Is the housing crisis coming to the Twin Cities?

I don’t know what the rest of the country is seeing, but this report from the Minneapolis Area Association of REALTORS looks pretty bad to my untrained eye. Comparing September 2006 to September 2007 (projected) we see:

  • The inventory of homes for sale increased by 11.4%
  • The number of homes sold the previous year declined by 14.6%

This means that many more homes are sitting on the market, waiting for buyers. The report observes “Massive inventory growth is taking place in the lowest price ranges, possibly due to the role of subprime foreclosures.”

In other words: Yes, the housing crisis is coming to the Twin Cities.

Read on for some of my thoughts on what should and should not be done about this.

I’m hearing reports in the news about possible bailouts at the Federal level. A bad bailout model would be direct payments or subsidies of mortgages. This would reward poor decisions and behaviors at the expense of the public treasury. If the politicians feel they must meddle, I hope they will keep the following principles:

  1. The lending institutions that made these loans should feel a bite from the bad loans.
  2. The homeowners who signed up for loans that they cannot repay, should feel a bite from being unable to repay their debts.
  3. The goal of any bailout should be to prevent a catastrophic surge of foreclosures, not to save lenders from going out of business.

Here’s an idea for a bailout that might help consumers and the mortgage industry without costing the treasury a fortune. Instead of foreclosing on a home and then trying to sell it on the open market, allow the lender to immediately sell the property to the government for 75% of the remaining mortgage amount. This allows the lender to get some value from a bad loan immediately, instead of waiting months for the house to sell on the open market. At the same time, the lender is taking a hit for the bad loan.

The government then backs a new 30 year conventional mortgage to the homeowner for the total amount that they owed to the lender, but at the current market rate for a 30 year conventional mortgage to a person with good credit. This transaction should be reported to the credit agencies as part of the bailout. Much of the sub-prime mess is due to adjustable rate mortgages suddenly getting too expensive for homeowners when the rate adjusts. This keeps the homeowner in their home and puts them on a stable, reasonable-rate mortgage, but it holds them responsible for the amount of money they actually borrowed. This is essentially a no-cost refinance package for sub-prime borrowers who are in over their heads due to high interest rates.

That difference between the 75% of the mortgage amount paid to the lender and the total amount being repaid by the homeowners is used to cover the costs of running the program and the eventual defaults.

Some people will object to this because it doesn’t relieve the borrowers of their debts. That’s a feature, not a bug. They knew they were going to have to repay that money when they took the loan. That’s what a loan is and they don’t lose their house. Compare that to a foreclosure.

Others will object that it might hurt the mortgage companies, who are surrendering 25% of the outstanding loan principal. This is true, but they get the money quickly instead of waiting for months. Compare that to a foreclosure.

Finally, some will complain that this isn’t fair to those who are making their payments on time, even though their rate is high. Agreed. All bailout schemes turn into rewards for those who made bad decisions at the expense of those who did not.

12 Comments so far

  1. Steve T (unregistered) on September 20th, 2007 @ 7:25 am

    Double edged sword for us. We are trying to sell our home in southern MN before we can buy here in St. Paul.

    The recent interest rate decrease was probably the only “bail out” the little guy will see. All that interest rate decrease means is that the Fed made it easier for lenders to resell home loans. Also, the US Treasury is considering lifting portfolio caps on Fannie Mae and Freddie Mac, meaning they will be able to purchase even more home loans. Which means that the lenders can continue to unload their loans onto someone else and keep giving out loans themselves.

    This has all been an effort to bail out the home mortgage industry, not the little guy. Proposed legislation to address the little guy does not seem to be getting anywhere. The problem with this is that when there is a foreclosure in a neighborhood, it adversely affects the values of the other homes by 3 – 5 thousand. And when news of the foreclosures is on tv and radio, people decide to wait to sell or buy. If everyone is waiting to buy and sell, then the lenders can have all the liquidity they want because no one is using their services.

    Vicious cycle.

    We have lenders who made bad decisions in giving risky loans and home buyers asking for those risky loans. Both made bad decisions. Who pays for it?


  2. Steve T (unregistered) on September 20th, 2007 @ 7:35 am

    Jim H, I like your proposal, but it can’t fly in the real world. Having the Fed government directly buying and then selling home loans en masse would raise the hackles on many.


  3. derrikd (unregistered) on September 20th, 2007 @ 9:45 am

    Also the problem of the lengthy process of getting people to leave once the foreclosure process starts. Much like an eviction, people do not usually cooperate.


  4. Alex Stenback (unregistered) on September 20th, 2007 @ 10:15 am

    Oh boy. Lets not forget that the sub-prime market is in the neighborhood of 450 Billion dollars.

    Leaving aside all the obvious stuff (like: who will service these new loans, who will pay delinquent taxes and insurance, overdue principal, interest, ect.) remember, these loans aren’t just sitting individually in neat little piles on the lenders books, they have been pooled into mortgage backed securities (an investment trust that issues bonds to investors) and then further sliced and diced into CDO’s (collateralized debt obligations, which mostly pool riskier slices of mortgage backed securities into a new instrument), and then these CDO’s are chopped up to make derivatives of these CDO’s (CDO’s Squared), then CDO cubed, and so on, and so on. It is endlessly, mind bogglingly complicated.

    Point being, all the these instruments have investors (maybe even your pension fund, or a CD you own) who hold rights to the principal and interest payments, and must sign off on any modifications. To get all of these moving in one direction to accept any sort of government buyout is a gargantuan task beyond the imagination of most of us.

    Besides, if the lenders, MBS/CDO issuer, Bond holder, etc. were willing to accept 75 cents on the dollar for only the good credit (investment quality) loans in default, there would be a ready and willing private market that would snap that paper up in a heartbeat.

    Bailout programs not too far off from what you propose are failing because so many of the bailout candidates were beyond any help – credit too poor, not enough income to even qualify for a fixed rate loan of even half the size, etc.
    Take Ohio as an example:
    http://interestrateroundup.blogspot.com/2007/08/ohios-foreclosure-bailout-experiment.html


  5. Alex Stenback (unregistered) on September 20th, 2007 @ 10:34 am

    “All that interest rate decrease means is that the Fed made it easier for lenders to resell home loans.”
    Posted by: Steve T at September 20, 2007 07:25 AM

    Actually, this 50 basis point cut by the Fed has made the bad, tough-to-sell paper (sub-prime, alt-a, Jumbo, etc.) even tougher to sell.

    The Fed’s cut (through it’s impact on the dollar and by extension adding to inflationary pressures) has pushed long term interest rates UP (30 year fixed mortgage rates have jumped almost .25% since the cut.)

    So the higher yields on new, long dated mortgages make the lower yields on the junk everybody is desperate to unload less attractive, and tougher to sell. Funny that.


  6. Erica M (unregistered) on September 20th, 2007 @ 10:44 am

    I already knew I didn’t fully understand what was happening, but… good lawd.


  7. ryan (unregistered) on September 22nd, 2007 @ 12:51 pm

    the census bureau said that 75% of minnesotans own a home, the highest in the nation.

    so yeah…it’s here, and it aint gonna be over for another couple years.

    I think a bailout of any kind is foolish.
    For the most part the home owners getting burned, didn’t read or take the time to read their loan paperwork. If you took out an ARM you should have known that you needed either; to get a serious raise in income or stop taking that damn credit card out of your wallet and pay it off.

    If you took out an interest only loan, you must like to gamble.

    What the hell ever happened to saving?


  8. ryan (unregistered) on September 22nd, 2007 @ 12:53 pm

    the census bureau said that 75% of minnesotans own a home, the highest in the nation.

    so yeah…it’s here, and it aint gonna be over for another couple years.

    I think a bailout of any kind is foolish.
    For the most part the home owners getting burned, didn’t read or take the time to read their loan paperwork. If you took out an ARM you should have known that you needed either; to get a serious raise in income or stop taking that damn credit card out of your wallet and pay it off.

    If you took out an interest only loan, you must like to gamble.

    What the hell ever happened to saving?


  9. Jim H (unregistered) on September 22nd, 2007 @ 7:39 pm

    FWIW, I agree that a bailout should be avoided if at all possible, but the political landscape may compel a bailout.


  10. Mr. X (unregistered) on September 24th, 2007 @ 4:33 pm

    Well well well, the bubble has burst and the Realtor are up in a Roar creating lies & alabi and making people cry left & right and file for bankruptcy. I don’t know what report they pulled out of their ASSES, but there’s no way in HELL that the % of houses being sold is 11.4%, that just bullshit!


  11. Jim H (unregistered) on September 24th, 2007 @ 8:13 pm

    Mr. X,
    Please re-read. The number of houses being sold increased by 11.4%. That is different than saying that 11.4% of all houses are being sold.


  12. Mr. X (unregistered) on September 25th, 2007 @ 10:05 am

    I don’t know where in the world they came up with the 11.4% increase when all the houses are sitting not so pretty for months and months. It’s all a freakin LIE – i know this off hands cuz i’m in the industry, and they’re ain’t got shit to do but sitting there picking their noses!



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