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Holden Lewis
Past posts from Holden Lewis's Web log about mortgages and real estate, and how they are affected by the economy.
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Foreclosures? Let 'em rent

Monday, July 13
Written 10:30 a.m. EDT
LET 'EM RENT: In response to my blog post from last week, "Theodicy and mortgages," Michael Hilmen writes about artificially high home prices:

As Mark (Burger) noted, foreclosure (and bankruptcy, but that's another topic) is an important mechanism in our economy to allow for capital allocation to reset once it has been placed in efforts that are not profitable. For a number of reasons (artificially low interest rates and an artificial secondary market for bad loans to name but two) we have had this speculative run on home prices and seen the prices skyrocket. These prices need to come down so that they can be purchased by real people working real jobs with real wages with long-term homeownership as their goal.

... Foreclosure is the mechanism with which to do that. And when you are foreclosed on, you rent. I rented for years before buying my first home; I don't see the problem. The foreclosures will be purchased at a price that is affordable and maybe turned around and rented to meet the increased rental demand.

By keeping the prices high, no one can buy ... and that does no good for anyone. These people may keep their homes, but they will be paying mortgages that are probably on par with what rent would be (or higher), and they will have to wait five, 10, 15 years for their homes to appreciate to their original purchase price (and with inflation taken into account they will probably never get there). If they foreclose, they walk away, rent and in seven years (and maybe less given the number of foreclosures we are seeing) they can buy a new home at a price they can afford and have equity right away, given they will put at least 10 percent down. And a side benefit, this does not cost the taxpayers.

Last month, I attended a news conference for Shaun Donovan, secretary of Housing and Urban Development. Donovan said that when he took over at HUD, his first responsibility was to stem the tide of foreclosures. I asked him a question that Hilmen probably would have asked, had he been there: Why didn't Donovan choose to just let foreclosures happen instead of delaying the inevitable for many homeowners? That way, houses get cheaper faster, benefiting first-time buyers. Why not focus, instead, on building a safety net for people who are displaced?

Donovan said that I was assuming that housing markets would stabilize faster if the government didn't try to prevent some foreclosures. He didn't think that this assumption was correct: "Our fundamental judgment is that the foreclosures were a part of the problem rather than a path to the solution."

Donovan added that not every foreclosure can be prevented. "But, fundamentally, if you look at the trends, we had gotten to a point where foreclosures were becoming a self-reinforcing cycle where roughly 50 percent of all home sales in the country were based on foreclosures, where the concentration of foreclosures, particularly in certain communities where subprime lending was fairly geographically targeted, was driving down neighboring property values substantially.

"One of the fundamental things to understand is to use the analogy of a house burning down. That has the possibility to light the entire neighborhood on fire. There's been studies that have shown concentrated foreclosures produce, on average, a 5 (percent) to 10 percent decrease in surrounding properties. So, for the broader health of the real estate market, I think our fundamental analysis was that allowing foreclosures to continue at the scale they were wasn't going to lead to a bottom, it was going to lead to a much more substantial decline than would have happened otherwise."

Yeah, he really talks like that -- in complete paragraphs.

-- Posted: Jul. 13, 2009

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