USA - A Nation Of Mortgage Slaves

A recent op-ed in the WSJ echoed many of my same sentiments around the current housing market with respect to foreclosures, and the need to encourage sustainable financial situations as opposed to homeownership at all costs:

From the WSJ:

Preventing foreclosures has become a top priority of politicians, economists and regulators. In fact, allowing foreclosures to happen has merit as a free-market solution to the crisis.

If the intent is to help homeowners, then foreclosure is undoubtedly the best solution. Household balance sheets have been destroyed by taking on too much debt via the purchase of inflated assets. With so little savings, a household with negative equity almost implies negative net worth. Walking away from the mortgage immediately repairs the balance sheet.

Credit may be damaged, but homeowners can rebuild it. And by renting something they can afford, instead of the McMansion they cannot, homeowners are most likely to have some money left over each month that they can save toward a down payment on a house they can eventually afford.

If the intent is to help the credit markets, then foreclosure is undoubtedly the best solution. The securitization model has proven to be flawed. Slicing loans horizontally into tranches created asset classes that have conflicting interests in a dissolution strategy of the same underlying asset. The holder of a senior tranche would be agreeable to modification, since his position is secured; the holder of a junior tranche would essentially be wiped out. The lower tranches are worthless but are still legally an encumbrance, hindering any type of sale or work-out effort.

Consider a property that sold for $500,000 at the peak, financed with a $400,000 first lien and an $80,000 second lien, which is now worth $300,000. The second lien is worthless, but the lien will remain as a cloud which complicates any modification effort by the senior lien holder. There is no incentive for the junior lien holder to voluntarily agree to a modification. Foreclosure would be the best and finite action. It wipes the slate clean.

Understandably there are a lot of emotions wrapped up in home ownership both at the political and every day citizen level,  which makes it difficult to sell the idea that some people are better off letting go of their homes and becoming renters. However I think these people need to ask themselves: do they want people to own homes for the sake of owning them, or do they want people to be in healthy and sustainable financial situations?

Nothing comes out of helping someone stay in a home they can’t afford, especially when all you’re doing is both delaying the inevitable and magnifying the financial impact of the inevitable foreclosure. At the end of the day it’s not “renter vs. homeowner” that defines a stable financial situation, it’s income vs. liabilities and savings. Better to be a renter that saves 10% of his/her income, than a homeowner who can’t make ends meet.

Activists, politicians, and various other policy makers will be able to create more long-term home owners by helping people get into healthy financial situations, than they will by focusing their energies on stopping foreclosures.

You can read more here.

Source:

The WSJ: “Why Be a Nation of Mortgage Slaves?” — Ramsey Su, January 31, 2009.

Disclosure: at the time of publishing the author didn’t own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn’t be viewed as financial or investment advice.

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