The renter/owner divide

It occurs to me that while there is a big conservative/liberal split on the Obama foreclosure plan, there may be a bigger divide between renters and owners.  I think that most of the people supporting the mortgage plan really do feel like falling home prices is an obvious catastrophe.  I also think that most of them own homes.  Because, of course, if prices stay high, where is the money coming from to support them?  Well, from people like me, who do not currently have a home to sell, but would like to acquire one in the not-terribly distant future.  Keeping people and banks from selling at a loss requires that I buy a house which is overpriced.  With the exception of Detroit, all 10 cities broken out by the Case/Shiller house price index show that as of December, home prices were still at least 15% higher than they were in January 2000; their 20-city composite index was still up over 50%.

One of the things that I think is badly understood is that the government cannot do much to prevent house prices from falling.  Foreclosures are not the cause of price declines; they are a symptom of them.  The underlying event is too many houses, and too little demand for them.  Propping up existing mortgages does absolutely nothing about the mismatch between supply and demand.

People point to waves of foreclosure sales, and falling home prices, and assume that these things are related.  They are, but the price shock is actually relatively small.  Banks aren't any fonder of selling their assets at a loss than homeowners are.  They will sell the property for whatever they think they can get for it.  The fact that they can't get much reflects the fact that the areas with the most foreclosures are the areas with the most marginal buyers--i.e., the areas with the most marginal demand.  Real estate declines are lumpy; the houses with the best locations hold much of their value, while the places on the fringes, the exurbs and the gentrifying neighborhoods, plummet.

It is true that foreclosures dump a lot of houses on the market at once, but again, this represents an actual mismatch between supply and demand.  The general rate of home occupancy is one family, one house.  You can call them "owners" or call them "renters", but they will still only occupy one house.  The credit bubble briefly expanded the number of people who were willing to gamble that some other family would want to occupy their house; and by convincing people that houses had investment value beyond providing a warm, dry abode, changed the price they were willing to pay for houses.  Now the investment premium has vanished, as have the speculators investors.  Playing with mortgage terms cannot prop up prices, because it cannot create more homebuyers, nor convince them to pay more than they want for a house.

To put it another way:  if the current occupants cannot afford their house at anything close to the price they paid for it, the chances are that no one else can, either.

Stopping foreclosures can prevent some overshoot, but it does so by making housing markets stagnant.  People who are just barely hanging on to their houses don't move to take better jobs, and they certainly don't invest in the houses, which means that the local housing stock erodes whether or not the houses are foreclosed on.

To the extent that there is an argument for a housing bailout, I think it rests not on keeping prices high, or keeping people in houses that they could just barely afford when they bought them (or after they refinanced them), but on preventing the price decline from crippling the future financial viability of either the borrowers or the lenders*.

That's the logic behind my lunatic plan--cut the losses to the lenders to the loss on the underlying collateral; keep the housing decline from crippling homeowners without awarding them subsidized housing in exchange for their financial illiteracy.  A number of my readers squawked that this wasn't fair, that banks need that information--but in fact, this event in the housing market is mostly sui generis.  The people defaulting may not be the brightest financial bulbs on the Christmas tree, but I think it's fair to say that there is little risk that they will, in the future, borrow 99% of their home value on an option ARM.