What happens when you put Robert Shiller, Phil Angelides and a bankrupt San Bernardino government in the same room? The end of the American housing market, that’s what.
Throughout the housing downturn, we’ve catalogued the attempts by government to undermine the housing market. Before the bubble burst, the Supreme Court was undermining private property rights with landmark cases like Kelo v. City of New London (2005), affirming the use of eminent domain to transfer privately owned homes to a commercial property developers, not to build public roads or bridges, but office buildings and hotels. (In an irony of history, the contractor never developed the site.) The Federal Reserve has done it’s part to undermine housing by encouraging inflation and reducing interest rates to a point where banks are better off not lending. Government officials openly envision a future where private property “isn’t for everyone” followed by bailouts and lawsuits. It’s enough to make one think this isn’t just random.
Throughout it all, Americans have remained resilient, even hopeful. Pew Research still reports that younger generations anticipate the day when they can own their own home.
Yet government will not be denied. And it’s crony allies are plenty, like “renting is the preferred option” HUD Secretary Sean Donovan, joined this week by housing expert Robert Shiller whose op-ed in this week’s New York Times is chilling. It boggles the mind that the co-author of the Case-Shiller Housing Report could endorse a plan that would undermine the very concept of home ownership.
Talk about trying to end the American dream.
The plan being considered by San Bernardino county’s government goes something like this: Using the power of eminent domain, the county would seize mortgages of homes that owe more than the property is currently worth (underwater). It would force investors to take write-downs on the principle and resell the mortgages to a private company who will refinance the homes into lower, FHA-backed mortgages (with a refinancing fee included). Investors who have been resistant to write down the value of their mortgage contracts will be brought to heel. And home owners will come out with a lower monthly fee and positive equity position.
And since, as Mr Shiller’s own research shows, homeowners who aren’t underwater are less likely to strategically default on their homes, further market erosion would be forestalled.
Everyone in San Bernardino county will be saved (notwithstanding the fact that the city declared bankrupt last week and is under criminal investigation for potentially mistating financial reports for years). And finally those intransigent investors who have been holding the market back from rebounding, by insisting on getting paid according to their contracts, will be thwarted. (Nobody likes those mustachioed fat cats anyway, right?)
Back in the place we call reality, this plan is an abomination. On every conceivable level, the abuse of governmental power to the distortion of the mortgage market, it will be a shining example of the law of unintended consequences. Ironically, the architects of this plan call it the Homeownership Protection Program.
It will do exactly the opposite.
I may be no Yale economist, but it occurs to my lemonade-stand mind that this program is both unworkable and dangerous. Here are five quick reasons:
- The forcible seizure of private property – in this case, the mortgage contract – would send shockwaves through the lending industry. Interest rates would soar, as risk of contract abrogation by government officials at any time would erode lender confidence in a borrower’s promise to pay. Credit standards would immediately tighten further. Lenders would demand higher down payments, harming first time buyers especially. Today’s younger buyers, saddled with huge college debts would almost certainly be locked out of the San Bernardino housing market for years.
- As mortgage costs rose, credit tightened and some lenders left the market entirely, homeowners would find their ability to sell their homes significantly impaired. The plan would freeze homeowners in their homes. Even cash buyers would avoid the area; who could assure them the home itself wouldn’t be seized the next time the county was in financial straits? Rather than improving the equity position of home owners, it would render it worthless, as the asset became unsalable. A rational response by owners would almost certainly be strategic default, the exact opposite of the plan’s aims.
- The mortgages under consideration for confiscation are currently performing. Destroying asset value on performing assets in the middle of a recession (or any time) is absurd. These assets also form part of the performing 401k, retirement and investment funds owned by other homeowners in other markets. It would spread San Bernardino’s harm far and wide. Nor does the plan address the non-performing (ie., foreclosed and vacant) properties in the county.
- The seizure would be mostly of private mortgages. The program would not apply to the more than 80% of underwater mortgages in the area that are already backed by federal programs.
- The risk of contagion to other housing markets would destabilize the state of California, and possibly other states. Once a county successfully used eminent domain in this fashion, mortgages all across America would be at risk. As Kelo demonstrates, there’s little reason to think the Supreme Court would stand in the way. Meanwhile, lawsuits by lenders (and owners) would multiply, slowing or stalling the housing market while litigation dragged on for years.
It would be foolish for the housing industry or homeowners to hope this is merely a plan “being explored” by the county. Just ask Susan Kelo. This is crony capitalism meets social engineering at its best. The private company that would earn fees in this plan, Mortgage Resolution Partners, once had Phil Angelides as its executive chairman. You might remember him from the Financial Crisis Inquiry Commission. He’s since stepped down, but his founding presence certainly adds an air of crony capitalism to the entire scheme.
Perhaps the saddest part of this plan is that the man quoted by many real estate professionals around the country, Robert Shiller of the Case-Shiller Housing Report, is all for it. How ironic is his New York Times article is entitled, Reviving Real Estate Requires Collective Action. Collectivism is the exact opposite of private property. Yet it leads Shiller to write in support of it with such gems as:
If such mortgage principal reductions could be applied on a large scale, there could be large neighborhood effects, raising a sense of optimism among homeowners and bolstering the value of all homes and, ultimately, the whole economy. But mortgage lenders in all their different forms lack a group strategy.
John Geanakoplos, a Yale economist, and Susan P. Koniak, a Boston University law professor, have proposed legislation that gives community-based, government-appointed trustees a central role. The trustees would have the authority to impose a write-down of mortgage principal that served the interests of mortgage issuers as a group, without having to prove that each and every one would be better off. But Congress has not acted on their idea. And so we are still lacking the authority to make everyone sit down. (Italics added)
Notice the words we’ve italicized: applied (a more honest word would be forced); community-based, because apparently homeownership takes a village, not a private deed; impose (a la Kelo?), and authority to make everyone sit down. At least the last part was brutally honest. If such statements don’t cause the real estate industry to recoil in horror, then perhaps the obscenely dangerous ideas of Robert C. Hockett, the Cornell University law professor Mr. Shiller admires will:
But eminent domain law needn’t be restricted to real estate. (New York Times)
If we agree with Mr. Hockett, why not apply it to real estate commissions, too? If the banking industry can have its contracts confiscated at any time, the housing industry won’t stand a chance. It’s no stretch to argue that underwater homeowners would benefit if their real estate commission were forcibly reduced by a community-based government appointed trustee.
Abraham Lincoln once said, The strength of a nation lies in the homes of its people. What a far cry his statement is from the closing arguments in Mr Shiller’s defense of the San Bernardino scheme:
But first we have to realize that much of our economic suffering takes the form of a collective action problem. We have to stop the wishful thinking that the problem will solve itself through a spontaneous rally in home prices. We need to summon our resources to exercise the authority that allows collective action.
Professor Koniak says the solution to this problem has been so slow in coming for a simple reason: “It’s the will that’s lacking! The will!”
Kind of reminds us of another quote from history: Sometimes history needs a push.
But then again, nobody thought Lenin would succeed either.