Defaulting Our Way Back To Normal

Robert Shiller, he of the Case-Shiller Housing Index, wrote in the last Newsweek issue of 2009, "My data show that between 1890 and 1990 real home prices actually didn't increase. "

Say what?

It's true. If you look at U. S. home prices over an entire century, corrected for inflation, they don't change much, if any, until after 1990. This covers wars and depressions and -- most importantly -- conversion from an era of low home ownership and nonexistent mortgages (the average mortgage in 1890 -- if you could get one -- was a term of less than five years) to one of high home ownership and huge leverage. What came after 1990, then, can be viewed as a bubble that finally peaked in 2006, popped in 2008, and is still deflating.

Important word there, "deflating."

Home prices are down 34 percent nationally from 2006, though your city may vary. If prices are truly headed for that corrected 1890-1990 line, they have another 22 percent to go, which will take four more years and put tens of millions of homes effectively under water.
What's America to do?

Michael White, a blogger and mortgage banker from Illinois says it is the patriotic duty of those millions of underwater home owners to take one for the team and just walk away from their homes right now, giving them back to the banks, allowing prices to plummet and demand to be restored as quickly as possible at price levels that can be historically justified.

It's interesting to view as patriotic this behavior which banks and credit bureaus and our grandmothers view as bad and even unethical ("No more credit cards for you! "), but maybe White is correct. Maybe a swift correction is best.

But it won't happen that way, of course, because politicians want to be re-elected and because we don't want to give up our houses and become renters again, even if we really should.

There are only three ways to fix this problem, and we've just rejected the first, massive default. The second and third solutions are variations on the same technique, which is reducing mortgage debt to a traditional ratio of family income. Over that same 1890-1990 period American home-owners tended to have homes that were priced at about three times their annual income. Today the ratio is about 3.7. Note that to get back to a ratio of three will again require an effective price change of -22 percent.

If "affordability" is defined as having houses worth three times what we earn then we can either reduce what we owe through mortgage modifications or forgiveness, or we can increase what we earn, which simply isn't going to happen.

The ultimate solution will likely be a combination of one and two, then, with millions of defaults and foreclosures to drive prices down further, eventually followed by some heroic and economically unjustifiable federal program to reduce what the rest of us owe (we who still have our houses then) by beating up Fannie Mae and Freddie Mac, as we'll likely hear next month from President Obama.

This end game was probably inevitable and the fact that it has taken so long can be attributed to an unspoken desire on the part of government for as many foreclosures as possible, keeping to a minimum the ultimate cost of saving the day and the election.
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