Friday, February 27, 2009

A modest proposal for the foreclosure crisis

Another one from my favorite guest blogger, The Opinionator.

I’m an economist. I’m trained to believe in the power of economic incentives, and in particular to anticipate that taxes will change people’s behavior. Higher marginal tax rates can reduce work effort, higher tobacco taxes reduce teen smoking, and higher energy taxes would be the surest route to greater energy efficiency.

Now we have a foreclosure crisis, with families being forced out of their homes, fire sales that drive down home prices, and further defaults and foreclosures as even more homeowners find themselves “under water” – with mortgages bigger than the market value of their houses. What to do?

If we want less of something, the most efficient way to get there is generally to tax it. In this case, we want fewer foreclosures, so let’s tax them. I propose that the federal government impose a 20% tax on the proceeds of sales of foreclosed property. This will reduce sharply the payoff to foreclosure, and induce lenders to make a much more intense effort to modify mortgages to keep homeowners paying. Writing down the mortgage principal by 20% will be a no-brainer for a start.

This tax should be strictly temporary, since the possibility of losing your home is supposed to keep people honest when they sign up for their mortgage. Right now it’s important to stop the rot, as each foreclosure makes things worse for everyone, but we don’t want to make life easy for deadbeats in the future. So I propose that this tax would apply only to mortgages written through 2008 – the precise date is arbitrary, but it would certainly not apply to new loans being made today.

Simpler is better, so my preference is that this is the end of the story. However, one could justify some exceptions, such as waiving the tax if the lender has already modified the mortgage by reducing the principal 20% or more. It might also be politically attractive to waive the tax where fraud by the borrower can be proved (though I suspect that fraudulent borrowing generally involved a co-conspirator on the lending side).

In any case, let’s apply the lessons of supply-side economics about the power of incentives. Tax foreclosures, send any revenue to the local government, and everyone wins except the most myopic lenders.

Next installment: what to do about the war on drugs...

The Opinionator


  1. Rebecca, please, for the sake of truth, would you stop having this joker The Opinionator write for us.

    The Opinionator might have academic credentials, which makes him/her an Academic Economist.

    However, the person does not know the first thing about real economics (the science -- recorded knowing -- of the right to claim one thing for another).

    The Opinionator is Wrong on Energy

    The Opinionator claims "higher energy taxes would be the surest route to greater energy efficiency".

    What claptrap that you give us The Opinionator.

    Better engineering leads to better efficiency -- both in products design and in markets design.

    Monolithic plants sending electric power down thousands of miles of wiring is inefficient.

    Rigging markets into oligopoly structures with firms that leverage the collectivist government to inhibit competition is inefficient.

    If we want greater energy efficiency, we need to dismantle the regulatory rules designed to inhibit competitors from entry.

    We need to eliminate the tax code subsidy that favors oil and coal over geothermal, hydro, wind and solar.

    We need to stop subsidizing oil through military means.

    The Opinionator is Wrong on Foreclosures

    The Opinionator uses the rhetoric ploy of hyperbole when he/she writes "...a foreclosure crisis, with families being forced out of their homes, fire sales that drive down home prices, and further defaults..."

    What crisis?

    97% of all cash rentees (mortgagees) are performing on their debt obligation.

    The sum of all house markets in the USA is $17 trillion.

    The Opinionator seems ignorant over the kick off cause to the house price bubble -- the 1031 Exchange law followed by Greenspan's ridiculously low interbank lending rate (Fed Funds Rate).

    Millions of greedy, solvent Americans supersized up every two years. This increased the velocity of transaction in house markets and fueled prices.

    Worse, they would use their house as an ATM machine to get those big screens and Beemers with home equity loans and then refi the whole mess, further driving up prices.

    Subprime Liars and Alt-A cash rentees did not come into markets until much later, near the end of the bubble (2005-2006).

    The Opinionator is Clueless over the Cause and Sees only Effects

    The Opinionator seems ignorant over knowing that the Federal Reserve alone as a charter monopoly for the manufacture and distribution of money, which is one of two things always in every economic exchange.

    Federal Reserve action alone causes continuous changes in the money relation to other things, which messes up production and the business calculus of millions of men and women trying to strive in their living.

    The Opinionator sees only the effect (house price bubble) without ever seeing the cause, the Federal Reserve.

    Those who are falling to foreclosure are those who could not pay their debt obligation even if interest rates were negative.

    Another way of saying this would be to say even if foreclosure deadbeats were being subsidized at negative 2%, that is being given cash, they'd default still.

    We Don't Need No Stinkin' The Opinionator

    The Opinionator comes across as a Collectivist meddler who sees only one sure fire way to fix things for the political/ruling/moneyed elites -- more taxes to change behavior.

    The Opinionator does not get it. We want money free from government and moneyed control.

    We don't want involuntary taxes.

    We want Freedom, not Officialdom.

    We want individualism not collectivism.

    We love our fellow man. We love our neighbors. We want our right of voluntary association and voluntary interaction restored.

  2. Better to adjust the rate of interest. Cap all interest on owner occupied homes at 1 percent for three years, and all securities backed by such mortgages.

    Have everybody continue to pay their monthly mortgage amounts, but have the bulk of the money go to principle.

    Only adjust the monthly payment amount for the few who really can't, at this time, make the payment. Do this through an abbreviated administrative bankruptcy type process, looking at assets and income.

    The mortgages would not fail because they are now paying an appropriate interest rate for this market, the banks would not fail because they would be paying the same rate to the investors who bought interest backed securities.

    The people who invested in the securities would trade the prior interest rages for a lower rate, but more security, because as most of the monthly payments are applied to principle the total amount owed on a property would decrease, bringing many right side up.

    By forcing the home owners payments into be paid against principle the home owner builds equity and reduces any gap that there is between loan amount and property value. They can then see the light, and are less likely to walk away, thus making the mortgage backed securities more secure.

    If you are holding a billion dollars in mortgage backed securities you are, at this time, more interested in securing your principle than making interest. You would prefer to go to 0% intrest with more security than 7% on a bundle of loans that may turn out to be worth only 50% of book.

    The holders of the loan bundles don't need bailing out, they need to know that people are going to continue to make the principle payments. At this point interest is not what they are worried about, it is will they get the principle back.

    It is the exposure of the principle of the loan that needs to be addressed. If 90% of the loans continue to pay the old monthly amount, but pay that mostly to principle, the exposure gap for both the home owner and the lender decreases.

  3. Nice rant Smack!

    I'd put Fed before 1031 and don't forget other tax misdirections like mortgage interest deduction (this helped the HELOC and other cash out of the home equity shenanigans). And in California, Prop 13. (Florida I believe has similar law(s).)

    The Opinionator needs to come and visit SoCal's open houses where Subprime ARMs have past the peak but Alt-A and Prime ARMs are starting up the recast peak in the next year or two.

    Prices here in The OC has gone up to 10x median annual income and has only come down to about 5x income. Historically, we have seen things come down to 4x but I have a feeling that we will undershoot (with so much foreclosures) I won't be surprised to see us hit 3x or even 2x income (i.e., another 40% to 60% drop in home prices even though we're down already around 50% since the peak).

    Obama et al. attempt at foreclosure slow down is laughable since the amount of correction needed is around $120K-180K -- few thousands or even few tens of thousands will hardly matter. And the prices I'm quoting are in the lower priced areas. Only the foreclosed and other "distressed" sales move around our area (we were able to buy from couple of siblings who inherited their home and wanted to get rid of it: $300-$350K was their asking range at their open house).

    The coastal cities have yet to hit their peak in recast/reset of ARMs: and their median prices are in 500+K ranges today: about $250+K of correction (at least -50%) is needed there to get into 2-3X median income for those neighborhoods.

    Government enabled the malinvestments of the past which will take time to unwind -- and no amount of "help" will stop the tsunami of washing out the malinvestments (i.e., foreclosures and bankruptcies as people cannot repay their debts as repayments are set higher as well as more people start losing their jobs and exhaust their savings).

    To put it another way, taxing 20% to prevent a foreclosure of someone unemployed (with 0 savings) won't prevent the bank from foreclosing the home.