(warning - this is a long post, the longest I've written. I hope you find it thought-provoking.)
Heather did a great job outlining Obama's plan as it stands today, and touches on a couple of the points I'll reiterate here. Jay (Thompson, my broker and ultra-blogger) has become a popular source of information on the topic as well.
Problem 1 - Doesn't address negative equity
In an article last week I looked at how this plan isn't solving the issue, but rather postponing it into the future. I won't repeat everything today, but you can click here to read that article.
Problem 2 - Over-Capacity
Our current real estate bust is a product of overcapacity, plain and simple. You can blame investors, banks, lenders, appraisers, Realtors, or anyone else, but the fact of the matter is builders were building houses as fast as they could, with buyers lining up out the door in the hopes of being lucky enough to buy one. More houses were built than people moving to the area - the very definition of overcapacity.
History is littered with bubbles bursting, and overcapacity has been at the root of most of them. When overcapacity causes a bubble to burst, it allows more efficient, better-run companies to replace the big, bloated companies who caused the overcapacity in the first place. This is especially true in industries where a large sum of capital is required.
Examples include the railroads in the 1800's, and the airlines in the 1980s and 1990s. (Remember names like Pan Am, Western, Hughes, PSA, TWA, Eastern, or even America West? And yet newer, low-cost providers like Southwest and Jet Blue are making money hand over fist.) We can also look at fiber optics in the late 1990s as a terrific example.
Maybe the builders, and the banks who financed their building, should be today's Pan Am.
Problem 3 - Who Qualifies?
The people who bought homes in late 2005 through early 2007 are in the worst shape today, and are the people who supposedly need the rescue package. Let's call them Stranded Homeowners. Will these Stranded Homeowners get any relief?
Obama's plan offers to refinance them, even if they don't have equity. OK, but rates in that time period were already around 6%. How much relief will they really get if we refinance them down to 5.5%? Small potatoes. Oh, but they can get out of their ARM and into a FRM - ok, that's a good thing long-term, but their ARM is probably at a very low rate today, and if they're paying interest-only their monthly payment might actually INCREASE when they refinance into a fully amortized loan.
Obama's plan won't help anyone whose mortgage balance is greater than 105% of the current market value. So most of these Stranded Homeowners won't qualify, as homes bought during this time period are worth much less than today, and very few people made significant down payments.
Obama's plan is related to first mortgage holders only. Anyone with a 2nd mortgage or HELOC will have to get that mortgage to sign a subordination agreement showing their willingness to remain in 2nd position. This might be possible, since the 2nd mortgage will get wiped out in a foreclosure and therefore has nothing to lose, but we all know how easy they are to negotiate with - NOT. Do any of our Stranded Homeowners not have 2nd mortgages? Very few.
Obama's plan won't help those people who can't otherwise qualify due to a reduction in income. Those who refinance will still need to show the ability to pay the new payment. That eliminates most people who earn some form of commission income, people who have lost their job, and those who managed to find a new job but at a lower salary.
Have I eliminated all of the Stranded Homeowners yet? A bazillion dollars to help struggling homeowners may sound great on the surface, but I don't think the people who need it most (and who are the biggest source of the problem we're trying to fix) are going to get any relief.
The stated goal is to stop the flood of foreclosures from hitting the market, but the people most likely to foreclose aren't going to get any help...
Obutter's plan - My Solution to the Problem
How can we use the government's willingness to help (and their bazillions of dollars) while still letting a free-market economy run its course? Rather than trying to stave off foreclosures on the front end, I propose the government let the foreclosure process happen, but then help these people on the back end, with the creation of a Federal Real Estate Investment Trust & Property Management Company. (FREITPMC would be a good federal acronym.) Rather than demand banks refinance certain borrowers, the government could buy these houses back from the banks, at today's foreclosure-depressed prices, and rent them back to the former homeowners. Here's how it would work:
The goal should be two-fold: A) provide housing to those who need help, and B) to earn a profit over a 5-10 year term.
Simplified Example: Let's say a family bought a home in 2006 for $350,000. Today they owe $325,000, and the home is worth $250,000 (family-owned) or $200,000 (bank-owned). The family's income has decreased, and they can no longer make the mortgage payments.
- The current lender will foreclose on the home.
- The FREITPMC buys the property for $200,000 cash.
- The FREITPMC then rents the property to a person/family who has been foreclosed upon. Credit screening will be relaxed, with more weight given to the person/family's ability to make the rent payment in today's situation.
- At some point in the next 10 years, the FREITPMC sells the property for an amount greater than $200,000. (possibly even to the family who's been renting it.)
- Repeat the above process hundreds of thousands, or even millions, of times.
Let's review what effect this process will have on the various players.
The builders won't be affected; they're already in the process of being weeded out. The strong will survive, the weak will perish, and new builders will join the market upon economic recovery.
The banks will get the benefit of selling foreclosed properties very quickly. The strong will survive, the weak will not. And since the weak are the ones who made the most bad loans, that's probably ok. They will get merged, bought out, or replaced by stronger banks. Good 'ole free-market economy.
The big investors who bought derivatives, tranches, and all those other fancy Wall Street creations will get the appropriate return on their investment.
The troubled homeowners will get to have a roof over their head at a more affordable monthly payment. Their credit rating will show what actually happened - late payments, foreclosure, bankruptcy, whatever it is. The stronger homeowners will recover and buy a home again in the future; the weaker homeowners probably shouldn't have bought one in the first place.
The "responsible homeowners" won't feel slighted, as if they're missing out on something and being punished for doing things right. There aren't any free handouts to anybody.
The government will get to save the day without risking bazillions of taxpayer dollars. They'll earn rental revenue while they own the property, and they'll get their equity back when they sell the homes. They also get a relatively short-term duration on their involvement.
The taxpayers will get their money back as the real estate is sold back into the market over the next decade.
The market will recover faster, as foreclosed homes are cleared from the market more quickly.
Seems like a fair-fair-fair-win-win-win-win-win solution to me.
Your hoping the President reads this Realtor,