Only fools bought houses they could afford

the_housing_bailout_w480
(Based on the Detroit Bailout, using a photo from Wikimedia Commons)

A nice follow out to only fools pay their mortgages

By David Leonhardt (corutesy Calculated Risk):

Now, not all economists buy this argument. They say that the psychology of the current bust is different from what it was in Boston in the early 1990s. In a handful of metropolitan areas, including Phoenix, prices have fallen almost 50 percent from their 2006 peak.

Homeowners in such places may wonder if their houses will ever be worth more than their mortgages. So fairly small changes in their lives — like a reduction in work hours or the breakdown of a car — may lead them to walk away from their homes.

“I would not minimize that risk at all,” said Frederic Mishkin, a member of the Fed’s board of governors until last year.

If even 10 percent of the underwater homeowners walked away, Mishkin notes, foreclosures would soar, exacerbating the economy’s many problems.

Other economists who share his view are calling for across-the-board programs that would reduce interest rates or otherwise juice the housing market. They are worried that without bolder government actions, the housing market will continue to spiral downward.

In the end, the choice between the two approaches becomes a matter of cost-benefit analysis. The more aggressive approach would almost certainly do more to reduce foreclosures. But it would also be enormously more expensive.

If the economists from the Boston Fed are right — or even close to right — then the aggressive approach may cost something like $500 billion to prevent 500,000 foreclosures.

That’s $1 million per prevented foreclosure. Is that really worth it? Or could the money be better spent in other ways? (There is also the small matter of whether Congress would be willing to spend another $500 billion anytime soon.)

An example of the sort of house that you may soon be paying for are these McMansiosn in California, which have lost a million dollars worth of value.

42 thoughts on “Only fools bought houses they could afford”

  1. We purchased our first house in Dallas at a time when prices were surging upward – 1983. We paid 135,000. Within just a few years the house was worth 60,000. I don’t remember when it recovered to 135,000, but it must have been in the mid 1990s. In 2008 a realtor told me we could remodel it a bit and get 750,000. Today, forget about it. Probably busted back to 500,000 or less.

    People who have been laid off, will default. But people with jobs? I don’t think so.

    The next season of Flip this House should be interesting.

  2. In the city I live near there’s a bunch of mansions that were transformed into apartments. I wouldn’t be surprised if Obama tried to turn these type of dwellings into apartments which would be reserved for section 8 people. This way he could “spread the wealth” of diversity among the diversity deprived.

  3. The thinking of the people who try to buy homes like this in the first place reminds me of the salesman on my last car shopping trip. I was looking at cars in a specific price range, (I’d already set my budget, researched models, and been to the bank to pre-approve that amount for the car loan. I always do my homework.) when the salesman asked me what my credit score was. I told him and he got a funny look on his face and asked why I was looking at cars in this particular price range when I could buy ‘any car on the lot’.

    I told him simply, If I were to buy ‘any car on the lot’ regardless of my budget I would soon not have a credit score that allowed me to buy ‘any car on the lot’ because I can’t afford ‘any car on the lot.’

    He seemed unconvinced by this reasoning. I did not buy a car from him.

  4. Calculated Risk has more on this… [1]

    This is not so good. The Obama administration doesn’t understand that there were two types of speculators during the housing bubble: flippers (they are excluded), and buyers who used excessive leverage hoping for further price appreciation. Back in April 2005 I wrote: Housing: Speculation is the Key

    [S]omething akin to speculation is more widespread – homeowners using substantial leverage with escalating financing such as ARMs or interest only loans.

    This plan rewards those homebuyers who speculated with excessive leverage. I think this is a mistake.

    Another problem with Part 2 is that this lowers the interest rate for borrowers far underwater, but other than the $1,000 per year principal reduction and normal amortization, there is no reduction in the principal. This probably leaves the homeowner far underwater (owing more than their home is worth). When these homeowners eventually try to sell, they will probably still face foreclosure – prolonging the housing slump. These are really not homeowners, they are debtowners / renters.

    sonofsamphm1c,

    The housing porn on HGTV has taken on a dark and tragic subtext through the re-runs. Especially for those who clearly bought

    Seerov,

    Creating a Google news alert for ‘housing crisis’ ‘social justice’ obama probably will alert you to if/when such a plan is seriously discussed… [2]

    aherring,

    If my dad’s financial advice was ‘cash is fact, profit is theory’ (something that escaped Madoff’s investors), my mom’s is a story of a vacuum salesman she met many years ago. ‘So you are saying you can’t afford this Hoover?’ ‘I’m saying, you haven’t told me why I should give money to you’ was (as I remember) the response. The story is so cringe-worthy, reading your story I a vacuum-salesman on that car lot, wearing stereotypical 1970s clothes!

    [1] http://www.calculatedriskblog.com/2009/02/comments-on-housing-plan.html
    [2] http://news.google.com/news?q=“housing crisis”+”social justice”+obama

  5. So the question becomes whether a means exists of rescuing the neighbors of reckless speculators without rewarding the speculator’s effort?

  6. Marketplace yesterday had a wonderful back-to-back feature, the first being on a real estate speculator, the other being a young people who have been trying to save to buy a house (impossible in a housing bubble, of course).

    I can’t think why we want to housing real estate as an investment (it’s nonproductive, like armaments and unlike factories, education, or bridges). Attempts to prop up housing prices encourage the misallocation of resources, reward those who are already landed, and punishes those who wish to purchase a landed lifestyle for themselves.

    Obama’s support of the wealthy against the poor, spending over investment, and bailouts over thrift as a satire of all that’s wrong with the left.

  7. Hence my question. How does society let reckless speculators pay for their mistakes without a chain reaction that hurts everyone else?

    I suppose the government could just buy up the high-foreclosure neighborhoods, innocent and guilty alike. Pay the exact amount owed, deconstruct the homes, turn the land into park or wilderness area. The innocent can move elsewhere, their lenders have more money and the idiots can then be investigated and exposed at the government’s leisure.

  8. Rewarding irresonsibility and poor planning. The Homeowner Stability Initiative.

    http://www.npr.org/templates/story/story.php?storyId=100807505

    This is the part I love:

    “The plan also offers financial incentives for lenders to reduce the mortgage payments of as many as 4 million homeowners who are at risk of losing their homes. Under the $75 billion Homeowner Stability Initiative, lenders would cut mortgage payments to no more than 31 percent of the borrower’s income.”

    Yes, you should have bought that house you couldn’t afford, because now you can. Thank you President Obama!

  9. remember that youtube vid that went around during the election where a young lady from miami was sceaming and crying that obama was going to pay her mortgage? and conservatives laughed at her? who’s laughing now?

  10. Michael,

    I suppose the government could just buy up the high-foreclosure neighborhoods, innocent and guilty alike. Pay the exact amount owed, deconstruct the homes, turn the land into park or wilderness area. The innocent can move elsewhere, their lenders have more money and the idiots can then be investigated and exposed at the government’s leisure.

    I’m not sure how rewarding people who made foolish risks by paying off their mortgages, and then retroactively criminalizing stupidity for investing them, makes anything worse.

    The federal government did not spend trillions on a massive NASDAQ-purchase program when the .com bubble collapsed. I don’t see how re-bubblizing the real estate market is a wise decision.

    Arherring & Doug,

    Yes, you should have bought that house you couldn’t afford, because now you can. Thank you President Obama!

    As Doug mentions, Peggy Joseph was right on the money [1]!

    [1] http://www.youtube.com/watch?v=P36x8rTb3jI

  11. Government was a big part of this. We elected them, so we own what they did, including the negligence.

  12. I’ve heard the “it’s all our fault” line (from CNBC, of couse) throughout this financial crisis.

    It strikes me as socialization of blame by Wall Street.

    Our Constitution intentionally sets up a complex and convoluted system of government with multiple sovereigns, each of which suffers from a separation of powers. What the government does is not the people’s fault, because the people’s will is systematically weakened and distorted.

    Which means, that now, what Obama does is his fault, not mine.

    In Britain, btw, they are allowing people to borrow more to make interest payments, essentially creating more negative ARMs. It helps those who have temporarily lost their jobs, without transferring this tremendous amount of wealth to speculators. [1]

    [1] http://www.calculatedriskblog.com/2009/02/uk-homeowners-mortgage-support-scheme.html

  13. “The federal government did not spend trillions on a massive NASDAQ-purchase program when the .com bubble collapsed. I don’t see how re-bubblizing the real estate market is a wise decision.”

    Hence the idea of removing whole developments from the market by turning them into parkland. The houses built on spec only to remain empty are removed from the market, as are the houses in other areas bought by the owners of the houses that had already been bought.

  14. So analogously, the federal government should buy shares of Citi, Bank of America, Yahoo, etc., and immediately run them through the shredder?

    I don’t get the justice of keeping young families who could responsibly afford a mortgage in apartments, in order to keep other home owners (who couldn’t responsibly afford a mortgage) in their homes.

  15. What percentage of the dot.com shares were collateral for government-backed loans? Some perhaps, but the vast majority were owned outright. It was pain for somebody, but it was contained.

    The housing crisis is like a backed-up toilet on the top floor flooding the entire country. We’ve got stinky stuff everywhere.

    There are plenty of empty houses on the market for those who want to get out of the apartment. In Houston 1/3rd of all house sales are foreclosures.

  16. “So analogously, the federal government should buy shares of Citi, Bank of America, Yahoo, etc., and immediately run them through the shredder?”

    One problem with that analogy. I used the term ‘deconstruct’ deliberately. If constructing a building is adding value to empty land, raw materials, etc, then deconstructing said building is returning that land and as much of the materials as possible to a lower value state which could then be reused as needed.

    To use bank shares in an analogy, you’d have to talk about deconstructing not just their physical existences as pieces of paper but their financial and legal existences as agreements between the shareholders and the shareissuers.

    “I don’t get the justice of keeping young families who could responsibly afford a mortgage in apartments, in order to keep other home owners (who couldn’t responsibly afford a mortgage) in their homes.”

    Who said anything about keeping them in apartments? Let them move from houses in overbuilt suburbs to houses in more stable areas. Anyway, the whole point of considering any sort of bailout is the fear that young families, responsible home owners, etc could be hurt by the problems of their less responsible neighbors. So I’m wondering if a means exists of protecting the one group without rescuing the other.

  17. sonofsamphm1c,

    What percentage of the dot.com shares were collateral for government-backed loans? Some perhaps, but the vast majority were owned outright. It was pain for somebody, but it was contained.

    Is your argument, that because early government bailout attempts used home mortgages as collateral, we need to expand bailouts so that market forces won’t drive down the value of the assets we so foolishly accepted as collateral?

    There are plenty of empty houses on the market for those who want to get out of the apartment. In Houston 1/3rd of all house sales are foreclosures.

    With this logic, there is plenty of everything for everyone.

    What matters is not quantity available in some abstract sense, but quantity available at market prices. Many title-holders are hoping for a government bailout, and thus keeping houses out of the market entirely, or else holding out for higher-than-market prices.

    The same dynamic led Lehmen Brothers to refuse attempts by other institutions to purchase them in 2008, because they (like bad title holders as a class) assumed they were too big to fail.

    Michael,

    To use bank shares in an analogy, you’d have to talk about deconstructing not just their physical existences as pieces of paper but their financial and legal existences as agreements between the shareholders and the shareissuers.

    Exactly. You are advocating a reduction in quantity of extant houses in order to increase the value of the remaining houses. In the same way, why not advocate a reducing in the amount of shares outstanding, by buying up and annihilating the existence of shares in publicly trading companies?

    Who said anything about keeping them in apartments?

    Your plan is to destroy housing stock. So, you did.

    Let them move from houses in overbuilt suburbs to houses in more stable areas.

    I don’t know what you are talking about.

    Anyway, the whole point of considering any sort of bailout is the fear that young families, responsible home owners, etc could be hurt by the problems of their less responsible neighbors.

    A speculative non-wealth-generating investment ceases increasing in value, so the government must step in destroying housing stock, in order to make that non-wealth-generating investment grow in value again

    By this logic, why should the government not bail out Madoff’s victims as well?

    You have re-described your plan in a couple different ways, but you still haven’t defneded it.

    So I’m wondering if a means exists of protecting the one group without rescuing the other.

    Again, you appear to have arbitrarily selected one class of speculative investors as an object for sympathy, and advocated destroying physical wealth in an effort to help their non-wealth-generating investors grow. Please defend this plan, as it strikes me as very strange.

  18. tdaxp – for decades housing has had all sorts of explicit and implied government backing of loans. The dot.coms did not have that. The dot.com bust was compartmentalized – mostly equity and with few/no guarantees. Its impact on the overall financial system was much more limited. With the GSEs, as a for instance, the exposure for the American taxpayer is somewhere between 1.5 trillion and 5 trillion. A complete collapse of the GSEs would bleed every taxpayer. Nobody much cares about the GSE shareholders. Other than Bill O’Reilly screaming at Barney Frank, the GSE shareholders have suffered their losses in relative silence. People do care about homeownership as it is, rightly or wrongly, perceived to be a cornerstone of our society.

  19. “What matters is not quantity available in some abstract sense, but quantity available at market prices. Many title-holders are hoping for a government bailout, and thus keeping houses out of the market entirely, or else holding out for higher-than-market prices.”

    By buying up the existing loans of responsible homeowners, they can be saved from being dragged into negative equity by their non-responsible neighbors.

    “Exactly. You are advocating a reduction in quantity of extant houses in order to increase the value of the remaining houses. In the same way, why not advocate a reducing in the amount of shares outstanding, by buying up and annihilating the existence of shares in publicly trading companies?”

    Key difference. A house’s value is tied up in its physical existence; regardless of the state of the market, it will always have a real value based on the price of its recoverable components and its utility as a shelter. A stock share, meanwhile, is tied to the issuer’s ability to pay dividends and offer privileges and/or the likelihood of the price per share going up in the future; you (and the company) could “destroy” all but one of its shares, and the remaining certificate would still be worthless if investors had no faith in the company’s ability to pay dividends and/or offer privileges to its holder.

    “Your plan is to destroy housing stock. So, you did.”

    My plan was to return responsible homeowners to the state of equity they possessed when they bought their houses so they can buy new houses in neighborhoods that aren’t dangerously full of non-responsible homeowners.

    “Again, you appear to have arbitrarily selected one class of speculative investors as an object for sympathy, and advocated destroying physical wealth in an effort to help their non-wealth-generating investors grow. Please defend this plan, as it strikes me as very strange.”

    The “class of speculative investors” I’m talking about helping is the home buyers who bought within their means and didn’t take out risky loans, aka, the “responsible homeowners” I was talking about earlier: Which class did you think I was talking about?

  20. As for defending, you’ll recall this thread was started by the issue of reckless and foolhardy individuals benefitting from efforts to save their victims. This brought up, in my mind, the question of whether it is possible to save those victims without benefitting their malefactors. If so, then government initiatives that do not do so are short-sighted at best and criminal at worst. If not, the question then arises:

    “What is more important to society: Aiding the victims or seeing the guilty pay for their actions?”

    As for the specific suggestion I made, and have been trying to defend, it was an idea right off the top of my head (witness my use of the phrase “I suppose”). If it has weaknesses, they should be eliminated or mitigated. If elimination or mitigation isn’t possible, then a better idea should replace it or an argument made for making punishment of the guilty more important than assistance of the innocent.

  21. Michael’s plan might be endorsed by homebuilders and realtors. They have no work right now, so demolition work might be welcomed by them.

    Who would be surprised if tearing down a McMansion requires more money than it cost to build it, and the 6% services of a realtor?

    Once they’d torn down the 10 million surplus houses they built in the 2000s, they could get to work building and selling 10 million new ones!

  22. “Who would be surprised if tearing down a McMansion requires more money than it cost to build it, and the 6% services of a realtor?”

    That’s the perennial devil in the details, isn’t it? Keeping private contractors from padding their receipts:P

  23. Excellent comments.

    sonofsamphm1c,

    tdaxp – for decades housing has had all sorts of explicit and implied government backing of loans.

    Yes, but these are two dramatically different states being.

    Have a government guarantee (for instance, the 250,000 guarantee on FDIC-insured accounts) and believing that one has friends in goverrnment that would prevent losses (for instance, owning a Fannie Mae bond) are not the same thing. I do not see how it is healthy for the economy for those to become the same thing.

    Michael,

    By buying up the existing loans of responsible homeowners, they can be saved from being dragged into negative equity by their non-responsible neighbors.

    So why not buy up and oblierate stock, to achieve the same thing?

    How is it fair for someone who ‘responsibly’ bought a DJIA index at 14,000 that their investment has lost about half its value, because of ‘irreseponsible’ speculators?

    How is this different from those who bought a house at the top of a bubble?

    Key difference. A house’s value is tied up in its physical existence; regardless of the state of the market, it will always have a real value based on the price of its recoverable components and its utility as a shelter. A stock share, meanwhile, is tied to the issuer’s ability to pay dividends and offer privileges and/or the likelihood of the price per share going up in the future; you (and the company) could “destroy” all but one of its shares, and the remaining certificate would still be worthless if investors had no faith in the company’s ability to pay dividends and/or offer privileges to its holder.

    Certainly value is tied up with expected utility. Both a house and a company have an expected utility. They both have some theoretical value as long as they hold this expected utility. Both of these could be destroyed. You haven’t demonstrated any key difference.

    I could easily write a paragraph that mirrors yours, but ends “would still be worthless if residents had no faith in the house’s ability to provide shelter or recoverable components.”

    My plan was to return responsible homeowners to the state of equity they possessed when they bought their houses so they can buy new houses in neighborhoods that aren’t dangerously full of non-responsible homeowners.

    Why not return shareholders to the state of equity they possessed when they bought their shares so they can buy new houses in neighborhoods that aren’t dangerously full of non-responsibly home-owners?

    I don’t get why you’re bailing out one class of speculative investors (those who bought homes in the buggle) while not bailing out another class of speculative investor.

    The “class of speculative investors” I’m talking about helping is the home buyers who bought within their means and didn’t take out risky loans, aka, the “responsible homeowners” I was talking about earlier: Which class did you think I was talking about?

    If someone had obtained a $300,000 loan to buy stock at the 140,000 level, and is now “under water” because of the collapse of a specualtive bubble, would you call that person a responsible stock-holder?

    If someone had obtained a $300,000 loan to buy a house at the $300,000 level, and is now “under water” because of the collapse of a specualtive bubble, would you call that person a responsible home-owner?

    I don’t get this preference for bailing out one class of speculative investors leveraged up (home owners), and not another class of people who typically did not leverage up (individuals who savings in the stock market, but did not leverage to do so).

    If elimination or mitigation isn’t possible, then a better idea should replace it or an argument made for making punishment of the guilty more important than assistance of the innocent.

    I don’t get how specualtive investors who leveraged up are “innocent,” “responsible,” etc. If I had leveraged $300,000 to buy shares of GM, and I have lost much of the value in that speculative investment, where is my bailout?

  24. I do not disagree with many aspects of your point with respect to the foreclosure remedy. I just don’t see house buying as being comparable with owning common stock. As a culture we have little sympathy for people who lose when they invest in the stock market.

    Nobody would buy into “It’s a Wonderful Life” if George Bailey was trying to save the homes of troubled homeowners who had borrowed on equity to buy common stock that went belly up.* We do not view people who buy a house with the intention of living in it as being speculators. Nobody would buy tickets to your version of “It’s a Wonderful Life”.

    * Even though in the 1920s there was a lot of that happening.

  25. sonofsamphm1c,

    Thanks for the comment!

    I do not disagree with many aspects of your point with respect to the foreclosure remedy. I just don’t see house buying as being comparable with owning common stock. As a culture we have little sympathy for people who lose when they invest in the stock market.

    Certainly ther’es a cultural bias though.

    Does it only work one way? That is, do we make mortgages sacred as a place a family might live, while also allowing mortgage-holders the extra cash from interest-only mortgages, option ARMs, second mortgages, and so on?

    Nobody would buy into “It’s a Wonderful Life” if George Bailey was trying to save the homes of troubled homeowners who had borrowed on equity to buy common stock that went belly up.* We do not view people who buy a house with the intention of living in it as being speculators. Nobody would buy tickets to your version of “It’s a Wonderful Life”.

    But for these people, nothing has changed. They had a mortgage to make before the financial crisis, as well as during it. If their interest in their home is truly to live in it, rather than resell it as a profit, being underwater does not matter.

  26. This debate seems to be turning into a deeper question of the societal benefits of home ownership and what credence should be given to the past financial benefits of same.

    “But for these people, nothing has changed. They had a mortgage to make before the financial crisis, as well as during it. If their interest in their home is truly to live in it, rather than resell it as a profit, being underwater does not matter.”

    Depends on why they’re underwater. If they’re under water because of a temporary event outside their control, and we as a society value home ownership, then being underwater matters a great deal. If either or both of those considerations is not the case, then the issue drifts away from keeping them in their homes to how and whether to help them in some other way.

  27. Michael,

    Thanks for the comment.

    Depends on why they’re underwater. If they’re under water because of a temporary event outside their control, and we as a society value home ownership, then being underwater matters a great deal.

    Not at all.

    Again, as I said before, for speculative investors or those who plan on cashing-out their houses (to buy a new kitchen, to invest in the stock market, to take a vacation, whatever) being underwater matters greatly.

    But for those who bought a house for sentimental reasons and do not plan on moving, then being underwater is an accounting fiction. The mortgage payments are the same as they always were.

  28. “But for those who bought a house for sentimental reasons and do not plan on moving, then being underwater is an accounting fiction. The mortgage payments are the same as they always were.”

    Completely true, in the short term. The question of equity comes when health problems or job problems forces such a person to sell anyway. A lot of people- even those who don’t want to move- may be planning on using the proceeds from the sale of their house to help them buy a new house or otherwise take care of their needs. If the Government doesn’t take steps to help them via equity preservation, then what steps (if any) should it take? I know you’ve already spoken out in favor of single-payer or some other variety of socialized medicine–any other thoughts on the subject?

    Getting back to my idea, I was thinking specifically of neighborhoods and developments built during the bubble of the past few years. Investigations of the developers, mortgage lenders and underwater buyers in these areas are more likely to dig up evidence of criminal wrongdoing which can be taken to trial. In cases where they evidence isn’t found, a public finding of gross stupidity and/or recklessness will probably kill their ability to borrow money in the forseeable future; any money paid to them would be more a stimulus for their more responsible creditors than a reward for wrongdoing.

    Tearing down the houses thus purchased: if you want to compare it to shredding stock certificates, go ahead. Unless the houses in question are both well-built and in areas with a short supply of housing, I don’t see them being worth much for the foreseeable future. Tearing them down would make land and construction materials available for higher-value pursuits now or in the future.

    Getting back to the equity of the responsible buyers in those areas. . . oops, running out of time. Will finish later.

  29. Michael,

    Thanks for the comment.

    I know you’ve already spoken out in favor of single-payer

    I have not.

    However, I am in favor of national health care [1] (or a better form of socialized medicine than what we currently have [2]). Among other benefits, it would take away the need to warp other aspects of policy making (trade, mortgages, etc) when what we’re really doing is providing socialized medicine in a far less efficient way than we could be doing.

    any money paid to them would be more a stimulus for their more responsible creditors than a reward for wrongdoing.

    I’m not sure who “them” is in this sentence.

    Tearing down the houses thus purchased: if you want to compare it to shredding stock certificates, go ahead. Unless the houses in question are both well-built and in areas with a short supply of housing, I don’t see them being worth much for the foreseeable future.

    Well, there is the obvious functional and sentimental value of serving as houses.

    I take it you believe that securing the wealth of the already fortune is more important than helping those “on the margin” move into homes. I’m not into that class-warfare style of politics, however.

    Tearing them down would make land and construction materials available for higher-value pursuits now or in the future.

    Should we begin systematically destroying our industrial and educational capacity as well, to increase the value of those physical stocks remaining, or is housing the only area in which the government should actively destroy real wealth in order to subsidize the consumption patterns of the upper middle class?

    [1] http://www.tdaxp.com/archive/2008/07/02/republicans-for-national-health-care.html
    [2] http://www.halfsigma.com/2009/02/why-healthcare-is-so-expensive.html

  30. Michael is proposing something that is radical. Throughout the 20th century a large number of homes and buildings and factories, probably millions, were destroyed by neglect – allowed to rot into the ground. They were located in places where large numbers of people and industries were leaving. It seems to me this happened several times:

    1. migration from farm to city
    2. migration from the rural south to northern factories
    3. migration from the rustbelt (industrialized north) to the south and southwest, and (industries) overseas
    4. white flight

    The homes he’s targeting are surplus, for the time being, and they are probably thought to be where people want to be. Only long term, they aren’t. Most of these homes are in the outer suburbs, or faraway bedroom communities. By 2030, a significant exodus away from those places will already be ongoing. Cities will be rapidly centralizing.

    Instead of tearing down the new houses as Michael is suggesting, they should tear down inner-city slums. Each substandard dwelling that gets demolished, move the family to a new house in the burbs. That way their kids will get to attend suburban schools. Clearing the land in inner Los Angeles, Houston, Orlando, etc. will prepare those cities for the massive influx of well-to-do professionals that will occur in the coming decades.

  31. sonofsamphm1c,

    Agreed that Michael’s plan is radical.

    The housing that Michael wants to destroy is ‘surplus’ only because the price the seller wants is higher than the price the market can support. The ‘irrationally’ underpriced mortgage derivatives you mentioned in another thread, for instance, are only ‘irrationally’ underpriced when one takes the seller’s — as opposed to available buyer’s — opinion of their present worth.

    When I watch CNBC and they make similar claims as you do, I’m struck how far against market competition much of Wall Street has become. These same arguments (that market prices do not reflect ‘value’ and should be ignored) were made by feminists in the 1970s and 1980s, who insisted secretarial work was just as ‘valuable’ as managerial work, and therefore redistributive policies were merely correcting an irrational market.

    I already blogged a major slum-to-suburb experiment, which ended in predictable failure. [1]

    [1] http://www.tdaxp.com/archive/2008/06/13/clearing-the-ghettos.html

  32. Sellers are one half the market, and they have every right to strategize and employ tactics (legal) to enhance their position. You want them self lobotomize.

    The value of the mortgage-backed securities is marked to zero because there are no buyers. In the absence of a buyer, the zero valuation is an arbitrary accounting number. It is not economic reality. It’s a complete fiction. Everybody knows a performing loan is worth more than zero.

    There are no buyers because the free market is frozen with fear, an exceptionally unusual circumstance that rarely ever happens in free markets. They are not marked to zero because they have zero value, and marking them to zero is entirely irrational (accountants love economic irrationality and Lemming behaviors), and it has had an irrational impact on the economy.

    If I advertised my vintage guitar for sale, and no buyer emerged in the first two months, does that mean my guitar is worth zero? Claiming that is economically irrational. Now, all the poor guitar players of the world would love to have my lovely 1937 D-18 for zero, but, as the seller, the market does require me to be that dumb.

    In a climate gripped with fear, a performing loan is marked to zero, and it is written off against income – income which includes the monthly interest payment for the performing loan that has just been written off to zero. Nuts.

    That is an irrational scenario, and, unfortunately for my country, it has happened.

    In the case of a bank that refuses to sell a foreclosed house below a certain price, if they believe they will make more money over time on the house than they could on the lower amount of cash the buyer wants to pay at that moment, then it is a rational market tactic to retain possession of the house. Time will prove whether they will be right or wrong.

    full disclosure – I seldom watch financial TV.

    I would say you want an executive for a secretary’s wage, and I’m saying the executive is worth more – even if he’s in the soup and bread line this year. This year will pass.

  33. S.,

    Thanks for your comment.

    Sellers are one half the market, and they have every right to strategize and employ tactics (legal) to enhance their position. You want them self lobotomize.

    I agree with the first sentence, and I don’t understand what you mean by the second.

    The value of the mortgage-backed securities is marked to zero because there are no buyers. In the absence of a buyer, the zero valuation is an arbitrary accounting number. It is not economic reality. It’s a complete fiction. Everybody knows a performing loan is worth more than zero.

    Are you being serious, or is this hyperbole?

    I, for one, would gladly pay $1 for a performing AAA-rated mortgage backed security. I could make back by investment in about a minute!

    I will await your clarification, but it strikes me as far mor elikely that the market price for these securities is below what the owners wish to take — say, between 40% and 60% for the bulk. In the same way, people who bought oil with a face value of $140, people who bought a stock index fund at 14,000, people who bought homes with a face value of $200,000, people who had been earning $80,000, each may face a lack of buyers for their products at prices they feel is “fair.”

    It is not true in these cases that there are no ”buyers’ — only that there are no buyers at a price they would like.

    Now, of course, some stocks are up on the year, others have sunk almost completely. Same with personal incomes, home values, and so on. I’m not saying there is no variation in the price of these assets — just that asserting there are “no” buyers reads like code for “no buyers at a price I prefer.”

    If I advertised my vintage guitar for sale, and no buyer emerged in the first two months, does that mean my guitar is worth zero? Claiming that is economically irrational. Now, all the poor guitar players of the world would love to have my lovely 1937 D-18 for zero, but, as the seller, the market does require me to be that dumb.

    This is a good example for the difference of zero market value, at zero buyers at a price prefered by sellers. I would wager there are very few guitars sold on ebay, for instance, with a winning bid of $.01. I imagine there are a lot of guitars there that go unsold because of a minimum winning price requirement. The first indicates an absense of buyers. The second represents a hope on the part of seller that the price will rise.

  34. “The housing that Michael wants to destroy is ’surplus’ only because the price the seller wants is higher than the price the market can support.”

    Oddly enough, this statement works well with Sam’s statement about population flows. How much housing of a price supportable by the market can be introduced by renovating or rebuilding housing in the inner cities, the areas those middle class people are gradually migrating towards?

    I wouldn’t say that the surplus of outer suburban and exurban housing is only because of the price, though. In many cases, you have housing that was built below standards or at least on the cheap. In some cases, it was the sites that were substandard, with subsoils that couldn’t support what was built on top of them for long (a big issue here along the Front Range) or a risk of wild fire or flood that was addressed only with insurance and hope of FEMA funds. Even if the prices fall for that housing, who is going to live in them aside from ghetto dwellers who can’t find better housing or rich morons who cost society more than they contribute?

    Which gets back to the issue where I left off in my last comment–the people living in the areas built up during the boom. What fate is best for them and for society?
    Negative equity in an underpopulated neighborhood might be at least partially eliminated by turning large contiguous blocks of vacant housing into parkland, wilderness area or (if otherwise absent) other community or commercial services. At least, that’s the case in large parts of Colorado where recreational areas and natural beauty are frequent selling points.
    But what if it isn’t? If a nearby park or school or whatever built nearby isn’t enough to raise prices back to parity, you seem to have 3 ways to view the situation:
    1. Assume that equity is the be-all, end-all of long-term financial security, like I did and many others do. If you can’t deconstruct and reorganize an area back to neutral or positive equity, what other options exist besides physically removing the remaining occupants to an area where they can have that good equity?
    2. Assume there are many ways to address future insecurity besides equity correction. Socialized health care is one. What others exist that denizens of this blog can live with?
    3. Assume there is little that can be done. Limit intervention to deconstruction of sub-standard housing- or doing nothing- and wish residents well.

    What methods of equity regeneration, viewpoints and/or options have I missed? Where do your preferences lie?

  35. “Are you being serious, or is this hyperbole? …”

    “Some analysts, including Rochdale’s Bove, argue Citigroup is solvent, and a victim of accounting rules that place too much emphasis on the current market value of assets. Because no one wants to buy soured mortgage-related assets that banks including Citi hold, their values have plunged — although the loans underlying many of them are being paid. …” – Richard Bove is an experienced financial analyst

    “Accounting rules require the banks to mark almost all such assets to market-adjust their value according to prices brought by comparable securities in recent sales. But the markets for many of these assets are frozen, making it difficult or impossible to value them accurately. …”

    http://money.cnn.com/2009/02/27/news/economy/tully_banks.fortune/?postversion=2009022707

  36. Michael,

    Thank you for your comment. I will try to address it soon.

    sonofsamphm1c,

    You did not address my point, but merely restated facts with which I agree.

    What I called “hyperbole” was your assertion that performing AAA MBSes are worth $0, with no buyers. I offered an alternative explanation that they had fallen significantly in market price, say 40%-60%, and that no buyers could be found at the price that Citi et al. would prefer. Could you clarify this?

  37. The securities in question are lightly traded.

    Consider common stocks, which are heavily traded. Mark to market means exactly what it says. In a heavily traded instrument, like a common stock, the sellers asks a price. The buyers make a bid. If the seller stays firm, the buyers make an unconscious group decision, they either go up to the ask, or stay with their bid. If the sellers detects the buyers are not moving up, the sellers make a group decision – usually to lower their price, and the buyers have their quest. 100 sold at 2 instead of 2.1. That process will ratchet up and down all day based upon all sorts of external and internal stimuli – news and rumor. That is mark to market on a by second basis.

    What happens when there are no buyers because they have no credit, and are scared to death of using their own cash? Would the seller of common stock tick down his price until 4pm, and resume ticking it down until 4pm of the next day – on and on? Or would trading rules rush in and end the insanity by suspending the mark to market activity until rationality returned? Are we going to let some kid in Sioux Falls break his piggy bank and buy the entirety of Apple for .000000001 cents a share?

    What Bove appears to be saying, and he is inside these banks quite often, is that they have MBSs priced far below the present value of their performing loans. That is irrational. In a normal market, that price would get the MBSs sucked off the table. Mark to market cannot work in an irrational market. Insisting markets are rational when they clearly are not is irrational human behavior.

    As for the actual discount, I don’t know it. The media uses “marked to zero.” That probably is an exaggeration.

  38. This data is helpful in understanding how government subsidies – guarantees, VA programs, preferential interest rates, etc. – influence housing values, though subsidies alone do not account for all of the value increase. F&F and collateral-back securities began around 1938:

    http://www.census.gov/hhes/www/housing/census/historic/values.html

    I myself would not mind seeing that unravel, but not in one fell swoop. There is no rational reason for housing and land to be so expensive. In the future people will need that money for energy, which is about to go through the roof. Something is going to have to get cheaper, and it’s likely to be housing.

  39. sonofsamphm1c,

    Thank you for your replies.

    Again, I want to emphasize that phrases like “no buyer” and “zero” are rhetorically powerful but deceptive.

    Perhaps you can correct me: As I understand what is going on, banks and other regulated financial institutions need to establish their solvency and safety to the government. This is done through the federally-requied “mark to market” accounting. The problem is that beacuse fo their previous investment sources, banks now find themselves holding MBSs that, if they would wish to sell, would have to be sold at a substantial discount.

    The same is true of course, for oil, stocks, mortgages themselves, and many other financial instruments.

    These financial institutiosn do not believe it is fair that the same accounting rule that would price oil pruchased for $140 at $40, and a NYSE index find purchase at 14,000 at 7,000, and a house purchased at $2,000,000 at $1,000,000, would price an MBS at a heavy discount as well.

    If these financial institutions would attempt to sell, they have two choices

    a) they can sale them for the value they priced at, in which case there would be no buyers
    b) they can sell them at some moderate discount, in which case only the most speculatiev and risk-friendly investors would occasionally buy them (a relatively less liquid market)
    c) they can sell them at some heavy discount, at which time the market becomes relatively liquid as many purchasers step up to buy them

    Again, as I understand, mark-to-market is allowing these financial institutions to use (b), the middle ground, where MBSs are not marked at face value, but marked far above a value which would bring a large number of buyers to the market. Of course, as a consequence of the upper-end estimates that apparently are allowed by mark-to-market, the market is relatively less liquid. (In the same way, a gas station at the interstate which sells gas at $3/gal will have far fewer customers — essentially, a less liquid market for gas — than one that sells gas at $2/gal).

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