Wednesday, August 22, 2007
OK. Now recall a quote I posted here:
When you buy a house you are doing two things: 1) paying rent to yourself instead of someone else (and forgoing the opportunity for someone else to pay that rent to you), and 2) taking a long position in the asset class that is real estate in your local area. The type of mortgage you take out has no bearing on the rent you are "saving" (or forgoing) but it has everything to do with how levered your long position is in the asset class that is real estate. While the details of ARMs, neg-am mortgages, NINJA loans, no-money down deposits etc. are complex, essentially they all add leverage to that position. This is fine when prices are rising, but it also means you will lose all of your money (equity) when prices fall. Historically, home prices have never fallen, but they have never had such leveraged financing either.Dean Baker (with an approving nod from Andrew Samwick, from whom I got the link) has been pushing the idea of a repurchase agreement between the holders of subprime mortgages, who are in their homes but can't afford the higher payments. In short, the lender gets back the house in a foreclosure but then rents the house to the former borrower at "fair market rent", to be determined by a government entity, perhaps a judge, and adjusted as market conditions change. The now-renter "could then remain in their home as a renter for as long as they liked," and the now-owner-former-lender "the mortgage holder would now own the house and be free to sell it to another person, but the former homeowner would still have the right to remain as a renter, regardless of who owned the house."
I think this is a bad proposal for two reasons. First, it assumes in some way that you can shift the risk of house prices from the borrower to the lender costlessly. But the process of giving the renter a usufructuary right to the home removes value from the house -- the collateral is damaged by not having the ability to sell to other potential buyers the right to use (or bulldoze) the house. Let me put it this way: If I'm auditing a bank who holds a house under this arrangement, can I use the price of houses in the area not under this arrangement as comparables for setting the value of the asset? I think not. And the bank itself has the same problem. The whole subprime problem in the market has been based on not knowing how to value assets -- this does nothing to solve the information problem. A house that had this put option on it, in short, is going to cost more because the bank knows it bears an extra risk. Hello red-lining.
Second, there appears a moral hazard problem in the housing market by these owners. If prices go up, I can keep the house and pocket gains. If prices go down, I lose the ownership claim on the house but continue to enjoy its services. Does this encourage or discourage risktaking by those least able to afford it? True, they are protected against loss, and they end up with a house they can continue to use. But they lose that extra incentive to maintain the house (not unlike affordable housing.) As the WSJ points out, these schemes have had a poor track record in helping upwardly mobile families get a leg up. Encouraging them to stay in homes they no longer own is hardly going to help.