There is little doubt that the U.S. housing market is hurting; the latest S&P Case-Shiller index shows residential values declined 4.2 percent in the first quarter compared with the previous three months.
The market has struggled, partly because federal policy has wandered all over the proverbial lot. Congress should create a clear and effective strategy for supporting mortgages or, given the remote odds of that happening, let the market stabilize on its own.
Past efforts to buoy the market haven’t worked, but the government is loath to stop trying. The weakness is both an indication of a sputtering economy and the bursting of the housing bubble that the federal government (and both political parties) did so much to promote.
With this in mind, two recent developments in Washington may provide a clue to the likely future of mortgage regulation. The first was the delivery of a 27-page so-called code-of-conduct settlement proposal between the companies that service many of the nation’s mortgages and the 50 state attorneys general as well as federal agencies. The second was the appointment of Sendhil Mullainathan, a Harvard University economist, to head the Office of Research at the new Consumer Financial Protection Bureau.
At the heart of the code-of-conduct settlement is a plan to encourage more mortgage modifications for borrowers who are underwater -- people who owe more than their homes are worth. The attorneys general propose, for example, that loan servicers -- the companies that collect and disburse payments to the investors who hold the mortgages -- modify loans when the investment return would be greater than if the home had been placed into foreclosure. The recommendations also call for servicers to provide as much as $20 billion in aid to homeowners, much of which would be used for reducing mortgage principal.
Here’s the problem: Mandated principal reduction plays little part in preventing foreclosures. Most people want to hold on to their home as long as they can pay the mortgage, even when the property is underwater. A recent Federal Reserve study found that borrowers didn’t skip out and default until they owed 62 percent more than the house’s value. In any case, given recent estimates that the mortgage market is more than $750 billion underwater as a whole, a successful principal-reduction policy would require much more than $20 billion.
So, if mortgage modifications won’t work, how about a more market-friendly approach? Mullainathan, a prominent behavioral economist, is the kind of thinker who might be expected to give that a try. His 2008 paper, “Behaviorally Informed Financial Services Regulation,” written with Michael Barr, a former assistant secretary of the Treasury; and Eldar Shafir, a cognitive scientist at Princeton University; argued that consumers are “fallible in systematic and important ways.” The goal of federal housing policy, the authors said, should be to correct “social welfare failures,” one of which is the preference for homeownership when renting makes more economic sense.
Among other things, the paper proposed that the federal government require lenders to disclose mortgage terms (and potential alternative options) in easy-to-understand language, and borrowers to affirmatively opt out of plain-vanilla mortgages. What’s more, Mullainathan and his co-authors proposed making it costlier for mortgage originators to sell exotic loans into the secondary market. That would make it harder for some buyers to get unconventional financing.
Alas, many consumers choose to purchase houses even when it is in their long-term financial interest to rent. So the Mullainathan plan sets up a contradiction: If his proposals were to become law, they would nudge Americans toward renting, while many other existing policies champion homeownership. Furthermore, discouraging buying wouldn’t do much to help revive the housing market.
Other behavioral approaches face even bigger challenges. Eric Posner, a law professor at the University of Chicago, and Luigi Zingales, an economist at the Chicago Booth School of Business, have suggested that the government require mortgages to be written down in areas of the country where prices have fallen 20 percent or more. In exchange, lenders would receive a portion of future gains in neighborhood prices.
But why 20 percent? And, what happens if a neighborhood’s prices rise on average, but an individual homeowner is left behind?
Unfortunately, none of the leading philosophies coming out of Washington today on how to change mortgage policy has much merit. The longer the government continues to try telling consumers how to behave, the longer the much-needed housing recovery will take to materialize.
The truth is, there is little the government can do to prevent the painful, but needed, marketadjustment. By moving out of the way and allowing foreclosures to proceed in due course, the markets will eventually clear.
(Douglas Holtz-Eakin is president of the American Action Forum and was director of the Congressional Budget Office from 2003 to 2005. The opinions expressed are his own.)
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