The Housing Crisis: What is the solution?

I’m not an economist, but I don’t think this is very complicated.

There are people who make money off home mortgages; always have been, always will be. That’s part of the American economy that allows most of those of us who own a home to get into it. However, about three years ago, mortgage lenders began to market gimmick loans to individuals based on the assumption that home prices were only going to go up. These products were sold as interest only loans, starting at an interest rate of sometimes as low as 1.5%, allowing initial payments as low as $800 on a $300,000 mortgage. The rationale behind these loans was that the market would continue to inflate the prices of the home and once the adjustable interest rates climbed to the 7-9% range, the family could refinance the home using the equity accrued from the inflating market (since they were not putting any equity into the home because they were only paying the interest.

Many of the consumer of these loans were high risk borrower and couldn’t qualify for standard home mortgages. These products allowed these individuals to participate in the American Dream of ownership of one’s own home. However, everybody in the industry forgot to study the laws of economics that once prices get too high, demand will drop, supply will increase and then prices will drop. Once the prices dropped on these homes, the mortgage valuation didn’t change. If the mortgage was for $600,000 but the appraised price of the home is now $400,000 and you are trying to refinance the home, good luck. Also, good luck trying to sell the home when there are 10 more just like it on the market and those who aren’t upside-down on the loan can take the low offer and be out of the mortgage.

So here we are, early 2008, with prices dropping precipitously and new homes starts dropping 26% during 2007, the largest drop in history, previously occupied homes flooding the market, and mortgage lenders going out of business. What about the signer on the mortgage? What should happen? If the bank implements the agreements of the contract and increases the payments due, the holder of the mortgage will often not be able to make the payments and the home will undergo foreclosure. Is this good or bad?

Let me tell you why I think it’s good. First, the bank will be left holding the bag for the bad loan it authorized. Second, the market will be flooded with homes, causing the prices to drop even further. And third, and most importantly, the home owner will be able to get out from under the $600,000 mortgage that is only worth $400,000 and dropping fast. This will allow prices to settle in an affordable range and that individual would be able to by a commensurate home in a fair mortgage, not an exploitative one. Current suggestions of not allowing the banks to enforce the provisions of the loan only serve the banks. They don’t want to have to sell the home for $400,000 (or less if it is in foreclosure). They want some poor schlep to continue paying $600,000 for a $400,000, wait, $350,000, wait, $300,000 home. It would only be in the interest of the banks to keep these homes from foreclosing.

In order to return home prices to an affordable range, prices must continue to drop and that will only happen if the market continues to be flooded. This way families and individuals will be able to again afford to purchase a home without being exploited by the greed of the mortgage bankers and general contractors

7 Replies to “The Housing Crisis: What is the solution?”

  1. That’s the role for someone to come in and protect the individual, not by propping up the banks. The borrowers who got screwed need to be given the benefit of the doubt, not the predatory lenders. I’m fine if the government will provide a way for borrowers affected by the sub-prime mortgage crisis to have their credit protected.

  2. Bernanke this last week stated that banks need to not only control the interest rates, but lower the principle on these loans. Maybe I am an economic genius;-) As long as the loans stay high (and the home values continue to drop), the banks are making a killing while the home owner is taking it in the shorts. Hopefully the govt. will do the right thing.

  3. Nicely stated. I think there’s no easy solution to all this…whatever happens, there will be pain. I remember going to a financial seminar in early 2006 where they were teaching brokers how to do what you were talking about (do an interest-only loan, then refi every 5 years or so using the built-up equity from eternal price appreciation). I was brushed off when I suggested that prices wouldn’t always rise. Economic education is much needed.

  4. See this from Citigroup: http://news.yahoo.com/s/nm/20080719/bs_nm/citigroup_housing_dc_2

    The interesting thing would be for those who are upside-down on their mortgage to walk away from their mortgages, leaving the banks holding the bag, holding them responsible for their shady lending practices. Then, in two years, when the market has stabilized, these families and individuals could enter the market again and actually be able to afford a home at closed to its true value. A smart lender would then be willing to take on those who couldn’t really afford an inflated home price, but will then be able to afford to take on a reasonable loan, disregarding their foreclosure history.

  5. Now that this is becoming more acute, it’s time for the Idealist to address it again. I persist with my argument that to step into the fray to prevent foreclosure, the government will only be helping the banks. The only role for the government here would be to protect the credit of the borrow.

    The decision that the Obama administration must make is whether to manipulate the housing market by artificially propping it up and keep people in their home that is not worth what it was, or leave it alone, protecting only those who cannot afford to make the payments and allowing the price to fall to where it should be, thus opening the housing market to many, many more Americans in 3-4 years.

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