India cannot grow fast again till the US economy recovers. And US recovery depends on reviving the housing sector, whence the downswing began. Alas, the Obama Plan for housing is a crutch, not a cure. Putting all the blame on insufficient regulation and overpaid, greedy lenders cannot rectify the structural flaws of US housing. Equally to blame is the political illusion that by tweaking markets and arm-twisting lenders, you can make all Americans home owners.
The Obama Plan has three main components. One, cash incentives (totaling $ 75 billion) for lenders and home owners to renegotiate mortgages. Two, allowing those whose mortgages exceed home value to refinance, up to 105% of the home value. Three, fresh capital of $ 200 billion for government agencies (Fannie Mae and Freddie Mac) to expand mortgage lending.
The Obama Plan aims to raise distressed home values by $ 6,000, cut foreclosures, and prevent entire localities from become ownerless and derelict. Whether lenders will be able to renegotiate millions of mortgages remains unclear. Many mortgages have been sliced and bundled into CDO bonds, and any administrator who writes down a mortgage risks being sued by disgruntled bondholders.
Refinancing mortgages up to 105% of home value will be disastrous if home prices fall further. The crisis owes much to the slack lending standards of Fannie Mae and Freddie Mac, yet the Obama Plan provides these agencies additional capital to extend sub-standard lending. This risky approach will work only if home prices rise soon. Otherwise, it will cause another housing crisis within two years.
The Obama Plan addresses current distress, but ignores two fundamental flaws in the whole housing system. One is the limited liability of home owners. In most countries, a mortgage is secured by the value of the home plus a personal guarantee of the home owner. So, if he defaults on mortgage payments, the lender can go after his salary or other assets. This is called a full recourse loan, and encourages home owners to do their best to repay loans.
But the US has non-recourse mortgages, secured only by the house. The lender cannot go after other assets of the borrower. If the market price of a house sinks below the mortgage outstanding, the owner can simply walk out and mail the house keys to the lender, with no further liability. This “jingle mail” loophole encourages willful default. European countries have full recourse mortgages—the lenders can go after all assets—and so have far lower default and foreclosure rates.
The Obama Plan is silent on closing the jingle-mail loophole. Politicians currently paint all lenders as crooks and borrowers as victims, and don’t want the supposed crooks to go after the other assets of the supposed victims. Such populism ignores the perverse incentives of jingle mail, which erode the foundations of the housing market.
The second, more fundamental flaw is the political determination to tweak housing markets to somehow attain the ideal of universal home ownership. In a market system, monthly mortgage payments are necessarily higher than monthly rents. People with uncertain incomes should rent cheaply, not borrow expensively to buy houses. Renting is an essential part of a housing market, not a deficiency.
Political measures to subsidise ownership and discourage renting have contributed to terrible lending and borrowing practices that caused the current crisis. Instead of reforming these, the Obama Plan provides billions to subsidise those same terrible practices. These practices survived for 60 years because of a quirk: US home prices never fell after World War II. Yet in a market system prices must fall as well as rise. When finally US home prices fell in 2007, the system collapsed. The US must, like other countries, have a housing system that can cope with declines as well as increases in home prices.
US politicians aim for universal home ownership in four ways. One, unlimited tax exemption for interest on home loans. Two, the creation of Fannie Mae and Freddie Mac, agencies with quasi-government guarantees to underwrite more mortgages than markets alone would find prudent. Three, federal mortgage insurance. Four, several laws—including the controversial Community Reinvestment Act—obliging banks to lend to all areas, and not discriminate against poor or crime-ridden neighbourhoods.
Though well intentioned, these measures are the wrong instruments. If you seek universal home ownership, the best way is massive public housing followed by privatization (sale to the renters). Governments should build low-cost houses and rent these cheaply to people with low or uncertain incomes. Renters who pay rent for a specified period—say 12-15 years—will become owners. Margaret Thatcher in Britain converted millions of government tenants into home owners.
This is not socialism. Even in pre-communist Hong Kong, which came closer than any other country to laissez faire, almost half of all housing was public housing. It was a non-market measure for a non-market aim.
If Obama is serious, he must grasp some nettles. He cannot have both responsible lending practices and universal home ownership. If he wants responsible lending, he must explicitly abandon the goal of universal home ownership, and aim for affordable rents. This approach implies limiting or abolishing tax breaks on mortgage interest for home owners, and instead providing subsidies for low-income renting. It implies full recourse mortgages. And it implies that prospective home buyers must put down 20% of the price of homes, so that the housing system can withstand a 20% fall in home prices. This will of course mean less home ownership and more renting.
If on the other hand Obama wants to aim for universal home ownership, he should opt for massive public housing followed by privatization. Renters of government housing should eventually become owners.
Alas, the Obama Plan refuses to face up to this hard choice. Instead it seeks to return to the pre-crisis situation, which was based on the assumption that home prices would always go up and never down. This is myopia or cowardice, or both.
