Marguerite Yourcenar’s Memoirs of Hadrian contains a stunning line: “I begin to discern the profile of my death.” The news of this evening has given me the perhaps mistaken impression that the end game of this credit crunch is similarly coming into view.
Before, it seemed an open question as to what measures would be taken to attempt to alleviate the pain of deleveraging. But it is becoming clear that the former defenders of markets want to have their cake and eat it too. They want to reap the rewards of economic growth, but avoid or socialize losses. Notice how “recession” has become a dirty word? it seems that, just as the US wants to fight wars without having body counts, so to do we want to have growth without down cycles,
Thus, the powers that be are increasingly pursuing measures to support asset values, rather than have a Schumpeterian creative destruction phase to thin out weak and penalize bad practices to set the stage for the next phase of growth. Even though the liquidation of S&L assets in the late 1980s-early 1990s is widely presented as a success, and Japan’s decision to shore up dodgy banks with bad loans is demonized as having cost them 17 years of growth, we seem to be going down the Japan path.
Just to be clear: if propping up asset values were done selectively and surgically, it could be helpful. Attenuating the process of price discovery of overvalued assets is probably a good thing, because it could keep a correction from overshooting into a crash. But the remedies being pursued are hopelessly politicized, focused on symptoms rather than root causes (note you still may have to treat symptoms, but to address only the surface issues is expedient and may in the end not provide any meaningful relief).
Perhaps I am a bit fraught from the market downturn today (and mind you, I’ve believed it was coming), but two news items tonight confirm my already grim view. The second item is the latest SIV update (headline: Paulson is jawboning like crazy, with some success, which is very bad for reasons we’ll discuss in a later post); the first is the proposal, hat tip Paul Jackson at Housing Wire, that would let borrowers facing foreclosure to access up to $100,000 of their retirement assets without paying the customary 10% early withdrawal penalty (although it appears the usual income taxes would apply). From the press release for the fetchingly named HOME (Home Ownership Mortgage Emergency) Act:
The HOME Act would allow homeowners who are 60 days late in their mortgage payments to withdraw penalty-free up to $100,000 from their retirement accounts through 2009 for the purpose of refinancing into an affordable mortgage or avoid foreclosure. Except for very limited cases, a 10% penalty is currently applied to early retirement distributions, although the tax code waives this penalty for distributions from Individual Retirement Accounts (IRAs) for first-time home purchases. The HOME Act would make withdrawals for the purpose of refinancing or avoiding foreclosure penalty-free as well, as long as they are paid back within three years. Senator Mel Martinez (R-FL), former Secretary of Housing and Urban Development, is a cosponsor.
Housing Wire noted that, predictably, the Mortgage Bankers Association gave an enthusiastic vote of approval.
This bill would sanction what is already afoot. A Wall Street Journal story earlier this month pointed out that consumers have already started to increase their 401 (k) borrowings and redemptions, even though most financial advisers consider it to be an unwise move.
Jackson is deeply ambivalent about the concept; he thinks it could be good for traditional borrowers (by that I assume he means either fixed rate or prime ARMs) who get in trouble, say due to illness or job loss. But he is concerned that borrowers with crappy deals will simply throw good money, in this case, their very last financial cushion, after bad:
I think it could be absolutely ruinous for less traditional borrowers: losing your home is traumatic enough, but it need not completely torch your future. A bill such as this might actually do just that (remember the word recidivism that I wrote about earlier this month).
In a nutshell, this bill could incent borrowers that simply can’t afford the mortgage they’ve got, irrespective of the existence of any “external event” — not a small group relative to the current universe of troubled borrowers, IMHO — to raid whatever nest egg they have as part of what is essentially a futile attempt at staving off the inevitable. These borrowers would then be out not only a home, but also their retirement savings and would have an nice tax bill from Uncle Sam to tack on for failing to repay their borrowings within a three year window.
The problem with this proposal, and too many of the ideas floating about, is that they are unduly preoccupied with salvaging the homeowner cum homeowner. As is implicit in Jackson’s musings, not all mortgage borrowers can be saved, nor should they be. But the press and Congress have picked up on the mantra of “2.2 million homeowners could lose their homes,” so propping up their mortgages has become the point of this exercise.
Unfortunately, the best remedy, of renegotiating mortgages, is time consuming, costly, andimpeded by mortgage servicing agreements (in mortgage securitizations, the mortgage services manages the relationship with the borrower on behalf of the investors). Because servicing agreements are governed by state law, any efforts to relax their terms must come on a state-by-state basis. Next-best solutions include letting the price of the home be written down to market value in personal bankruptices, as is done in commercial bankruptcies, and making counselling more readily available to overstretched borrowers. When faced with painful decisions, most people put them off as long as possible, in the hope that they will find a stay of execution or a winning Lotto ticket. But with foundering mortgages, cutting oneself free sooner is often the best choice.
Another element that rarely gets much attention is that in the communities with the greatest likelihood of significant housing price falls are ones where prices had risen badly out of line with local incomes and rents. Letting people tap into their retirement savings, even if they can “save” their house, may be a bad investment. And it’s bad social policy. Overpriced housing is a tax on anyone who is new to the community: young people, job seekers, transferees, and it weighs particularly heavily on lower income groups. But that consideration has been lost in the political and economic calculus.
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It’s amazing how our culture has changed in such a way that people are now conditioned to think recessions are almost not even allowed to happen any more. It doesn’t seem to be accepted that this is a normal part of the business cycle.
I find this quite disturbing. It’s as if everybody has been brainwashed to think happy thoughts, because this tremendously imbalanced system depends on this perpetual confidence.
Bernard
I work for an attorney that helps debtors, primarily those in foreclosure. Our position is that the only real help is to allow bankruptcy courts to modify mortgages to freeze interest rates (preferably under some Till scheme) but leave the principle allow. Changing the principle affects the value of the home forever, and may affect neighboring homes. Freezing the rate, freezes the payment and doing so in bankruptcy allows federally supervised reorganization of PRIMARY residences only. If the home is too expensive under these terms, it is too expensive. This will also allow the market to digest the hundreds of thousands of homes over a longer period with fewer fire sales.
Several months ago a number of banks and thrifts announced plans to allow stretched mortgage borrowers to modify the terms of their loans in an attempt to prevent foreclosures. Nonetheless, so far there has been little evidence of widespread use of these modifications.
Furthermore, the reduction in interest rates has provided ARM borrowers with little relief. This is because a large percentage of ARM loans have cap rates that prevent interest rates from rising to max cap rate, of say 9%. So despite the rate cut,rates have still topped out at 9%. Unless the Fed cuts rates to 1%, only then will borrowers see rates on their resetting ARM mortgages fall. Looks like the Fed has been caught out by financial innovation this time and that monetary policy may have been rendered less potent. All sounds like the FED may need to reexamine the dis-intermediation of mortgages. Yes, more regulation!
Is it coincident that a homeowner who cannot make a payment and declares bankruptcy may lose the property, but gets to keep their Retirement Savings?
I didn’t think so.
Ken,
Policy is seldom consistent, but it would be more so if US retirement accounts were inviolate in other ways. I don’t know much about retirement savings laws in other countries, but in Australia, you simply cannot touch your superannuation account until you retire.
I like the idea that if people want to “save their house” then they must pay for it themselves, rather than taxpayers. Opening up access to IRA funds looks like a good idea.
Better than 75% of our clients with retirement accounts have already raided them prior to foreclosure.
Tracy,
Oof, that’s depressing, but I guess not surprising. It takes a very tough minded person to cut his losses before all options, even questionable ones, have been exhausted.