posted by Titus Levi, PhD
When the financial crisis boiled over in September, Washington’s wizards of finance made their first bold interventions by bailing out big banks, insurers, and other financial institutions. No wonder: these organizations have much better access to decisions makers; when they cry out for help, they get heard by the right people. Even if Richard Fuld is in the doghouse, you can bet that Hank Paulson will take his calls. People like you and me don’t get the time of day.
That may be changing since federal regulators and bailout strategists have begun shifting their attention to foreclosures. It’s high-time: Main Street sees its connection to Wall Street, but the truly vulnerable individuals and households facing foreclosure or just a barrage of uncertainty and a lot of scary news need to know that they will not be thrown under the wheels of the economy. Unfortunately, a plan of action for dealing with the foreclosure problem has yet to emerge. But on the upside, the Federal Deposit Insurance Corporation (FDIC) has developed a template for tackling the problem through its efforts to restructure dodgy home loans made by IndyMac Bank. Soon after July 11, when the Office of Thrift Supervision (OTS) closed the bank, the FDIC initiated mass-modification programs that lowered interest rates, thus keeping solvent households in their homes and allowing the most toxic of mortgages to enter foreclosure.
This move makes good sense; the mystery is that markets didn’t adjust prices – in this case, interest rates – downward without regulatory intervention. After all, banks take on considerable expense and risk in taking on foreclosures, especially in an environment of falling prices caused by so many properties coming on the market at once. The FDIC’s moves met with skepticism at first, but the sound economics of the move eventually won over industry watchers.
Scaling up this program will prove complicated, though. Thus far the FDIC has handled only a few thousand loans; a national program will need to address hundreds-of-thousands. All by itself Countrywide, now part of Bank of America, plans to restructure 395,000 loans. Currently, the FDIC lacks the resources to implement programs at this scale. As with a variety of other federal government agencies, it has shed employees by the thousands: total staff now stands at about 4600, down from a peak of 23,000 after the late 1980s savings and loan crisis. Rebuilding staff numbers will take months. During this time the number of foreclosures will continue to climb and this will put downward pressure on real estate prides.
Finding people may be the least of the Chairperson Sheila Bair’s worries; the FDIC’s 45-billon dollar war chest may not be up to the demands of a nationwide mass-modification program. The agency estimates that the next five years will burn through 40 billion dollars, but given that no one knows how many bad loans exist or their shakiness, this amounts to a guess. The organization looks to raise additional funds by doubling premia paid by banks, but as more banks go belly-up that plan may fall short of expectations.
Mass modification does not eliminate foreclosures nor should it. Separating the chaff from the wheat will prove difficult especially because loans have been repackaged and resold within bewilderingly complex bundles of instruments. Disentangling these contracts, and tracking down just who holds them, will prove tedious, expensive, and time-consuming. Only after doing this can regulators and banks reexamine their portfolios and make clear-eyed assessments about which loans deserve restructuring and which go into foreclosure. Once they do this, though, we will begin to return real estate markets and the financing system that supports them to the realm of serious economic and financial fundamentals. This represents a return to work-a-day economics and business dealings that need to permeate our commercial culture.
We also have to look beyond real estate markets in order to make well informed decisions. Cities like Riverside, California may well fall into the same sort of economic malaise that has afflicted Rustbelt towns over the last three decades because of the secondary and tertiary effects of mass foreclosures. While cities that shortsightedly bank on development schemes to energize their economies deserve to experience some pain, the long term erosion of quality of life may cause acute hardship for people living in or near these towns, many of whom had almost nothing to do with the real estate bubble.
Agencies engaged in market intervention need to remain mindful that homes, lives, and futures hang in the balance. The symbol and meaning of home touches on the most imitate aspects of our existence: the need for shelter, security, and sociality. Developing meaningful, effective, and humane plans to stave off the worst of the foreclosure debacle has to consider these dimensions. Doing so should direct mass modification programs to those areas where foreclosure rates run highest. This will not only help to maintain real estate prices, it will keep upside-down mortgages from getting worse. By keeping people in their homes, regulators hold blight at bay. Finally, keeping neighborhoods more intact reduces negative impacts on retailers who will soon face serious and ongoing pain as the consumer-driven economy enters a period of deep restructuring.
Implementing this effort will require the FDIC to coordinate with the Treasury Department and banks to help borrowers that can stay afloat. But what of those who cannot manage the weight of their debts? They should forfeit their mortgages, but they should have better options than being thrown out into the streets. For instance, banks can offer to rent houses they hold to such households. This not only stabilizes families, it keeps housing prices from unraveling. Some households facing foreclosure might relocate to smaller domiciles; realtors and banks could work together to identify empty properties that provide all parties some advantage: households get their bills under control, banks earn money on that would otherwise sell at steep losses, and realtors pick up revenue on referrals. Furthermore, we begin to rebuild fair dealing into markets, which will have welcome and widely beneficial benefits.
Policymakers face a nasty challenge. Too much coddling keeps real estate prices from falling to more affordable levels; a lack of support throws families, banks, and retailers into a deepening hole. So even though falling prices cause pain for mortgage holders and banks, prices clearly need to readjust to prices in line with incomes. In the medium term, lower prices will begin to rekindle demand, which will help banks, retailers, neighborhoods, and a great many households looking for affordable homes.
Beyond all these technical details about prices, loans, and foreclosures, we need to revisit the basic issue at work here: how to provide adequate shelter to individuals and families, while helping to build vital, nurturing neighborhoods. Home ownership can help accomplish this, but given that many persons do not have the wherewithal to buy, we need to find alternatives that deliver results and keep the economy from falling into a trap driven by outsized American dreams. As bad as the current situation is, it returns us to reality and opens up the possibility of meaningful change in delivering on an American reality that makes sense and helps to build the economy and society that we truly need.
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