The flurry of announcements by the government and major banks that they are engaging in a massive campaign to modify mortgages that are in or are hurtling toward default and foreclosure will certainly give rise to predictions that the housing market has been stabilized and disaster averted. If only it were so.
Make no mistake, policymakers and banking executives had to launch this concerted campaign to try to stop the wave after wave of foreclosures that seems to feed on itself. As lenders foreclose on one delinquent borrower, and then sell the home at what is invariably a steep discount, that just pushes a number of nearby homeowners so far underwater that they just move out and mail their keys in, which just sets the cycle in motion again.
But anyone hoping that this synchronized effort to modify millions mortgages that are in trouble is likely to be disappointed. Because behind the splashy headlines, there are limits to what the government and banks can hope to achieve. And trying to slow the free-fall in housing markets is akin to the government trying to put its finger in the dike.
The fact is that despite the double-digit declines in housing values in most cities, housing remains significantly overvalued in many markets by all of the traditional benchmarks: One key ratio – the median cost of a new home vs. median income – suggests that home prices nationwide still need to drop another 15% to 20% on average, as you can see in this chart compiled by money manager Barry Ritholtz. And the equilibrium price is far more than that in bubble markets like southern California and Florida. According to this “fair value” calculator, one suburban neighborhood outside Washington, D.C. that I checked (Alexandria, Va., where I lived in the mid-1990s) is now 47% overvalued. Ditto for a few communities in Los Angeles that I surveyed.
A second measure – home prices to average rent –also remains out of whack, and would require another 20% to 25% plunge in home prices to make it more advantageous for the average apartment dweller to buy a home instead, particularly now that few homeowners have any illusion that their house is an “investment” that’s going to soar in value in coming years.
Providing relief to current homeowners who are in trouble is a politically expedient move, but at the end of the day, prices are still far too high for the next generation of buyers – particularly now that lenders have reverted back to demanding hefty down payments and using more conservative underwriting standards. Which means that the current imbalance in supply and demand will remain a problem and help push prices down for years to come.
Then there’s the presumably simple task of getting troubled borrowers out of a mortgage they’re struggling to repay and into one they can afford. Except that it isn’t as simple as you’d think. For one, there’s the fact that many mortgages were bundled into securities that were sold to hedge funds and other institutional investors – many of whom aren’t interested in modifying the mortgages they hold. And getting homeowners who might qualify to have the terms of their current mortgage modified isn’t necessarily easy.
Consider the experience of IndyMac, the big California thrift that was seized by the FDIC this past July. At the time, FDIC Chair Sheila Bair made clear she was going to offer loan modifications to as many troubled borrowers at IndyMac as possible. But in last October, Bair told Congress that roughly two-thirds of the 60,000 mortgage that were more than 60 days in arrears at IndyMac would qualify for an interest rate reduction and other modifications. But two months into her grand experiment, the FDIC had only contacted fewer than 20,000 of those delinquent borrowers – and fewer than 4,000 borrowers had accepted the government’s offer. (And since the government didn’t’ require borrowers to verify their current income to prove their eligibility for a rate reduction until the very end, it’s a safe bet that not all of those respondents would make it to the finish line.)
Why such a low success rate? I’d speculate that many of the borrowers who were initially qualified under those 1% teaser rates of yore couldn’t come close to affording the “reset” when the mortgage reset to a higher interest rate, and a point or two reduction isn’t much help. And presumably many other homeowners who bought in the past couple of years in bubble markets like southern California and Florida are so ridiculously underwater on their mortgage that paying a lower rate doesn’t solve the fact that their house is now worth $150,000 than what they paid – and they’d rather just walk than negotiate.
Policymakers probably know that, and their secret goal may be that the loan modification programs will help turn the current free-fall in housing values into a more orderly correction that plays out over years rather than weeks – and doesn’t take the broader economy down in the process.
BusinessWeek editors Chris Palmeri, Prashant Gopal and Peter Coy chronicle the highs and lows of the housing and mortgage markets on their Hot Property blog. In print and online, the Hot Property team first wrote about the potential downside of lenders pushing riskier, "option ARM" mortgages and the rise in mortgage fraud back in 2005—well ahead of many other media outlets. In 2008, Hot Property bloggers finished #1 in a ranking of the world's top 100 "most powerful property people" by the British real estate website Global edge. Hot Property was named among the 25 most influential real estate blogs of 2007 by Inman News.