Solving the Housing Market Riddle

Even the experts are having a hard time assessing the current housing market, as conflicting reports and inconsistent metrics make it difficult to predict which direction things will turn, especially when even relatively minor events have major impacts on a fragile recovery. One thing that everyone does seem to agree on, is that things will be more stable, healthy and predictable when more mortgages are made up of the sort of traditional loans and lending factors that once made real estate nearly as dependable as a Swiss timepiece. Unfortunately, there doesn’t seem to be much emphasis on making that the case.

According to most indexes, the national housing market enjoyed a solid year of slow but steady improvement that has only begun to level off the last couple of months. Interest rates began to creep up after Fed Chair Ben Bernanke hinted that the Federal Reserve might begin tapering its bond-purchasing program this fall, but because the housing market has been one of the few bright spots in the economy at large, Bernanke dialed back those plans earlier this month, hoping artificially-liquid lenders and pent up housing demand will result in more long-term borrowing.

But interest is only one piece to the puzzle and keeping rates artificially low can have disastrous consequences, as we saw during the housing boom. It’s true that variable rate and interest-only loans are not nearly as common as they were during the run up to the bubble, but while that might mean less defaults resulting from payment resets, sale prices are still deeply impacted by how much home a specific monthly payment can finance. As interest rates rise, that number obviously falls. If sale prices stop going up (or worse yet fall), homeowners suddenly have less equity.

The slow and steady rise in values has helped reduce the total number of negative-equity, or “underwater” loans, though that number remains significant. About 2.5 million homeowners have gotten right-side up in recent months, but over 7 million still have houses worth less than they owe on them. The Fed has already nearly quadrupled its balance sheet with all of this debt purchasing, something it clearly cannot sustain into perpetuity. Keeping money so cheap also continues to discourage people from saving money that they cannot get a meaningful return on, and less people with significant savings also means less potential quality borrowers to purchase homes as the market improves – a pool already hampered by the high number of potential buyers who saw their credit scores plummet during the bust.

There’s also the massive shadow inventory which still persists, as banks remain reluctant to pull the trigger on many delinquent, underwater mortgages, not wanting to recognize the loss or add to the large pool of homes they are already charged with maintaining until they can resell. Several cities in California are even exploring the use of eminent domain to seize loans on homes in danger of being foreclosed on, in order to speed up the process and protect surrounding property values.

That leads us to the lack of productive loan modifications aimed at helping homeowners who are willing and able to remain in their homes, were a practical payment schedule reached. If there’s a silver bullet in this dilemma, this may well be it. The main federal program is the Home Affordable Modification Program, or HAMP. To put it mildly, HAMP has failed to live up to its expectations.

Originally intended to assist 4 million homeowners in avoiding default, less than a million mortgages are enrolled in HAMP today. The program has consistently been described as a bogged down bureaucratic nightmare with an opaque denial process. Despite over $4 billion in incentives to mortgage servicers, the re-default rate of mortgages that received modifications is alarmingly high. A recent report by the Special Inspector General for the Troubled Asset Relief Program (SIGTARP) identified just over 300,000 re-defaults out of the 1.19 million homes receiving modifications under HAMP. Re-default rates on modifications issued in 2009 are nearly 50 percent, 38 percent for those issued in 2010.

Why are so many people who received modifications going into re-default? Well, we don’t exactly know, because somehow the Treasury Department didn’t track it, or require the mortgage servicers who took the incentives to do so. That means that taxpayers have paid about $800 billion in incentives to these companies, just on loans that re-entered default anyway. The SIGTARP report (click here to read PDF) faults Treasury for failing to track re-defaults in order to determine what factors are impacting them and hopefully avoid more modified mortgages from defaulting in the future.

The report does suggest that many of the mortgages that went into re-default should have been recognized as unsustainable. It also includes several stories from homeowners in HAMP alleging widespread fraud and abuse by mortgage servicers. And again, that’s just feedback from the homeowners who were approved, saying nothing of those who seemingly met the program’s guidelines but were denied modifications. 

There are other programs in which federal funds are being distributed as well. In Florida, a state program that reduces principal on some underwater mortgages opened Wednesday. Applications poured in so fast (10,000 the first day), that they crashed the online application system. The program is funded federally from the $1 billion in assistance the state was awarded as part of the Hardest Hit Fund.

The program had previously provided mostly monthly mortgage assistance to homeowners who were unemployed or underemployed. After being criticized for spending only a small portion of that money, Florida announced last week that it would expand the program to include reducing the remaining principal on certain mortgages. The Florida Housing Finance Corp. plans to distribute $350 million to such cases, though it is expected to help about 10,000 people total – or 10 percent of the state's underwater homes.

Over the past few years, we have probably all known more than a few people who were good borrowers, people who wanted desperately to stay in their mortgage and their home, and seemingly could have managed it, were lenders willing to cut some losses and modify their loan to reflect the reality of current markets. Conversely, we each probably know more than a few who were in a home they should have never been approved to buy and could never realistically repay, even with significant modification – homes that needed to be foreclosed on. There doesn’t seem to be a lot of correlation in terms of who received assistance and that's a problem.

Many taxpayers rightfully feel as though they’ve seen their tax dollars lavished on lenders, even as those institutions realized record profits, only to be left out in the cold themselves. Though we can’t change the past, most everyone can agree that long-term, sustainable growth in the housing market is an important factor in our economic recovery. That road is paved with good loans to traditional buyers. Until our focus is directed at the factors still encumbering that dynamic, all of the interest-rate tinkering in the world is only a temporary bandage – one which ultimately could wind up infecting the wound.