Based off of our highly successful conversation over on the Executive Compensation thread, I wanted to create a post about the housing situation and in particular one article that got me thinking. Here is the article: http://www.economist.com/world/unitedstates/displaystory.cfm?story_id=13145396
What struck me as most interesting were the following paragraphs:
Mr Obama’s chances of being any more successful depend on whether his team has correctly diagnosed what is driving the wave of foreclosures. Is it that homeowners cannot afford to pay; or is it that they are declining to do so, because their homes are now worth less than their mortgages, the phenomenon known as negative equity?
Both factors play a part, but economists are divided on their relative importance. One school thinks that, even in cases of negative equity, most homeowners will not default if they can afford the payments—not least because defaulting will wreck their credit records. A second school believes that once the home is worth less than the mortgage, homeowners have a significant incentive to walk away even if they can make the payment, since in many states lenders cannot then pursue them for the shortfall.
What strikes me as so fascinating is how every person assigned to tackle this problem has so completely missed the completely obvious, and is therefore destined to fail. Here's why, and see if you can follow me on this. Alot of the people that are way upside down on there mortgages find it is much easier to not pay (and walk away) rateher than to continue paying. There are two main situations that all of the housing plans have missed that are the most common. They are related.
1. You have a married couple where only one person bought the house. Therefore only one of the couple's credit is at risk if they foreclose. This is a very common occurence. Let's say you are now $100K-150K underwater on your house, but you have no problem making the payments. Things might be tight, but you can make due. However, if you walk away from the house, your spouse could buy the home next door for $150K less on their credit and you would save a $1,000 or more on your monthly payment. Why wouldn't you do that? While it might ruin one person's credit, it's not really that big a deal if you plan to stay married for the next few years until the foreclosure is expunged from your record. Obama's plan does not address this very commom occurence of people that choose not to pay.
2. The second situation involves a quote from the article.
One school thinks that, even in cases of negative equity, most homeowners will not default if they can afford the payments—not least because defaulting will wreck their credit records.
This is absolutely wrong. These people were Alt-A and subprime borrowers, they have obviousley cared very little for the credit up to this point. What would make them change now? These people will always walk away from a home rather than continue to make the payments if they are upside down.
Basically, until we change the rules to prevent people from walking away with very little on the downside, this problem will continue to occur. Politicians are making the assumption that people in these situations care about their credit scores - and that is where they are wrong. These people have never cared about their credit scores and that certainly won't stop them in the future.
I have a couple of thoughts to prevent people from walking away voluntarily:
First, make the credit score for purchasing a house or apartment dependent on both borrowers. Or at the very least, require both spouses to be on the mortgage. It hurts both their scores if they walk away. Make this retroactive to 2006. Second, let the unqualified people default, but allow the lenders to go after them. Make them declare bankruptcy if they have to to pay off their debts. Punish them for making stupid decisions and enforce the 'moral hazard' behind those decisions. Don't let them off scott free. I mean for a person with a 600 credit score, what do they care that they now have a foreclosure on their record and their score is 500? I mean, there is no real punishment there.
Well, those are my thoughts. Please feel free to add yours as well. Also, as a caveat, my ideas were pretty much thought up on the fly, so there may be something I overlooked that will also cause my plan to fail.