denver houses more than a million products of the illegal wildlife trade, from tigers and bears to bald eagles.

Video

Is Wine Healthy?

James Hamblin prepares to impress his date with knowledge about the health benefits of wine.

Video

The World's Largest Balloon Festival

Nine days, more than 700 balloons, and a whole lot of hot air

Writers

Up
Down

More in Business

Just In