Foreclosures Are Not the Problem

The Obama administration appears to have focused on promoting a single idea as their justification for overt efforts to avert foreclosures through government intervention, homeowner bailouts and direct mortgage subsidies. This stated rationale is that foreclosures should be prevented at all cost because when they occur these transactions injure all Americans by lowering the value of neighboring properties. The argument is that good citizens, who are paying their mortgages, didn’t borrow more than they could afford, didn’t buy overvalued houses and didn’t take out home equity loans, should be forced to bail-out bad citizens who did because it is actually in their best interest to do so.

This is a pathetic proposition. This same logic could be applied to price moves within all markets that have ever existed. Each time a seller accepts a low bid in any market transaction every other owner of that particular stock, bond, commodity or other asset is injured as the market price has dropped.

The stock market is presently down close to 50%. Why doesn’t the President’s administration bail out the stock market and actively attempt to prop up prices? Recent stock sales have been forced by similar themes as are driving foreclosures. Positions are being liquidated over fears about the future, concerns about risk, liquidity requirements, the damage of already realized losses, collapsing portfolio values, job losses, bankruptcies, worries over adequate retirement funds, 401k losses, margin calls and liquidating hedge funds. Yet each time Citigroup’s stock ticks lower by a penny, driven by a single transaction which lowers the bid, tens of millions of Americans are directly injured. How is it that we understand that it is ridiculous to attempt to set prices in financial markets, yet we are willing to overtly meddle in the housing market in an attempt to prop up values?

Beyond the flawed logic, it is laughable that these same sanctimonious politicians did not decry the identical, and equally damaging, phenomenon while prices were rising. Every time some fool, dullard, speculator, optimist, con-artist or little old lady purchased a home at a higher than market price, the valuations of all comparable and neighboring houses increased in value. This phenomenon was extraordinarily dangerous as it created a Housing Bubble, dramatically distorted economic activity and gestated the conditions necessary to collapse our economy, yet none of the government entities that were contributing to the problem and are now attempting to prop up housing values complained or protested as prices rose dramatically and homeownership rates increased. It is morbidly amusing how quiet the political class is when unsustainable economic phenomenon serves their purposes by increasing tax receipts and perpetuating the impression of false prosperity. By their stated logic and deafening silence, I conclude that the government’s position is that the housing market should only be allowed to go up. When housing prices rise everyone benefits, which is great, but when prices fall everyone gets hurt which must be resisted with government intrusion and price fixing?

And while it is convenient to argue for the greater good in justifying the manipulation of prices, I argue that “everyone” is not injured by falling prices. In fact lots of people were directly injured by rising prices and are only now benefiting by a return to rationality. Think about the 35% of Americans who don’t own homes? As prices fall these people directly benefit from the availability of increasingly affordable housing. What about the children of 100% of Americans who will directly benefit from reasonably priced housing? I personally have never owned a house because the value proposition never made sense and the financing mechanisms being employed to purchase overvalued houses were the equivalent of gambling at best and financial suicide at worst. I am thrilled by falling house prices. Now I am being forced to subsidize an effort to prop up housing prices, which will fail but be extraordinarily costly, in an effort to keep housing prices unaffordable?

As real estate transactions go, the fact is that foreclosures are the hero of our story. These transactions rapidly force housing prices towards sustainable valuations based on new market fundamentals. They force the market to clear. Before foreclosures proliferated housing transaction volumes had collapsed because sellers had not come to terms with changed market conditions. Foreclosures extricate owners from bloated mortgages they can’t afford and allow lenders to resolve non-performing loans. Anyone who can afford a mortgage on an overvalued house can, by definition, afford rent on an equivalent property while saving money in the process. Those people who could never have afforded their mortgages, should never have been able to buy a house, and will be better off renting something they can afford. The government’s efforts to postpone inevitable foreclosures are not doing anyone any good.

The villainous transactions in this ongoing narrative are numerous and include house purchases which were consummated due solely to the government-mandated availability of subprime mortgages, transactions funded with little or no down payment, transactions which were affordable only due to introductory teaser rates which would adjust over time, transactions affordable using negative amortization mortgages, transactions which were purely speculative and transactions which were frauds executed to steal money from lenders. These are the transactions which should be demonized.

Whether the current administration wants to become self-aware or not, the market will solve this problem regardless of the interests of the political class. Housing prices will eventually reflect the reality of market conditions despite attempts to delay foreclosures and prop up housing values.