Homeowner Bailouts Destined to Fail

December 9, 2008 by  
Filed under Economics, Loans and Borrowing

After years of observation of American consumers, Mr. ToughMoneyLove some time ago arrived at the opinion that some folks just are not meant to be homeowners.  This does not mean they are bad people or fundamentally undeserving.  The fact is that some people lack the resources, judgement, or discipline to make good financial decisions or to fulfill all of the financial obligations associated with owning a home and paying on a mortgage.  For them, it’s just not going to happen.

Unfortunately, our government has thought differently, with its incessant drive to make homeowners out of almost any adult with with pulse.   (Actually, the government didn’t really “think” about it, it just assumed it.)  So Congress and the President created all sorts of housing programs and policies that pushed lenders and borrowers together to create a sub-prime lending frenzy, a gigantic real estate bubble, and then a perfect storm of mortgage defaults.

Faced with the initial results of failed homeownership policies, our government had two choices.  The first would have been to concede failure, pull all of the “homeownership for everyone” programs and attitudes off the table, and let the markets work things out.  (In other words, be attentive to the hard truth as spoken by me and others.)  The second option was to deny the truth and create yet more programs to “rescue” the troubled homeowners from themselves.   This included strong-arming lenders into adjusting the mortgages of those in default and even throwing more money at the problem by guaranteeing re-worked mortgages.

Well, the initial returns are in.  Mr. ToughMoneyLove was right and the government was wrong.  The U.S. Comptroller of the Currency regulates banks and tracks data on mortgage default rates.  Here is the latest data on mortgage re-default rates.  

 

What the chart shows was summarized nicely by the Comptroller himself on December 8:

After three months, nearly 36 percent of the borrowers had re-defaulted by being more than 30 days past due. After six months, the rate was nearly 53 percent, and after eight months, 58 percent.

I don’t know if the data can be any more compelling than this.  A majority of the people who struggle to meet their payment obligations on a market-rate mortgage will also struggle on a re-worked mortgage that has been adjusted to supposedly make it more affordable.  Default, re-default, game over.

Yesterday, GM did something refreshing.  It admitted that it made some bad decisions in its entire automotive marketing strategy.  It came a little late but it was better than a stubborn insistence that its dire financial condition was not its own fault. 

I think it’s time that we get some of that humble pie eating from our federal government regarding its failed housing and mortgage policies.  Bad government housing policy creates unrealistic expectations and costs the taxpayers a lot of money.  I’m tired of it.


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17 Responses to “Homeowner Bailouts Destined to Fail”
  1. No Debt Plan says:

    We discussed this in my MBA econ course a bit. Forgive me if my numbers aren’t exactly right, but I think the average homeowner population as a % of total population has been something like 68% over the last 20-30-40 years (significant amount of time).

    Then the professor showed that an increase of even just 1% to 69% is a MASSIVE change because of the number of people. And if those people are not truly qualified… house of cards… crashing down… etc.

  2. No Debt Plan: I wrote about this in the article linked in this post. Actually, the homeownership rate hovered around 62% for decades then jumped to 68% over the last 10-15 years, due in most part to bad government policy. As you say, that is a gigantic and unsustainable increase.

  3. TMN says:

    There’s nothing wrong with an increasing level of home ownership, IF the homes people are buying are well within their means. Done right, a monthly mortgage payment can be just as cheap as your rent payment, only you get to keep part of it. As long as you buy something affordable and plan to keep it for a couple years, you can even weather some market drops okay. Provided the price doesn’t drop by more than the amount you own on the principle, at least you’re no worse off than renting.

    In my opinion, the problem comes from the recent trend not just to own a house, but to jump straight to a mansion. Someone on an average salary can reasonably afford around an 80-100k starter home, but instead they’ve been going out and buying 300k homes. And to make matters worse, they keep refinancing to extract their theoretical value increases to blow on junk. Cut those activities out, and home ownership becomes a really good idea again… it’s just a question of whether people have enough self control to make that happen.

  4. TMN: I have no objection to increased homeownership levels but therein lies the problem. Government policies have encouraged the purchase of homes that are not within the financial means of the buyers, not just McMansions.

  5. What is wrong with renting? Is there something that makes someone inherently worse off because they are renting rather than owning their own home? Why do people HAVE to buy a home?

  6. Wise: Absolutely nothing wrong with renting but the Realtors, builders, and government want you to think otherwise.

  7. G. Jules says:

    WiseMoneyMatters: Good question.

    I spent 2004-2007 hearing “You’re pissing your money away on rent! When are you going to buy a place?” from certain family members. Never mind the fact that I live in Boston, where just my rent on a very small one-bedroom is probably higher than their mortgage payments.

    I’ve looked into condos in my area, and for right now, I’m happy renting. My apartment rent is lower than the interest and property taxes on a mortgage for a similarly-sized condo would be, but somehow people never tell you you’re pissing away mortgage interest.

  8. TMN says:

    No, you really are pissing away rent. Sure, if you go overboard and get a giant house right away, you’re going to pay a ridiculous amount in interest and taxes, and build up hardly any principle. But if you look a little lower on the scale, you can find places where all your monthly payments combined will be about the same as your rent. Yes, it sucks to pay interest, but even in the first month, you get to keep a part of that payment, where with rent you keep nothing. A year or two in, you’re keeping even more. You’re paying the same amount you would have anyway, but you keep some of it, and your payment never increases which isn’t true of rent.

    Of course there’s a risk involved. If you bought a house in Detroit a couple years ago, you’re totally screwed now. But if you buy in a city with reasonable growth prospects, and keep an eye out for signs of trouble, you can usually avoid that. If I walked up to you and said I would rent you an apartment for the same price you pay now, and then turn around and give you back part of your rent to put in a savings account, would you laugh at me? I’m assuming not. So why do you laugh at people who point out the downside of renting?

  9. doctor S says:

    Yes, for some reason, our society has painted a picture that frowns upon those who rent units. Why? Why do they view it as an unwise use of money in comparison to purchasing a home that people can not afford?

    Too many people today purchase homes who should not be and the creditors rolled out the red carpet for them to encourage everyone. And then the government bails out these fools? It will fail, Mr TML is always right! Great work as always.

  10. @ G. Jules and @ TMN: Homeownership is fine for some people in some circumstances. Too many people who analyze the buy vs. rent equation assume that every dollar paid to principal will be recovered + profit when the house is sold but that is not the case. First, you have to live in the house long enough to capture some appreciation, which is never a sure thing. Second, you have to have experience appreciation that exceeds the cumulative maintenance costs, taxes, and insurances (which are not insignificant) plus the costs of selling (commissions etc.) When you take all of those costs into account, a house can be a very poor investment or even a money loser compared to renting. Second, you have to have sufficient cash flow to justify the mortgage. There are millions of “house poor” middle class consumers in the U.S. and being house poor is a miserable life. You end up hating those mortgage payments and if the market has crashed, you don’t have a way out.

    @ doc s – Thanks. I heard on the radio today that even Barney Frank has admitted that the government erred in leading the “homeownership for everyone” parade.

  11. TMN says:

    Yeah, I’m by no means saying that buying is best for every situation. And the attitude that most people have seems pretty bad to me. As you said yourself, some people assume that they’ll recover every dollar of principle plus extra in profit when they sell. And when people think that way, they probably tend to take out a larger mortgage than they should, thinking of it as an investment.

    I’m talking about something different: looking for a home in a price range that will put your mortgage + taxes etc roughly at the same cost as you would otherwise pay in rent. That way you get guaranteed rent for as long as you stay, the freedom to make whatever internal changes you want (something you usually can’t do with an apartment), and as long as the house sells for the original cost MINUS your principle, you break even. It can actually go down in value by several percent a year and you’ll be no worse off than if you had rented. That sort of decrease is pretty unusual, especially if you put in some do-it-yourself improvement time while you live there, so you’ll likely do better than breaking even. But you don’t have to.

    Again, I think the attitude that a house is a fantastic investment often leads people to take on mortgages with payments much larger than they would ever consider paying in rent, hoping to cash in on the appreciation of a larger property. And that’s indeed risky, because they end up putting their “oh shit” money into the house, instead of something guaranteed.

    That’s not what I’m advocating at all. I’m saying aim low enough in the housing market that you convert your current rent to a mortgage payment, put your emergency money in a CD ladder where it’s guaranteed, and put further dispensable money in any well-diversified investments that are NOT your house. Don’t even think about paying off the mortgage early unless you’re just swimming in cash. The goal isn’t to pack as much of your income into your house as possible, it’s to keep as much of your rent cost as you can WITHOUT over-investing in one asset just because it’s called a mortgage.

    The key is, figure out what you’d reasonably pay for rent anyway, and get a short mortgage that gives you the same total monthly payment. Way too many fail miserably at that step, and are enticed to do so by greedy lenders and a confused media.

  12. G. Jules says:

    looking for a home in a price range that will put your mortgage + taxes etc roughly at the same cost as you would otherwise pay in rent.

    You’re assuming that a housing unit that would satisfy this formula is available in my area. It isn’t. (And yes, I’ve looked.) I could get a much smaller, much crappier studio apartment, in a very bad part of town, for several hundred a month *more* than I pay now in rent. I’d rather put that money in the bank and wait.

    I do eventually hope to buy a home (that’s what that money in the bank is for, after all). But for right now, I’m happier renting. My rent money goes to get me a safe, comfortable place to live. I don’t consider that pissing my money away.

  13. TMN says:

    I totally agree, zero availability (without raising your housing costs) is absolutely a case where it does make more sense to continue renting.

  14. Kristin Brann (Everybody's Fool but Hopefully Wiser) says:

    I do rather resent the implication that some people are not meant to be homeowners. We can blame the government, but this mess has been a case of greed and envy on many fronts. Potential buyers who would not have qualified under traditional mortgage requirements because we had too much debt already were encouraged by mortgage brokers to get in over our heads with ludicrous loans with the prospect of refinancing, possibly at a lower rate, later. Since in some cases, it was a matter of keeping up with the Jones’, who were also in over their heads, this can also be attributed to overly aggressive marketing, lax banking requirements, and naive believe that the housing market would continue rising in value at the unsustainable rate it was. For one, I hope that ten or fifteen years down the road I will not have any debt and will have enough money in the bank to afford a traditional down payment and mortgage. If criminals can be rehabilitated, why can’t those who make poor financial decisions? I prefer to think that maybe we’ve just had a lot of overgrown children in our society learning to grow up and not give in to peer pressure.

  15. Kristin: I agree with most of what you say but the facts have shown repeatedly that there are some people who are not fiscally or otherwise prepared to be homeowners. Some as you say got in over their heads and can be rehabilitated. But that should not include trying to keep them in a home that is too much home for them by fiddling with the mortgage terms. Get them out of the house, let them financially prepare themselves for another try, and then give them another chance. And yes the lousy sub-prime loans were overmarketed and oversold. The government seems to have taken over that role.

  16. David says:

    A mortgage payment plus taxes might equal rent but then there’s that “etc.” that everyone always dismisses as being nominal. I rent an i have never written a check to the gardeners or bought a lawn mower, paid to have appliances repaired, needed to buy tools to fix something myself, or deal with a contractor to fix anything. Also, i pay about $100 for renter’s insurance and i can’t imagine that homeowners insurance would be the same cost. Then there’s the opportunity costs of owning a home. Better job in another city? Take off. No weekends spent “working around the house” either.

  17. David: What you say makes a lot of sense, as long as the rents are relatively stable. Too many people are pushed into ownership when it makes little financial sense for them.

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