We seem to be getting only half the curriculum in our Home Economics instruction from presidential candidates — the half about the foreclosure process. That’s an important part for Nevadans who are residents of one of the five states in which foreclosure is concentrated, the others being California, Michigan, Arizona, and Florida. [USreo] As of December 2011 Nevada homeowners were looking at a foreclosure ratio of 1:177. Arizona’s ratio was 1:357, Florida’s was 1:360, and California’s was 1:254. [RealtyTrac] So, yes, discussing what to do to alleviate the foreclosures in Nevada is an important topic in the state. What we are missing here is the relationship between foreclosures and the other half of the problem: Declining Home Values.
Nationally, real estate property values declined 4.7%, and they’ve been declining for the past five years. While the “non-distressed” property values have seen only modest declines, the “distressed” category and a sluggish economy for middle class Americans keep pushing the prices down. This has implications for several states, “Including distressed sales, the five states with the greatest fall in prices were Illinois which was down 11.3%, Nevada down 10.6%, Georgia down 8.3%, Ohio down 7.7% and Minnesota down 7.5%. [PropWire] (emphasis added)
These figures have meaning for those who signed adjustable rate mortgages:
“These kind of loans, which adjust interest rates after being fixed for a set period of time, have come in for a pounding because so many of them are behind the foreclosure crisis sweeping the nation. Many borrowers of limited means were able to manage a home purchase based on the lower payments of introductory teaser rates. But as rates on those loans have adjusted upward, the higher monthly payments have been too much for thousands of home buyers.” [BostonGlobe]
Increasing interest rates + higher unemployment or under-employment rates, or stagnating (declining wages) = Trouble. If the value of the property is such that it could be sold (non-distressed sale) and the mortgage could be paid off with the revenue from the sale, Great — but for many homeowners that’s a fleeting vision of past enthusiasm. Underwater is, obviously, when the property value declines below the cost of the mortgage, and if the value of the property keeps sinking beneath increasing mortgage costs the homeowner is sitting in a property ‘basin’ watching the water flow in above his or her head. This would explain why adjustable rate mortgages, once the darling of mortgage originators, are now as popular as Yersinia Pestis.
Here’s where the second shoe drops. There are three factors associated with declining property values — Disasters, Rising Crime Rates, and Foreclosures. [FinWeb] What a lovely cycle we have here! As homes go into foreclosure the values drop and as the values drop the number of homeowners (especially those with adjustable rate mortgages) who are underwater increases; the number of “underwater” homeowners goes up, the number of foreclosures increases…
What we probably ought to be thinking about is a multifaceted approach to the current real estate problem, and one that incorporates some harsh realities.
#1. While the foreclosure problem is concentrated in a few states, others such as Georgia, Illinois, Ohio, Texas, and Wisconsin aren’t immune from the problem. Georgia’s foreclosure ratio now stands at 1:381 and Illinois comes in at 1:419. [RealtyTrac] Those who contend that the problem is “only in a few Sand States” and therefore should not be attended to by national policy are missing the implications of rising interest rates, declining property values, and the pressure these place on the national real estate market.
#2. We have had five consecutive years of declining real estate values. The real estate bubble was inflated with a vast amount of air. The faster the mortgages could be securitized the faster the profits rolled in, and the more air got pumped into the bubble. Any proposed solution which does not address the financial sector’s contribution to the creation, marketing, and sale of dubious (if not downright deceitful) mortgages and mortgage related financial products only insures that the financial sector will be perfectly free to create the next bubble.
#3. Despite recent impressive gains in productivity in the U.S. wages and salaries have been relatively stagnant. Productivity increased by approximately 80% between 1979 and 2009, but wages only increased by 10.1% — with most of that growth occurring between 1996 and 2002. [EPI] This trend is not conducive to home ownership. Unfortunately, it may not matter how many hedge funds jump into to purchase distressed properties for re-sale if there are few eligible buyers.
How Does Romney’s Lesson Plan Address These Three Parts?
Let’s assume that in order to bail ourselves out of our current predicament we need to think in terms of (a) diminishing the deflationary pressure on home values; (b) mitigating the possibility that financial sector “creativity” will only serve to create another bubble; and, (c) increasing the possibility that middle income Americans will be a major contributor to the national housing market. How do the proposals we’ve been hearing address these factors?
Here’s former Governor Romney’s suggestion:
“ROMNEY: Are there things that you can do to encourage housing. One is, don’t try and stop the foreclosure process. Let it run its course and hit the bottom, allow investors to buy homes, put renters in them, fix the homes up and let it turn around and come back up. The Obama Administration has slow-walked the foreclosure processes that have long existed, and as a result we still have a foreclosure overhang.” [Dayen, FDL]
What we have in this comment is a classic Financialist “Invisible Hand” argument. Let investors soak up the excess inventory, prices will achieve equilibrium, and all will be well. At this point the proposal becomes a bit muddy. Is the Governor assuming that the investors will become property management agents in the rental sector? Or, is he assuming that the investors will hold the properties temporarily while rehabilitating them for sale? Given his experience with Bain Capital we might easily assume he’s thinking the latter. What’s the problem with this?
The first, and most obvious, problem is that Mr. Romney appears to be adopting the premise that the foreclosure problem is a localized issue with few implications for the national housing sector. However, as long as sellers in California and Nevada can’t get away from the mortgages/home value binds in their home states they won’t be participating in the housing market anywhere else. And, then there’s the Shadow Inventory dilemma.
“It’s a paradox for banks. If they clear the shadow inventory slowly, home prices will be depressed for an extended period. If it happens quickly, the glut will overwhelm the market and quickly drive down prices, the S&P report showed.” [USAT]
So, if we “foreclose slowly” the prices are depressed for an extended period (and more foreclosures may result as more home values decline), or we “foreclose quickly” on the surplus inventory and the resulting crash drives prices/values down even faster.
If adopting either option to reduce real estate inventory, immediate or shadow, results in the further depression of prices then the most evident answer is to do what we can to mitigate foreclosures in the first place. This is precisely the opposite course from that proposed by Governor Romney. Strike One.
How does Governor Romney propose to cope with the enthusiasm on Wall Street for creating financial products which exacerbated the housing bubble crash by amplifying the impact in the derivatives market?
Governor Romney’s position in terms of the second question is almost clear. First he would “Repeal Dodd Frank,” i.e. the financial regulatory reform bill recently signed into law. [BostonGlobe]
Let’s go into more detail about the Dodd Frank Act, because, as we’ll see in a moment, Governor Romney was loath to do so. The Dodd Frank Act (1) created a process to determine systemic risk, (2) included the requirement that banks create a ‘living will’ for orderly liquidation in case of failure, (3) requires a rationalization of duties among the Federal Reserve, the FDIC, and the Office of the Comptroller of the Currency, (4) created the regulation of insurance firms such that the debacle of AIG would not be repeated, (5) introduced the Volcker Rule limiting the banks’ ability to speculate with depositor funds, (6) provided for oversight of credit default swaps and credit derivatives, (7) granted authority for the Federal Reserve to set standards for risk, (8) revised the structure and authority of the SEC to better protect investors and enhanced regulation of the ratings agencies, (9) created the Consumer Financial Protection Bureau, (10) set better standards for mortgage origination,and (11) established standards for property appraisals.
It seems that Governor Romney’s position is clear, but not so clear:
“In July, Romney was unable to name specific parts of the bill that he liked or disliked. When asked, he said only, “It’s 2,000 pages. I’m sure there’s something in there that’s good…I’d be happy to take a look at it perhaps line by line at some point and lay out the provisions that I think are unfortunate.’’
Today, he was more specific. Romney said he believes it does make sense to regulate derivatives. He said it also makes sense to have different capital requirements if someone is holding a home mortgage compared to someone holding high-risk securities. “Some features have to be addressed,” he said.” [Boston Globe]
“Some features have to be addressed?” What features? Which of the eleven parts of the Dodd Frank Act would Governor repeal? Which would he modify? Which would he retain? Would he repeal the Orderly Liquidation Authority? Wouldn’t this leave the banking system at risk? Would he repeal the Volcker Rule and allow bank holding corporations to invest in high risk derivatives with depositors’ money? Would he repeal the provisions which addressed the problem of Regulator Shopping — for the least effective oversight — by financial institutions? Would he repeal the part wherein the ratings agencies could potentially be ‘bought’ by the highest bidder? The little devils are certainly in the details.
Whenever someone’s ox is being gored we’re sure to hear about the length of the legislation, Governor Romney is no exception: “… he said, the 2,000 pages of the bill are “overwhelming” for community banks and the fact that pages of rules must still be written creates too much uncertainty.” [BostonGlobe] Perhaps we got a 2,000 page bill because the financial sector created a $7.1 TRILLION crash? Perhaps we got a 2,000 page bill because on September 29, 2008 the stock market plunged 788 points on the news that the House had failed to pass TARP legislation? [CNN] Thus wiping out $1.2 Trillion in market value in one day. Maybe we got a 2,000 page bill because three years after the crash the American middle class had lost 23% of their accumulated wealth? [Atlantic]
And the effect on community banks? First, many of the provisions of the Dodd Frank Act don’t apply to community banks, so the entire 2,000 pages or so aren’t something with which they’d need to comply. Additionally, while community banks may be concerned about new rules, it is also entirely possible that the rules will be written to specifically exempt them. Secondly, while the community banks aren’t happy about limits on card swipe fees, they are pleased that there’s a 40% reduction in their FDIC assessments. [PF]
Unless Governor Romney would care to be a great deal more specific on exactly WHAT portions of the Dodd Frank Act should be modified, or more precise in his comments about derivative oversight, then I’m giving him a Strike Two on the second element.
Now, how about our third element: Increasing the wealth, and thus the capacity, of the American middle class to participate in the housing market?
Governor Romney is evidently of the school that “Government doesn’t create jobs,” that is done by the private sector. [ABC] This is a lovely sound bite, but it really doesn’t answer our question. What would the former Governor do to enhance employment for middle income Americans such that they might be more able to become home buyers? It appears as though the only response in this area we are likely to get from the former Massachusetts governor will be wholly composed of the Three Pillars of Financialism. Strike Three.