Viewpoint

How to Fix the Housing Mess


The global economy has been battered for four years by the effects of a real estate bubble gone bust.

The resulting losses incurred by the world’s financial institutions led to the credit crisis that destroyed Lehman Brothers, which in turn triggered a recession in most of the world’s major economies. Three years after the Lehman collapse, the world struggles with persistent weak economic growth that has taken its toll on European sovereign borrowers and the U.S. job market.

Home ownership has been a fundamental component of the “American dream” for more than a century. Political leaders on the left and right have long supported home ownership, and for much of the past two decades government policy has encouraged Americans to buy a house regardless of whether they could actually afford it. Because real estate prices always seemed to rise, buying a house was viewed as a good way to create wealth and build the proverbial retirement nest egg. Moreover, residential real estate creates jobs in construction, real estate, finance, retailing, and many other industries. In fact, the residential housing sector is a primary driver of the U.S. economy. As we have seen over the past four years, putting Americans back to work is indeed difficult when such a large percentage of the economy is effectively on hold. The conclusion is fairly simple: Fix the housing mess, and the economy will grow.

Home prices have fallen more than 30 percent since 2006 and may not have hit bottom in some parts of the country. With more than six million homeowners not paying their mortgages, the pressure from even more foreclosures will further depress residential real estate prices. It is clearly time to remediate this huge problem.

To put it bluntly, solutions won’t be cheap or easy, and any efforts to revive the real estate market raise the risk of creating yet another bubble. Given the enormity of the problem, the effort and risks are fully warranted and, in many respects, long overdue. Here are a few proposals that should have an immediate and positive effect on the U.S. real estate market.

  • Allow homeowners to refinance their mortgage even if the owner has negative equity in the home. (Negative equity is when the mortgage balance exceeds the fair market value of the home.) Homeowners who are up to date on their mortgage payments and have been current for at least one year would be able to refinance even if they have negative equity in their homes. Millions of homeowners have been unable to take advantage of historically low mortgage rates since home prices have dropped so dramatically, creating negative equity. This change would allow these homeowners to save money and make it less likely that they will stop paying their mortgages and simply walk away from their homes.
  • Have Uncle Sam match down payments, up to $25,000, for any first-time homebuyer. These buyers would have real equity in their homes from day one and would even have a buffer should home prices deteriorate further.
  • Uncap the mortgage deduction for anyone purchasing a home that is in foreclosure. Homes in foreclosure are a drag on the real estate market, often create blight in otherwise stable neighborhoods, and burden the financial institutions that hold the mortgages. Buyers who would not otherwise be able to deduct any additional mortgage interest payments (currently capped at interest on $1 million of mortgages on first and second homes) would have a real financial incentive to buy foreclosed properties.
  • Let all income on residential real estate purchased for investment be tax free for five years. This would apply to all investors, whether individuals, corporations, or real estate investment trusts. Given the rising demand for rental properties, this would provide investors with an additional reason to buy income-producing residential real estate.
  • As with any proposal to deal with significant national problems, the fix must be calibrated to ensure that it does exactly what it is designed to do. These initiatives would be limited to the purchase of existing housing stock (homes already constructed or whose construction started before Nov. 1, 2011.) Also, to ensure that these programs would spur immediate activity in residential real estate, they would apply only to transactions completed in the next 18 months.
  • Efforts to prevent fraud and reduce the risk of another housing bubble would be essential. To reduce the risk of another bubble, these incentives would be available only when the purchase price being paid is no higher than the appraised value of the home and when the downpayment is equal to at least 10 percent of the purchase price. Enforcement of strict mortgage underwriting standards would also be essential.

While these initiatives would be costly and controversial, the size of the overall problem is such that it cannot be ignored. If the U.S. economy is to turn around, the sector that led the decline will need to drive the recovery. The sooner we fix the residential real estate problem, the sooner we can look toward a brighter economic future.

Frank_aquila
Aquila is a partner in the Mergers & Acquisitions Group of Sullivan & Cromwell LLP.

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