Academic

Unless you live under a rock, you know by now that President Obama has unveiled the latest proposal to help homeowners who cannot keep up with their mortgage payments and have little or no equity in their homes.  These homeowners are on the brink of default, which has negative effects not only on themselves and their families, but also on mortgage holders and their bondholders, neighborhoods, surrounding home owners, local taxing authorities, and more.  Obviously, the solution to this problem is not coming easy to anyone, and we've bounced around ideas on supporting various parties in an effort to save the real estate market from collapsing.

Much pressure has come to "help the homeowners."  The transaction costs of foreclosure, eviction and relocation are hard on everyone, but particularly the defaulting homeowners.  But in trying to help the homeowners, no one will be made happy:

You can't help all the homeowners.  This NYT editorial complains because the plan won't help homeowners who really can't afford their houses or who won't be able to afford them for long, even with a modification.  This NYT article complains that the plan will only help homeowners in severe trouble, not those with underwater mortgages who can still make their payments.  In any environment of scarcity, we must triage, so it seems rational to help those that can be helped with the most success.  I'm not sure how the government can (or should) help someone stay in a house that is unaffordable long-term or help someone who overpaid for a house they can afford.

More importantly, you can't make all homeowners happy.  People who can make their mortgage payments (or who don't have any, you lucky guys), aren't all that happy paying the mortgages of those who can't.  Rightly or wrongly, we're historically not the kind of country that likes to pool resources of those that made good decisions to help out those that made bad decisions.  So the above-water homeowners and the underwater homeowners are in tension here.

You can't make the pro-bank people happy.  We seem to like to compare the costs of forced mortgage modification to a mortgage lender with the prospects of the mortgage being paid off according to the contract.  Obviously, the mortgage lender is worse off.  Whether the mortgage lender is better off with the transaction costs of foreclosure and auction or a forced mortgage modification does not seem to be part of the debate.  See my friend Todd Zywicki's op-ed in the WSJ.  Some argue that if the modification would make the mortgage lender better off, then modifications would be happening already.  Others argue that the securitizations of mortgages make this almost impossible.  And others point out that modifications are more likely to end in eventual default anyway -- see here and the first point that you can't help all homeowners.

So, some very smart and able people have been trying to come up with a politically acceptable solution for quite awhile now.  I am going to take a stab at this myself, but from the standpoint of helping "home-debtors," not "homeowners."  The problem is that we have people who owe more than they can possibly pay back under any workable plan, and no one is willing to purchase the pledged collateral in any amount to pay off this debt.  The debtor has very little incentive and possibly no ability to pay off the debt over and above the value of the collateral, and the lender really doesn't want the collateral anyway.  If this were ordinary debt, there would be factoring and discounts and write-offs that were compensated by the higher rate of interest charged.  But here what is causing the problem, what is creating the negative externalities is (1) the illiquidity of the collateral, which is causing havoc to the market for that collateral and (2) the externalities of displacing the debtor.  For example, if the debt were a car loan and the collateral a used car, the car would be repossessed and sold into the used car market.  Used car loans are high because of this possibility, and repossessions are expected.  But houses are not cars.  So, let's come up with a plan that focuses on (1) and (2).  Here is a shot in the dark:

Take this money we have allotted and give grants to entities that will purchase these near-foreclosure houses.  These entities could be federal agencies or private entities (we'll call these "real estate trusts" or RETs).  That discussion is tabled for now.  The RETs would purchase the properties at appraised value, which may be greater than a lender would get at auction.  As part of the purchase, the homedebtor agrees to rent the property for a certain number of years from the RET.  The homedebtor doesn't have to move, relocate their families, change schools.  The neighborhood doesn't suffer from foreclosure ripple effects or houses sitting vacant or "for sale."  Now, the homedebtor isn't really a homeowner anymore, but they really weren't anyway.  They had no equity in a home they paid a mortgage for every month.  The stupid saying renters pay their landlords every month but owners pay themselves didn't apply here.  The homedebtor was paying the mortgage holders.  So, we are requiring both the homeowner to pay for its bad decision a little bit and the mortgage holder to pay for its bad decision a little bit.  Now the RETs won't want to hold these houses forever, so we could set up a system to allow the now homerenters to try to purchase the house several years down the road, possibly with tax credits earned through timely rental payments each year, etc.  Of course, this plan would cost a lot upfront.  However, the federal government should be able to see some income from the purchase of these assets, unlike some other troubled assets we've seen.  By controlling the supply of these 4 million foreclosed houses, then hopefully the houses could be sold over time as real estate markets recover.  And, the rental payments should be good for something.  This plan is just a suggestion of one that would keep the rewards for moral hazard down and de-mythologize homeownership out of the equation.