The housing-foreclosure problem hasn’t gone away …

Ken’s Take: Mortgage defaults and housing prices are still a big problem, though they seem to have been pushed to a back burner.

In his WSJ essay, Economist Martin Feldstein has the diagnosis right, but the prescription wrong …

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Some Facts

  • More than three million homes are now in serious default (nonpayment for 90 days or more) or foreclosure, nearly double the number a year ago.
  • Sales of properties in foreclosure or serious default made up one third of all home sales in May and June.
  • So far only about 200,000 mortgages have been modified this way, far fewer than the administration’s goal of modifying three million mortgages.
  • Nearly half of all modified mortgages go into default within six months.
  • Today one-third of all homes with mortgages have mortgage debt that exceeds the value of the home. Among these homeowners, half of the loan-to-value ratios exceed 130%.

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Feldstein’s Remedy

Borrowers should get relief now, and the banks should get a guarantee down the road.

An epidemic of mortgage defaults and foreclosures is threatening the economic recovery. The problem is serious and getting worse.

There are two separate but mutually reinforcing reasons for the surge in defaults and foreclosures: the reduced affordability of mortgage payments and the high loan-to-value ratios of many houses.

The United States, unlike almost every other country, mortgages are effectively no-recourse loans. If a homeowner defaults, the creditor can take the house but is unable to take other assets or income to make good on the remaining unpaid mortgage balance. No-recourse mortgages increase foreclosures, resulting in more properties being thrown on the market, and lead to an excess decline in house prices.

The risk remains of a continuing downward spiral of house prices.

The administration should work with creditors and homeowners to reduce the principal on mortgages that are at risk of default.

Here’s how such a plan might work in a way that homeowners and creditors could both welcome, that is fair to taxpayers, and that would help the economy:

Any homeowner with a loan-to-value ratio over 120% could apply for a reduction in his mortgage balance. The government and the creditor would then share equally in the cost of writing the loan balance down to 120% of the value of the home. But the homeowner who opts for this write-down would be obliged to convert the remaining mortgage to a loan with full recourse that could not be discharged in bankruptcy. The bank gets a more legally secure loan

Slowing the downward spiral of house prices will protect the solvency of the banks and the net worth of households. The failure to do that could mean a deeper and longer recession that imposes much higher costs to the government.

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Ken’s Rx: Create a more robust rental market of single family homes by providing tax incentives to investor-landlords – e.g. no cap gains taxes, accelerated depreciation, application of cap losses to offset earned income.  That would bolster prices – albeit, artificially – and provide affordable housing  — albeit, sans ownership.  I’ll detail the plan in a subsequent post.

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