Rental-Backed Securites: Wall Street's Clever Plan for Foreclosed Homes?


It feels like this country went from a housing glut to a housing boom almost overnight. One day, all you're hearing about is how much extra housing capacity there is, and the next you're reading headlines about record home starts.

But before the housing-market resurgence, the other thing you heard about was how no one knew what to do with all that extra housing.

Well, Wall Street is trying to figure out what to do with it, and their idea doesn't bode well for either individual neighborhoods or the economy as a whole.

It's Deja Vu All Over Again

Though you're currently seeing new home developments springing up left and right, the fact is there are still plenty of empty houses out there, especially in certain areas of the country. These are homes people bought during the boom but in short order discovered they couldn't afford.

As these homeowners defaulted on their loans, the mortgage-backed securities the loans had been bundled into also began to fail -- triggering the financial crisis. But someone owns these foreclosed homes, and they want to do something profitable with them, which has turned out to be renting them.

Sounds good so far.

However, now Wall Street is considering packaging up these rental properties into securities that can then be sold off to investors. (Sound familiar?) But apparently, even the ratings agencies are nervous about this untested bit of financial innovation. That's right: Those same ratings agencies that gave AAA ratings to so many of the mortgage-backed securities that ended up going bust and dropping the U.S. economy off a cliff? Even they don't feel comfortable with Wall Street's latest clever idea.

Your Friendly Neighborhood Renter

So, Wall Street may be brewing some new macro-level concoction that could come back to bite us all. Again. But what might this idea for rental-backed securities mean on a more micro level?

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Nobody likes empty, foreclosed homes in their neighborhood. In the best-case scenario, a bank or some similar entity is keeping the grass cut, the driveway weeded, and the squatters out.
In the not-so-best-case scenario, none of the above is happening, plus the windows are broken or boarded up; "entrepreneurs" are stripping the home of interior furnishings, wiring and plumbing; and your kids have decided these ripped-up homes are a great place to play in.

So are renters worse than the worst-case scenario described above? Hardly. A responsible renter can be as good a neighbor as a home owner. And it's far from gospel that all home owners are responsible neighbors, diligently keeping up their property, and therefore the neighborhood's property values. In fact, the right kind of renter could turn out to be a far better neighbor than the homeowners you're living next to right now.

The Truly Worst-Case Scenario

But if the idea of rental-backed securities takes hold with investors, and the Wall Street securitization machine consequently gets humming, the same thing that happened with mortgage-backed securities might happen again: The demand for investments would drive the demand for rental homes, and thereby lower the caliber of the renters.

Not only would this be bad for neighborhoods, but if enough poorly qualified people are renting properties that have been bundled up into securities, and those people stop paying their rent, the securities could also then fail. This could put the financial industry -- along with the rest of us -- right back where we were four-and-a-half years ago.

Before the boom in mortgage-backed securities, no one knew how they would perform on a large scale, nor how they would change the real estate market, and today, no one can be sure how these rental-backed securities will perform on a large scale either. But here's a hint: If the previously AAA-happy credit agencies are nervous about this new type of investment, maybe the rest of us should be wary as well.

John Grgurich is a regular contributor to The Motley Fool. Follow his dispatches from the bleeding heart of capitalism on Twitter @TMFGrgurich.

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