Underwater Sports

DAVID LEONHARDT had an interesting column in today’s New York Times. He noted that the $700 billion bailout probably won’t have any allocations for homeowners in trouble, that it’s more like a $4 trillion issue, and that we have reached a point where so many homeowners are underwater in their houses – they owe more than their house is worth – that they are likely to walk away and stick the banks with the property without any personal liability to repay the loan balance. Add this group to so many who have no ability to pay their monthly nut because their subprime mortgages adjusted upwards beyond their wallets or they have simply lost their jobs in this horrific economy.

Leonhardt notes: “At the start of this month, almost 1.5 million homeowners — out of about 75 million nationwide — were in this [latter] category. They were at least two months behind on their mortgage payments. Mark Zandi, the chief economist of Moody’s Economy.com, estimates that another five million or so will fall into the category over the life of their mortgage, as the economy worsens and more adjustable-rate loans reset.” This goes beyond all those who have already faced foreclosure.

But “the number of underwater homeowners is much larger than the number of people who will be unable to make their mortgage payments. Assuming that home prices still have a ways to fall, something like 19 million homeowners may be under water by 2010 (only a few million of whom will be struggling to make their payments).” So there isn't enough money in the kitty to bail all of these folks out?

What to do… this is a self-fulfilling prophecy: the more homes are underwater, the more foreclosures, and the more the housing market values fall, and then there are more homes underwater, etc. While the feds are off fixing money markets and financial institutions, and while we don't have $4 trillion lying around, we could:

1. Start with that damned 90 day moratorium on foreclosures I've blogged incessantly about.

2. Since the banks are pretty much becoming a branch of the federal government anyway, we then can cap mortgage interest rates at a going-forward 6.5%, give folks a 60 day grace period for past defaults, and see who still can't afford to be in the market. We may lose a few along the way.

3. We can let banks petition the feds (maybe through a local Treasury office) where there is a foreclosure to use some bailout money (half the $700 billion would be a start for the total program) to pay up to the value of the loan (the amount the house is underwater), and have the feds take a proportionate ownership in any future appreciation in the house (which gets paid to the government if the house is ever sold, maybe even with a preference over the homeowner who got the benefit). The petitioning bank would first rate the creditworthiness of the borrower and the value of the property and then decide if it is worth the petition. The feds can set the general standards they require and let the banks implement and vet. We do this until we run out of funds (in which event we take another look at the plan) or the market settles. This takes a lot of people, but it relies mostly on banks who report to the federal government, so a pile of work gets done by them. Notice how this deploys capital to fund only a portion of the mortgage, which stretches the bailout value considerably under this plan (a dollar multiplier, if you will) – you don’ have to buy out all of the bad paper to make a difference.

But we need to settle the homeowners of this country even more basically than we need to resuscitate the stock market, although they are linked. I'm sure that there are other, better “direct help” plans, but not addressing this core issue will only make things much worse. We need to start now. Help the people who need it most.

I’m Peter Dekom, and I hope this works.