Last year I made the best financial decision of my life.
I was getting ready to buy my first home, and was clicking around the internet for information to get started. I considered myself pretty savvy, having an advanced degree and all, and thought it would be pretty easy. One of the first sites I landed on was the HUD site, which gave links to local housing agencies which provided homebuyer education classes. I didn't think much of it at first, figuring it would pretty much be stuff I already knew, but not being in a big hurry to buy, I decided to go. I figured we could take seats near the door just in case it turned out to be a waste of time.
Boy, was I wrong -- the class was extremely helpful, and made the process of buying a home much easier. But not only can these local agencies help homebuyers, they also form an infrastructure that could move us out of this crisis.
Local housing counselors -- not Wall Street bankers -- are best equipped to maneuver the economy out of this mess. Housing is at the root of the trouble, and local counselors work with homeowners and homebuyers every day, teaching classes in homebuying and financial fitness, and offering individual counseling to people having trouble buying or keeping a home. They are positioned to assess situations on a case-by-case basis, and determine the "moral hazard," if any, in offering assistance to to each particular distressed homeowner.
So a bailout plan could look like this: Offer the bulk of the funds to local housing agencies, and allow housing counselors to purchase distressed loans, under a set of clear guidelines. A few situations might arise:
- In some cases, a homeowner isn't able to afford the ARM he has on the price he paid for the home in 2006, but could afford to purchase the home at its current market price with a standard fixed-rate loan. In that case, the counselor could negotiate with the mortgage holder to buy out the loan for its market value, and then issue a new FHA-type loan to the homeowner.
- In other cases, a homeowner did go too far and took out a questionable loan to get a house they never could afford. In that case the counselor could still buy out the loan, but now seize the property. The counselor could then steer the homeowner toward a less expensive property that she can afford, and issue a new loan for that home.
- Then there are the cases where the homeowner was never creditworthy enough to buy a home in the first place, but managed to get a very risky subprime loan. In that case the counselor could buy the loan, seize the property, and steer the homeowner toward an affordable rental. In exchange for leaving the house peacefully, the homeowner would avoid any further damage to his credit rating, and be provided financial education classes so he could begin to rebuild his credit and maybe take another stab at homeownership in a few years.
There would of course be concerns: Why would mortgage holders agree to sell these loans? Wouldn't buying these loans be extraordinarily expensive for the housing agencies' relief funds? And if the loans could be sold, why wouldn't they be sold on the private market anyway? The way this scenario is win-win for everyone is that the local housing counselors' work actually creates value, and avoids the loss of real value that foreclosure involves.
Here's how it works: Suppose that Liz bought a house with an ARM in 2006 for $250,000. Her rates reset and now she can't afford to make payments. Housing prices have fallen, so her house is now worth only $210,000, but she still owes $240,000, so she can't sell and still hope to repay her loan. She's heading for foreclosure. But the housing agency wouldn't have to pay the full $240,000 to buy out the loan -- they'd only have to beat what the mortgage holder could reasonably expect to get by going through foreclosure.
If the mortgage holder forecloses, they take a BIG hit. First, the lender has to wait to foreclose, anywhere from about 3 months to over a year from the time Liz first misses her payment, depending on the state. The foreclosure process then takes a few more months until the lender can force Liz out of the house. In the meantime, Liz might have ripped out and sold the appliances, the furnace, A/C, and water heater, and even the copper wiring to make ends meet. Even if Liz hasn't deliberately trashed the place, it won't be a pretty sight. My real estate agent said that families going through foreclosure are "wigging out," and the signs of domestic tension are apparent. Most of the distressed homes I looked at were in pretty bad shape. In a few cases, the homeowners had tried some rushed repairs on the cheap to get the home value up to the point where they could sell and come out ahead, but hadn't made it, leaving the house in a half-finished state. Once the lender takes the property, they'll have to pay taxes, insurance, and utilities until it's sold, at which point they'll have to pay a broker the sales costs. And they haven't earned a dime of interest since Liz stopped paying her mortgage. While the house sits empty, it deteriorates through lack of maintenance, and loses even more value. The lender will be lucky to get $170,000-$180,000, and they'll have to wait easily six months to a year to get it -- more if Liz throws a wrench into the whole process by declaring bankruptcy in the middle of it.
So the mortgage holder would be glad to take perhaps $200,000-$210,000 in cash, up front, from the housing agency, and wash their hands of it. The housing agency can resell the house for about $210,000, so they're not losing much money. And the market can't handle this by itself: A private investor would have to wait until the foreclosure process completes to buy and then flip the house. And the lender doesn't have much incentive to work out a deal with Liz. Just because she can make some payments this year doesn't mean she won't run into problems next year, so the "toxic paper" that is her loan wouldn't get much less toxic in that case.
Aside from the relief funding, there would have to be a few other terms. Issuers of mortgage-backed securities would have to be required to negotiate in good faith with local housing agencies for the mortgages they hold, or risk having the property seized out from under them. There would need to be new laws specifying how much issuers of credit default swaps would have to cover in the case of housing agency intervention. And part of the funding would need to go to hiring more housing counselors (there are plenty of out-of-work mortgage brokers with the necessary experience), and maintaining properties while waiting to sell them.
So this is a win-win for Liz and her original mortgage holder. But what about the broader economy? It wins too. The housing agencies' intervention prevents Liz's house from visibly deteriorating (overgrown weeds in the yard, etc.), preventing nearby houses from losing value, which could otherwise cause the foreclosures to spiral out of control. And when a housing agency buys a failing loan, that gets cash back to the capital markets within a few weeks of the default, instead of less money taking 6-12 months to get back. If a housing agency issues Liz a new loan, it would be full-documentation, where the housing counselor verifies Liz's income, assets, and credit history, so that loan could be bought and sold with much less risk than her original one. And taxpayers would be protected, knowing that local housing counselors are evaluating each situation on a case-by-case basis, providing homeowners with only the relief they need and deserve. While this might not correct the entire problem, and some more money might be needed to shore up the capital markets, providing this direct relief to homeowners would go a long way.
Finally, this is a sure-fire winner politically. Even if only $100 billion instead of $700 billion is allocated to local housing relief, that's still over $200 million to each congressional district. What could be better for a congressman running for re-election than being able to claim credit for bringing $200 million into the district, under local control, while voters see "foreclosure" signs come down around the neighborhood?