And Now Homeowners

The two most important features of the administration’s plan to help homeowners are (1) its support for amending bankruptcy laws to allow judges to modify mortgages. This will give homeowners bargaining leverage with mortgage servicers (and give the servicers more leverage with securitized creditors on up the line) to get better terms; and (2) a massive expansion of the government’s commitment to Fannie Mae (FNM) and Freddie Mac (FRE) - allowing F&F to buy more mortgages by increasing the government’s guarantee against losses to $400 billion.

Expect the usual grousing about “moral hazard,” especially from Republicans who normally grouse about normal hazard. And under normal circumstances, they have a point. The government should not be bailing out mortgage lenders who should never have lent money to people unlikely to be able to repay, or borrowers who should never have taken out a mortage loan. Under normal circumstances, government shouldn’t be bailing out bankers, either. But these aren’t normal circumstances. We’re in an economic crisis. And a failure to put millions of homeowners on a firmer footing would send more shock waves throughout the economy. Not only will more people lose their homes. Surrounding homes will lose value as well, as neighborhoods become blighted with more empty houses. And lenders, worried that even more borrowers can’t repay loans, will stop making additional ones.

The Obama plan will help prevent a tsunami of foreclosures this year and next, but no one knows how big the wave may get notwithstanding. Nationwide, home prices have fallen 17.5 percent from where they were in early 2007, back to where they were in late 2004. But the housing bubble started earlier than 2004 — and based on long-term ratios of home prices to rental prices and incomes, home prices probably could easily fall another 5 to 10 percent before bottom is reached.

And then what? Whether we’re talking about the bailout of Wall Street, of the auto industry, or of homeowners, the biggest questions are (1) how long will it be until the business cycle turns up again? and (2) how long until the median value of financial assets, the demand for automobiles produced by the Big Three, and median home prices all return to where they were at the height of the bubble?

The answer to (1) is likely to be a year or two. But a turnaround is just the beginning. Taxpayers who are shelling out trillions of dollars (including, indirectly, commitments by the Federal Reserve Board), as well as people who are saving for retirement, many autoworkers, and a large number of homeowners won’t be - or feel - safe until the economy at least returns to where it was in early 2007, and then continues to move upward from there. When will this be? It may take five to ten years, or longer; as to the Big Three, maybe never.

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