Wednesday, May 14, 2008

Housing Policy Incoherence Part I: Which Borrowers Should Be Helped?

Every day I read multiple posts touting or panning a "solution" to the housing mess. A few weeks ago Risk and Return has a post criticizing a plan which would fund acquisition of abandoned foreclosed homes by states and localities. There are many good points made in the post, but it (and every other post on various plans I've read) does not address a fundamental question: who should be helped?

Let's start by talking about the characteristics of a borrower we're most likely to agree we should help.

This borrower (let's personalize it and call her Teresa) owns and has occupied her very modest home for 40 years. Teresa is 82, worked all her life as a maid, has limited reading and math skills, is disabled by arthritis, and supports herself on fixed social security payments. She has no living relatives except for her severely retarded 55 year old daughter, who lives with her and also receives disability payments. Over the years maintenance problems with the house accumulated because Teresa lacked the money to fix problems as they arose. An unscrupulous mortgage broker proposed a loan with a low teaser rate. Teresa used the funds to repair the house, but when the rate adjusted she could not afford the new payments. She is now in foreclosure, and when she's evicted she and her daughter will be homeless.

Now, let's meet Tom Rakewell. Tom, a recent MBA graduate, bought a luxury condo in La Jolla in 2005 using 100% financing and rented it to a college friend with the intention of flipping it in a year or two. In 2006 Tom took out a $200,000 stated income home equity loan. Tom exaggerated his income and used the money to start a brokerage business. The brokerage business failed and when the interest rates reset on his loans Tom was unable to keep the payments up and the condo is in foreclosure. Tom is living with his parents at their Santa Barbara estate.

Let's parse out Teresa's and Tom's respective situations:

Modest housing versus luxury housing. Some believe people who got in trouble buying high end housing should not be helped.

Long term owner versus recent owner. Some argue recent purchasers who bought at the top should take their lumps.

Owner occupied versus investor/speculator. Some argue investors and speculators should not be bailed out.

Limited opportunity for recovery versus good future prospects. Some argue those who are in a position to start over should not be helped.

Loan funds used for necessities/productive purposes versus loan funds used for frivolous purposes. Some argue people who bought big screen TVs and new pickups with their home equity lines do not deserve help.

Limited capacity and/or duped versus knowledgeable and/or complicit. Some argue those who knew or should have known the risks of the loan they were entering into should not be helped.

Unable to make contractual payments versus able to make contractual payments. Some argue those who are able to make their contractual payments should not receive relief.

Able to make modified payments versus unable to make modified payments. Some argue to receive a modification ability to succeed under the modification should be demonstrated.

No housing alternatives versus those with housing alternatives. Some argue those who have housing alternatives after foreclosure (e.g., move back in with Mom and Dad) should not be helped.

I don't expect there would be consensus on which criteria are most important (although I do think a program which provided funding to a municipality to buy Teresa's house at the foreclosure sale and let her continue to live there would get more support than such a program benefitting Tom).

Part II of this framework is to identify who should help the borrowers.