Sunday, August 26, 2007

More on Own to Rent

Jim Pethokoukis picks up on Dean Baker's proposal in the current U.S. News & World Report. He quotes a phone conversation we had as follows:

Andrew Samwick, former chief economist for Bush's Council of Economic Advisers, admits his first instinct is that the government should do nothing. Yet he admits feeling more than a "pang of sympathy" for people who were misled when taking out subprime mortgages. So if the government does take action, he would prefer a plan like Baker's that "leaves as small a footprint as possible" over one that creates billion-dollar bailout funds or sweeping changes to Fannie Mae and Freddie Mac. Even Andrew Mellon might have approved.

This answers some of the thoughtful comments on the last post. In particular, if the government is going to intervene in some way, I want it done in such as way that it assists borrowers, not lenders. Baker's proposal in fact helps borrowers at the expense of lenders and does not create or expand the government (or government-sponsored) bureaucracy by much. My views of what happened in the floating rate mortgage market are very much influenced by advertising come-ons like this one that I blogged about last year. So I was persuaded fairly easily that some government-mediated remedy might be appropriate.

In the comments on the last post, ed asks a very good question:
Why should we give advantages to foolish buyers not enjoyed by prudent renters?

... or prudent buyers who locked in a higher (but still low) fixed-rate mortgages, ... or prudent buyers who chose a home that they would be able to afford when the ARM reset? These questions will arise any time that the government intervenes on distributional grounds. If these are your concerns, then you will join me in looking for the government intervention on the smallest possible footprint. This is not a policy that I think of as permanent, and it is certainly one that should only be invoked when there is evidence of systemic fraud or abuse.

The comments also point out that the problems of implementation and equity with Baker's proposal rise with the length of the guaranteed tenancy. That's a key parameter to be decided through the public policy process if the proposal moves forward.


xtoph3r said...

Here's something the government could do with a smallish footprint: Tax amnesty for people who get a 1099 from a foreclosure or short sale.

Let's say I can't afford my $500K loan, but the market has tanked and I can't sell my house for the full amount that I owe. I finally find a buyer at $400K, and arrange a short sale with the bank. Normally, the bank would issue a 1099 to me for the $100K of debt forgiveness, and I would owe the IRS about $25K or so in taxes.

Having just lost my house and taken a nasty hit to my FICO, I'm probably in no position to fork over that kind of money, at least not all at once.

I would support a limited amnesty that would comprise some combination of penalty waivers, outright forgiveness of the taxes owed, or zero- or low-interest financing of the taxes over some period. I'm not really in favor of 100% forgiveness, because of the moral hazard. It's got to sting a little. A blue-ribbon panel can work out the details.

Here's the upside: It's not a bailout, and it facilitates an unwinding of the situation without creating a huge new bureaucracy. It just helps people get on with their natural course of their lives a little quicker.

xtoph3r said...

Oh, and you would have to prove that your income was what you said it was when you took out the loan: stated-income 'liar loans' are clearly fraudulent and hazardous to the entire market and should receive no taxpayer relief whatsoever.

ed said...

Once again xtoph3r makes a great point...taxing the supposed "gains" on a short sale seems pretty crazy to me, and I'd certainly favor relief in that area. I'd even favor complete tax amnesty here...I dont' see a moral hazard problem, since I'd guess around 0% of these buyers were even aware of this tax rule when they signed their mortgage to begin with. The tax just amounts to kicking people when they're down.

I agree with Andrew that if anything must be done here, I'd prefer that it be small in scope and that it not spend any public resources to bail out the lenders. Maybe this suggestion wouldn't be too bad if it is implemented in a modest way (perhaps it would even be good). My main concerns remain:

(1) Banks shouldn't be forced to become property managers. Baker's proposal says people should have the right to stay "indefinitely," which seems stupid.

(2) I've thought for a while that rent levels have become abnormally low need to rise. The supply of rental properties probably needs to rise as well. The presence of a bunch of bank owned properties with rents set by "appraisers" seems likely to impede this process.

Tom said...

You know what? I just can't take the position I know I'm supposed to (as a good, though conservative, Democrat) on this issue. I believe strongly in the native smarts of people...and the only way to maintain and improve those smarts is to let consequences happen.

The most obvious moral hazard is to bail out lenders, but bailing out people who acted foolishly will have long-term reverberations as well. I don't see what the big deal is...they didn't put any money into the house anyway, they'll be able to rent in the same neighborhood for a lot less than they're due to pay...and the emotional scar will teach both them and their children to pile up some money before "buying" a house.

What did I miss here?

Ken Houghton said...

Not much on the individual level, Tom, which is why we're all hesitating.

The problem is that on the group level (e.g., neighborhood) the rest of us suffer as well if the house stands vacant.

Which is the beauty of (renter) Dean Baker's proposal: the income from the property is not reduced from what it would be, and the transaction costs on all sides--e.g., foreclosure (bank), moving (occupant), income loss (security holders) -- are reduced.

Otherwise, I get foreclosed, the person four houses down gets foreclosed, and the neighborhood gets a reputation for "blight," punishing the prudent as surely as ed fears.

You want to modify the assurance that someone who pays a market rate on the property can stay there indefinitely? Please rationalise this with the idea that "prudent" buyers (those of us who thought we bought at the top of the market, $100K or so ago) get to stay in their house at what are "below market" rates.

The agreement is that they can rent indefinitely--there's no equity gain, and those who really want to OWN their home will move as soon as they can.

Tom said...

Ok, so I'm still at a loss. You've got a neighborhood full of people who spent an awful lot on their houses, some of whom couldn't possibly pay a normal 30-year loan including principal. They stay in a place paying interest (sometimes even less!) with the possibility of flipping the house to some other dope for a capital gain...but when the dust clears, they're left holding the house.

Some of these people are now in a district where the "rent" is too high. They move. Others who have money, like a college professor, see a place that needs an owner and buy it. Or rent it.

The prices will go down to match some price people will move in...Your whole gain from the "top" of the market was driven by speculation...again, I see no reason to intervene, although I certainly feel bad.

Fritz said...

It's generally not the vacant house that blights the neighborhood, it's the foreclosed occupant that lets the property deteriorate. Most communities have ordinances and the banks will comply. Plenty of people live in neighborhoods that have spec homes sitting there for years, this is nothing more than a populist trope.

Ed, the President has asked for the income tax waiver. It will be interesting if they make sure to put in a provision that forbids this if the new owner was the old owner. e.g. On most foreclosures, the bank is the only buyer up to the mortgage price knowing they will hold the property during the owners right to equity of redemption. In the current market, the bank might just bid to market value due to regulations, that allows the buyer to recover his home at that price if he can get financing.