There is an insidious hook buried inside President Obama’s expansion of an existing mortgage refinancing program. He sold it as a way for underwater homeowners to reduce their monthly payments by refinancing at today’s low rates. That would save them some money, he said, “…and it gets those families spending again.”
I mean, come on. With our huge trade deficit ($500 billion by year end), a big part of consumer spending goes into baubles from overseas—so we’d prop up the Chinese, German, and Japanese economies. How about using that extra money to pay off credit cards or save for retirement? He should have mentioned those options, but didn’t.
At any rate, the plan was billed as an additional governmental action to “heal” the housing market. Alas, today’s housing market is the consequence of a historic credit bubble that the Greenspan Fed engineered. Cheap, unlimited credit caused demand for houses to spike. Developers went crazy. Lenders made liar loans. Values soared. People bought houses sight-unseen to get rich. Cities and states took in their share in taxes. After years of overbuilding, the construction bubble hit its peak in January 2006, when housing starts clocked in at an insane annual rate of 2.3 million units. By comparison, housing starts came in at 658,000 units this month—still contributing to the hangover from the construction bubble: the gigantic inventory of vacant homes.
So, where are home values going? Down, according to another set of numbers we got today:
- The August S&P/Case-Shiller Home Price Index dropped 3.8% from the same period last year. It’s down 31% from its peak in July 2006.
- The Federal Housing Finance Administration index dropped 4% from last year. It’s based on homes with mortgages backed by Fannie Mae or Freddy Mac, which taxpayers are still bailing out.
Clearly, this market has little chance of recovering anytime soon. Even Obama admitted that much when he said, “Given the magnitude of the housing bubble, and the huge inventory of unsold homes…, it will take time to solve these challenges.” Yet, his program is an inducement for homeowners to stay in their homes even if they’re way underwater. And in this foul market, it’s an insidious inducement.
When a non-recourse mortgage exceeds the value of the house, homeowners need to do some basic math. They no longer own equity in the house. They’re making payments on an overpriced rental unit. Financial institutions and developers walked away from properties. Why? Because they have people on staff trained to do basic math—and they determined that it would save them a fortune to walk away.
It’s harder for a homeowner to do the math because feelings get in the way. Guilt and shame, among them, and the fear of “ruining” your credit. Now Obama made it even harder by promising to make it cheaper to stay.
But a homeowner who owes $250,000 on a house that is now valued at $200,000 makes a financial mistake by staying. The housing market would have to recover 32% before he would break even after fees when he sells the house. Not particularly realistic in most markets. If he walks away, he gets rid of the mortgage, and his net worth jumps instantly by $50,000! He might rent for a while (it’s cheaper), then buy something at a lower price, and finance it at the low rates the Fed continues to force on the market. Thus, he’ll benefit for himself if home values start rising again. And the FICO score? To heck with it. $50,000 is worth a lot more than that silly number. The math isn’t that hard. And Obama’s program is a special tax for people who can’t do it.