international analysis and commentary

As the campaign marches on, so too does the housing crisis

56

After weeks of negative ads, glossy mailings, and otherwise intense campaigning, the circus that is the GOP presidential primary election has finally left Florida and Nevada. While residents in those two states may be breathing a sigh of relief, there’s one thing they probably wish the campaigns could also take with them, along with their lawn signs: their massive foreclosure crisis.

True, it’s hard to call it a crisis when it’s been going on for years. Currently, one out of every seven homes in Florida is in foreclosure, about the same as a year ago. Home prices are still down 40% from their peak and haven’t shown any real improvement. Although lower than in Florida, Nevada’s foreclosure rate is the second-highest in the nation and its houses have lost over half their value.

In a situation like that, many are surprised that a candidate like Romney was able to win the recent elections there. After all, his solution to the foreclosure crisis is, well, to do nothing and wait for them to stop. In fairness, he believes that the weak housing market is merely a symptom of a broader weak economy, and that his policies to create jobs will spur the economy—and thus the housing market—back to life. But he proposes no fix for the housing market specifically.

Let us set aside the question of whether or not his policies would help the economy (I’m skeptical, to put it mildly). Undoubtedly, Romney is right that the housing market is a symptom of our economic woes, but what he misses is that the housing market also keeps the economy weak in the first place—the causation arrow, in other words, points in both directions.

To fully understand this, we have to go back to 2008. The bursting of the housing bubble inflicted a huge negative shock on spending in the US economy. In the course of six months, 8 trillion dollars in housing wealth and over 4 trillion in stock wealth disappeared, reducing household net wealth by 20%. In response to suddenly being poorer, households radically cut back their demand for goods and services. Demand for new construction dried up. Of course, this led to massive layoffs, reducing income and economic security and resulting in even more cutbacks in spending—thus perpetuating the cycle.

There are two lessons to this story. First, the recession was caused by a precipitous drop in demand, then supply reductions—such as layoffs—followed. In other words, the main problem was—and continues to be—the lack of consumer and business spending. Second, this drop in spending was caused by a loss of wealth, which blew massive holes in household balance sheets.

Unfortunately, the economy hasn’t made much progress on this front. Since the depths of 2008, household net wealth has risen by less than 10%, and remains trillions below its pre-recession peak. In Florida, over 40% of homeowners are “underwater”, meaning that their mortgage is costing them more than their house is worth (thus actually reducing their net worth). In Nevada, that figure is closer to 60%.

And that’s really the problem: the economy can’t regain steam until consumers start spending again, and that will only happen once their balance sheets are repaired and they’ve regained much of their lost net worth. Which means we need the housing market to recover.

But what of the arguments that any aid to distressed mortgage holders is just rewarding bad behavior? Few remember this, but the original Tea Party movement was ignited by Rick Santelli’s rant against mortgage assistance, which he described as “paying for your neighbor’s mortgage.” And along with being unfair, won’t this just promote bad behavior in the future?

These objections, however, don’t stand up to serious scrutiny. Foreclosures do not exist in a vacuum. On the contrary, a foreclosure depresses the value of nearby properties, leading to more homeowners finding themselves underwater and deciding to simply walk away from their homes. Even the homeowners that decide to stay tend to reduce their spending on goods and services as their net worth falls. This, in turn, causes more jobs to be lost. In the end, foreclosures actually lead to more foreclosures. That’s why Florida and Nevada have the highest foreclosure rates in the country, even among prime mortgages. The contagion has spread, sweeping up everyone. At this point, objecting to any type of assistance to distressed homeowners is like objecting to the fire department putting out the fire in your neighbor’s house, because hey, it’s not like we want to reward him for being careless, right? An hour later, the entire block is on fire.

Despite the recent positive economic news, the housing market is still on fire, holding back the economic recovery that millions of unemployed workers so desperately need. Ironically enough, one of the better proposals to help distressed homeowners comes from one of Gov. Romney’s economic advisors, Glenn Hubbard. A former key Bush advisor and current dean of Columbia University’s business school, Hubbard proposes that the government buy up mortgages from banks and refinance them at a fixed 5.25%, which they estimate is what would be available to homeowners if the credit markets were functioning correctly. Such a deal would also allow underwater homeowners to reduce their mortgage to 95% of the value of the house, thus guaranteeing that homeownership would no longer be a drag on household balance sheets.

This type of policy has strong political support, and President Obama proposed a policy similar to this in his State of the Union speech. But the Hubbard proposal carries a heavy price tag, and in this paralyzed political environment, Congress can barely even pass the bills necessary to keep the lights on.

Another idea is to circumvent Congress by using Fannie Mae and Freddie Mac, which currently already own about 30 million mortgages and either own or guarantee over half the mortgages in the country. The two mortgage giants could refinance and perhaps even reduce the principle on distressed mortgages. But Edward DeMarco, the acting director of the Federal Housing Finance Agency (which was put in charge of Fannie Mae and Freddie Mac when the federal government took control of them), has not been receptive to these ideas. DeMarco is a hold-over from the Bush Administration, and for nearly two years Obama has been trying to replace him, but his preferred candidate has been blocked by the Republican minority in the Senate. So, DeMarco stays, Congress does nothing, and the foreclosure crisis blazes on.