There is little question that the root of our current economic problems is the housing market crash. The severity of the problem is daunting: at the end of 2010, 23.1 percent of all residential properties with a mortgage were “underwater,” meaning that borrowers owe more on their mortgages than their homes are currently worth. That “negative equity” totals $750 billion. Moreover, the housing market is largely frozen, due in large part to the fact that banks attempting to foreclose on delinquent homeowners cannot produce titles for said properties. They were “bundled” to sell on Wall Street, and the “paper trail” determining who actually owns the deed to a given property has been obliterated. This reality produces an extremely troubling question: how much moral hazard are Americans willing to accept to get the housing market functioning again?
With to respect that market, moral hazard has been an all-encompassing affliction. Lending institutions were more than happy to grant mortgages to borrowers manifestly ill-equipped to pay them back. Borrowers were more than happy to sign on the dotted line and take the money, even as they ignored the implicit contractual obligations. Government was happy to pressure lending institutions to make sub-prime loans to unqualified applicants, often with ridiculous terms attached, such as no money down. Banks in turn extended those ridiculous terms to prime borrowers, vastly expanding the pool of risky loans. The risky loans were then pooled together and sold to investors, many of whom were convinced to buy them when the financial ratings agencies (who were paid by the banks), gave those securities an AAA rating.
Virtually all of the activity that took place during the boom years was based on two ridiculous premises: one, a house was viewed to a large degree as an entitlement, when the government contended (and still does) that a certain number of mortgages should be exempt from the normal requirements imposed on borrowers; and two, real estate values would continue to go up indefinitely. Neither of these premises withstood reality. The rest is history.
So how do we get out from under? One plan is being floated by the Obama administration. Another one is being proposed by the banks and the state attorneys general. The former is aimed at aiding homeowners, by allowing them to re-finance their loans to prevent foreclosure, with a possible reduction in principal as well. This plan underwrites borrower irresponsibility, allowing people who bought more house than they could afford, or failed to make payments to which they contractually obligated themselves, off the hook for their bad decisions.
The latter is a plan attempting to address the reality that banks, via a concept known as “robo signing,” were foreclosing on properties for which they could not produce proper documentation of ownership. This plan underwrites lender irresponsibility by giving them the opportunity to pay a one-time fine, and possibly get immunity from further litigation related to improper foreclosures. That allows a lot of bankers who knew better than to make questionable loans and bundle them into questionable securities off the hook for their bad decisions as well.
Both plans are aimed at stabilizing, and eventually re-invigorating, the housing market.
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