Thursday, February 4, 2010

Should Policy Try to Reduce Foreclosures?

In 2006, Benjamin Koellmann bought a condominium in Miami Beach. By his calculation, it will be about the year 2025 before he can sell his modest home for what he paid. Or maybe 2040.

“People like me are beginning to feel like suckers,” Mr. Koellmann said. “Why not let it go in default and rent a better place for less?”

After three years of plunging real estate values, after the bailouts of the bankers and the revival of their million-dollar bonuses, after the Obama administration’s loan modification plan raised the expectations of many but satisfied only a few, a large group of distressed homeowners is wondering the same thing. ...

In a situation without precedent in the modern era, millions of Americans are in this bleak position. Whether, or how, to help them is one of the biggest questions the Obama administration confronts as it seeks a housing policy that would contribute to the economic recovery.
In my mind the crucial question is whether to help distressed homeowners, and the right answer is no:

1. these homeowners assumed the risk of buying houses; they should accept the consequences;

2. homeowners who default will acquire a bad credit rating, but they will be free of their debt burden.  Instead of putting money into an asset they may never actually own, they can start to accumulate savings.

2. foreclosing on these homeowners does not mean homeownerhip will decline; it means the houses will become available at low prices to others with limited income.  What's wrong with that?

11 comments:

Clifford said...

Well ... since many of the homeowners are taxpayers and will be burdened by the debt incurred by the gov't's efforts to bailout others ... it seems to me that fairness would require that at least an equal amount of "help" be offered to them.

Also, since we all have an interest in social stability and being aware that a well placed stitch in time can save nine ... why rule it out as a matter of "policy?"

Anonymous said...

I think this is a "teaching moment". We should allow the free market to adjust prices. Maybe after people who should have known better feel the pain of making an ill-informed choice will change their behavior. This economic turndown will not become reconciled without pain. The only question is, do we make people accountable (so they learn), or do we make us all accountable for the bad decision-makers?

Mike Huben said...

"In my mind the crucial question is whether to help distressed homeowners, and the right answer is no..."

What's wrong is that as an economist, you should be able to spot the Pareto improvement.

The value of the house has declined. If the homeowner is foreclosed upon, it costs him some credit rating, the expenses of moving, any equity accrued and the emotional costs involved. The bank eats the loss in value, has legal expenses AND has to go to the expense of selling the house.

If instead the bank simply revised the mortgage to reflect the new value, the situation would be a Pareto improvement because the only significant cost would be the bank's loss in value of the loan: that hasn't changed. All the other transaction costs disappear.

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