Friday, July 30, 2010

Mobility and Underwater Homes: A humble suggestion

Today, the Washing Post reported:
Labor mobility has nearly ground to a halt in the past two years, and policymakers are increasingly worried that the slowdown is not just a symptom of the nation's economic struggles but also a barrier to overcoming them.
The biggest factor seems to be the large number of unemployed homeowners who have little or no home equity. Between 2006 and 2009, the number of renters who moved out of state decreased by 13.6 percent, according to census statistics, while interstate migration among homeowners has plummeted by 25.5 percent.
It must be a slow news day because this is no news. The WaPo covered it in June 2008. Bill over at Calculated Risk added:
approximately 1 in 8 households (the same proportion as with negative equity) will probably not accept a job transfer now because of depressed home values - and that is about 200,000 fewer households per year that will probably not move for better job opportunities.
This was all later confirmed by the Census Bureau in December 2008 and even more supporting evidence showed up in Paul Krugman's blog yesterday (source: Atlanta Fed). But I'm not here to berate the WaPo on repeating themselves, we all do it, I'm here to put a couple of things together and make a suggestion.

The problem
People with low or negative equity are not moving to the areas where they could find a job because they are trapped by unrealized losses or don't want to realize these losses. I would be willing to venture the guess than in the past households used proceeds from capital gains or built-up equity to fund relocation expenses; with low/negative equity, that just isn't possible.

Credit to MacroBlog
Additional obstacles
Cutting people's principal is a non-starter in many cases. Banks don't want to get a reputation for cutting loan principals and non-delinquent homeowners see it as reckless buyers getting rewarded at their expense.

A proposed solution
Seeing as how the government is already throwing massive amounts of money away trying to either reflate, or turn people into permanent renters, I suggest something slightly different. The government could maybe create a facility that lends money to underwater homeowners that need to free themselves from a home.

This is not a giveaway, it is a loan. This is not a below-market-rate loan, and therefore carries no implicit subsidy. The loans should probably made at a rate similar to or slightly higher than the original mortgage rate. Home-owners who are underwater and are being held-back from taking a job in a different area should be offered the loans, which would be contingent on a job offer. The loans would be used to pay-off negative equity at the time of a home sale. The borrower could then free him or herself from the home anchoring him or her down and return to employment.

I don't know if this next part is possible, but if the lending facility vowed to reduce the rate on the loans by a set amount if the borrower transformed the loan into a second lien on any new property bought, it could furthermore enhance the quality of these loans. These loans could then either be kept until maturity or sold to banks for securitization for a profit. Why a profit? Well, if the transaction was correctly orchestrated, the borrower rid him or herself of the anchor home, allowing them to enter a new job. If the borrower decided to buy a new home, the drop in rates would almost ensure they will be able to buy a similar home for a smaller monthly payment, improving the debt-to-income ratio. Because of the same lower rates, the new monthly mortgage payment plus the loan payment should be lower than the original mortgage payment, putting the borrower in a better position to meet their obligations. Additionally, banks holding undercollateralized loans would get to rid themselves of those loans and the possible losses associated with future defaults or short-sales. Finally, freeing people from their underwater properties would increase liquidity in the real-estate market, encouraging price discovery, getting assets to the people that want them and getting people to the employers that want them. Here's the list of pros in my mind:
  • Worker mobility is augmented
  • Worker / employer mismatched is reduced, increasing employment and PCEs and income taxes collected
  • Putting people to work reduces unemployment benefits being paid out
  • People decrease their debt service expense, leaving more money for PCEs
  • Real-estate liquidity improves
  • A couple of commissions are generated for brokers
  • Price discovery is sped up
  • Undercollateralized loans are reduced
There may be no debt permanently retired, but increasing mobility and employment prospects should put the underwater borrowers in a better position to pay-off their loans. If they still default, well, they probably would have done so anyways, and seeing as how the Fannie & Freddie black-holes probably guaranteed that paper, the Treasury would have probably taken the same loss on the assets--more if you include the added expense of the foreclosure process. Before you argue that it's basically a subsidy for the MBS holders, think about who owns $2T in MBS and who guarantees a whole lot of the rest.


  1. MB,

    Interesting thought. In my mind, anything is better than continuing on a trend of the gov't just footing the bill for people's problems. I think that those that had a variable rate reset and balloon their monthly payment would benefit from such a program. I would tend to agree with you that most people use built up equity or capital appreciation to fund relocation expenses as well as the downpayment for their next home. Absent a downpayment, saddled with a new debt, and starting a new job, I wonder how anyone in this situation would be able to obtain financing? That being said, I think a progam such a this could be successful if it were coupled with job creation efforts in the hardest hit real estate markets.

  2. Well, it seems I spoke too quickly. The latest negative-equity report clearly shows that the vast majority of underwater homeowners are significantly underwater. The people in the 50+% range are probably beyond these sorts of schemes, while the ones in the 5-20% are probably easier to help out.

    Regarding the absence of down-payment, what do you think all that federal credit was all about? There was a reason you could use it for a down-payment, it was essentially down-payment assistance from Uncle Sam, to get people who could handle a loan, but didn't have the down-payment, out on the market.

    The fact is that many people should have been renters and not owners. If people were allowed to exit home-ownership through a deal like this, they wouldn't need to worry about down-payments because they would likely become renters until their finances settled and they could actually afford ownership.


Do the right thing.