A Government Bailout

In attempting to address the current foreclosure crisis, many are looking back in American history to see how this problem had been addressed previously. When reasonable people are faced with a problem, a good first step is to look around. See if someone has faced the same issue, examine what actions were taken, qualify how successful the actions were and then decide if that solution will adequately solve the problem at hand.

A possible solution to today’s foreclosure crisis is a program mirrored to what Franklin D. Roosevelt created in 1933, The Home Owners’ Loan Corporation (HOLC). The mission of the HOLC was to purchase non-performing mortgages from banks and write new mortgages that homeowners could afford. I’m not going to go into the details of the program but during the period the HOLC was conducting business, it acquired nearly 20% of the outstanding mortgages in the country. It couldn’t help every homeowner and ended up foreclosing on approximately 200,000 homes. It was however, successful in rewriting over 80% of the mortgages.

The corporation was closed in 1951 showing a small profit for their efforts and had sold off the entire inventory of foreclosed properties. The HOLC proved to be an example of a successful federal program that not only accomplished its goals but also did it at no cost to the taxpayer.

A growing group of influential people, ranging from Senator Christopher Dodd of Connecticut to Alan S. Blinder, former vice chairman of the Federal Reserve as well as Nicholas Retsinas, former Federal Housing Commissioner, are pushing for the creation of a similar corporation.

I agree that this is a solution that deserves to be discussed and is a viable solution to the problem at hand. We do need to keep in mind that we will not be as fortunate this time around. The fact that the HOLC successfully completed their mission with no cost to the taxpayer should not lead us to think that a similar program today could be effective at the same cost. Today’s borrower's live by a different set of standards then those of the thirties.

The attitude that our parents and grandparents had, of paying your rent (or mortgage) first, is no longer prevalent. The fear of being thrown out of your home and having no place to live is no longer first and foremost in our minds. In addition, today’s homeowner has little or no money of his own invested in the property.

The February 29th, 2008 issue of The New York Times contains an article, “Facing default, some walk out on new homes”. This article confirms what I’m saying.

“I think I could make a case that some borrowers were ‘renting’ (with risk), rather than owning,” Nicolas P. Retsinas, director of the Joint Center for Housing Studies at Harvard University, [and former Federal Housing Commissioner] said in an e-mail message.
For some people, then, foreclosure becomes something akin to eviction — a traumatic event, and a blow to one’s credit record, but not one that involves loss of life savings or of years spent scrimping to buy the home.
“There certainly appears to be more willingness on the part of borrowers to walk away from mortgages,” said John Mechem, spokesman for the Mortgage Bankers Association, who noted that in the past, many would try to save their homes.

Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania is quoted in the same article:

“Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”

The National Association of Realtors tracks ongoing trends in homeownership. This is what they’ve found:

“Last year the median down payment on home purchases was 9 percent, down from 20 percent in 1989 Twenty-nine percent of buyers put no money down. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home in order to cover closing costs.”

The mortgage industry has been meeting the needs of the first time homebuyer by developing programs that enable people to purchase homes with little or no money down. This was done to encourage home ownership. History has proven that a higher percentage of homeowners in a community creates a more stable community. Over time, as mortgages are paid down and property values increase, each family’s wealth increases.

Over 60% of the US economy is based on consumer spending. In order to keep the economic engine of our economy running, the government encourages consumers to spend. Consumers are expected, if not encouraged, to spend above their means. Homeowners have been using their homes as an ATM machine, drawing down the equity in their homes to feed their spending addiction.

The majority of the mortgages today that are in default are not purchase money mortgages; they are cash-out refinances. Recently, homeowners bought their homes with very little or none of their own money. They have little motivation to make their mortgage payments when they see the value of their homes falling. Those who took the equity out of their homes by refinancing, have even less motivation. They converted the paper profits of the housing bubble into cash. Cash they could spend anyway they wanted. It’s hard to find any motivation for these individuals to pay what they owe to the bank.

The homeowner from the thirties that got into financial trouble appreciated whatever the government or any one else did to help them out. They were determined to do whatever they could to live up to their financial obligations and hold on to their home. Today’s homeowner feels that he is entitled to be bailed out and feels no obligation to live up to his responsibility to the lender. In fact, they believe that the lender is the cause of the problem!

Communities can’t survive with a high level of foreclosures. Some form of intervention needs to be implemented and a modern day HOLC is an excellent approach to address the problem. We all need to realize though, that there will be a hefty cost to the taxpayer this time around.