In order to resolve the foreclosure crisis in this country, we need to spend less time addressing the symptoms and more time understanding and addressing the root causes. The primary symptom that is being addressed is the amount of non-performing assets on the books of banks and investors: you know, the so-called toxic mortgage assets. They are toxic because it’s not possible to apply a value to the mortgage assets because there is no market for the underlying real estate assets. Without a market there is no way to place a value on housing assets. The Federal government is loaning hundreds of billions of dollars to banks to shore up their balance sheets. While the resulting consequence of non-performing loans is underwriting standards have tightened, and lending levels are dropping off a cliff as fewer people can qualify for loans.
One of the root causes is that the Federal government had an admirable objective: to increase the level of home ownership in this country. As a result of numerous bills, the federal government created sub-prime lending and down payment assistance programs resulting in 0 down loans. The goals of government were achieved, and in the past two decades, home ownership increased from around 62% of households to around 68%. The current wave of foreclosures will continue until we are back to a more sustainable level of home ownership.
Another root cause is that we built too much inventory. We currently have about 8 million housing units of oversupply, and an annual family formation rate of about 1 million. With an annualized rate of new home construction settling at just under ½ million units, it’s obvious we have years of inventory, and a large portion of our economy has idled.
To solve the foreclosure problem, we need to address how to put the construction industry back to work without increasing the number of residential housing units. We also need to address how to move the housing vacated as a result of foreclosure into the hands of the investor landlord. Someone must own the housing stock and the displaced people need somewhere to live.
The rationale behind putting the construction industry back to work is that people that are not working can’t pay rent and they can’t pay a mortgage. The construction industry is not just the men and women that build the houses; it’s the manufacturing component that fabricates the materials that go into housing, and the auto industry that builds the trucks that the construction industry uses. It’s the material supply houses that sell the materials, and the freight industry that moves the materials from the manufactures to the retailer. In other words, it’s the entire fabric of the American economy.
The rationale behind moving foreclosed homes into the hands of the investor landlord is that we need the oversupply of housing to be owned by someone, and the displaced owners won’t be able to obtain a mortgage for some time, if ever. We also don’t want the underwriting standards to once again become lax, or the creation of mortgage products to allow sub-prime borrowers to receive loans. The government will continue to use the old tools to address housing, and these approaches created the problems we are dealing with today.
The Federal government should provide a strong incentive for homeowners to spend money to remodel or rebuild existing homes. An incentive such as a tax credit of 15% of the costs for labor and materials, up to a maximum credit of $15,000, would stimulate many to spend money on their existing homes. The lost tax revenues would be offset by the increased economic activity, and the jobs that would be saved or restored would prevent some of the foreclosures. In addition many people wishing to move up to a larger or newer home would have an incentive to stay put by adding a bedroom, or updating the kitchen or baths; in other words, enhancing their home instead of competing with the REO properties for buyers. Such a tax credit would also provide an incentive to non-homeowners to purchase properties in distressed conditions and fix them up for personal use. They could then later sell them when this market is behind us and take advantage of the tax exclusion on gains. This type of program would help to decrease the “on the market” supply of existing homes. This would help the housing market to stabilize quicker as the percentage of “on the market” homes would be biased to REO property, allowing for more rapid price adjustments, and shortening the time until we declared a bottom.
Today, real estate investment is hampered in two ways. First, if a real estate investor decides to liquidate a particular asset, they would either deal with the tax consequences or attempt to postpone their tax liabilities by doing a 1031 exchange. Second, investing in real estate in a recessionary period, with predictions of no appreciation for many years to come, is not attractive. What if the tax code was modified to give the residential real estate investor a similar incentive to the tax exclusion on gains realized on the sale of a primary residence? Perhaps, we could allow the investor to exclude up to a $250,000 of any gain realized on the sale of an REO property that was purchased and rented as residential housing for 4 out of 5 years. This would change the risk-reward balance for the investor and would stimulate REO sales. It would move today’s vacated homes into the rental market, facilitating the shift back to more sustainable ownership levels. The government could also provide additional incentives to the investor if the defaulted homeowner remained in residence.
Finally, we need to find some way to incentivize lenders to prioritize handling short sales of non-defaulting properties. There are many people that have a need to move on, but because they are underwater and don’t have the financial where with all to bring the difference to the closing table. The limited resources of the lenders are focused on non-performing loans.