Obama's Foreclosure-Prevention Plan Will Lengthen the Depression by Years

There are two primary reasons why the economic collapse we are presently experiencing represents an “Affordable Mortgage Depression”. These mortgage affordability products were the keystone to creating and perpetuating the Housing Bubble and are now and for the next several years the primary constraint to housing prices stabilizing or recovering.

(For a full explanation see the 10 sequential articles beginning with "Analyzing Economic Distortions that Caused the Housing Bubble" posted November 17th 2008.)

The mania portion of the Housing Bubble could not have taken place nor persisted without the presence of hybrid-affordability mortgages. Lending products that eliminated down payments and temporarily reduced mortgage payments effectively removed all barriers to homeownership and dramatically reduced a buyer’s sensitivity to price. Once the built in price regulating mechanisms of down payments and mortgage payments were eliminated, there were no constraints on how high prices would rise other than the market running out of buyers or house prices increasing to the point that buyers were unable to service teaser mortgage payments. In doing so, affordable mortgages created the distortions that allowed housing prices to decouple from the fundamentals of value and rise to unsustainable levels.

These ARMs, Option ARMs, Alt-A loans, Sub-prime loans and their brethren still exist. They represent an unresolvable, institutionalized barrier to housing price stabilization. These mortgages, which are a known source of inevitable foreclosures, are spread out through 2012 like daily economic land mines. Every day thousands reset setting off foreclosures. Foreclosed properties are liquidated through price discounts relative to prevailing market prices. As long as lenders take possession of a steady stream of foreclosed properties, prices will continue to fall.

Now the Obama administration has proposed an attempt to save the housing industry, prevent foreclosures and prop up housing prices by refinancing ARMs with new government ARMs. Inevitable foreclosures will be delayed by handing out 100%+ loan-to-value, resetting-interest rate mortgages that will result in inevitable foreclosures.

The only real effect of the proposed foreclosure prevention policy is to slow down but not prevent price declines, delay inevitable foreclosures, lengthen the economic downturn, extend institutionalized barriers to a housing recovery by several years, and expose taxpayers to horrific losses as prices continue to fall, defaults accelerate and refinanced mortgages fail.

The following are concepts that do not work! Price fixing, borrowing more money to get one’s self out of debt, rewarding bad behavior and punishing good, and confiscating the property of productive people to redistribute it to unproductive. None of these ideas work in theory or in historical practice.

The proposed foreclosure prevention plan might be politically expedient but it will result in a longer and deeper economic depression that will make our current, painful but healthy correction seem quaint.