None of these foreclosed houses is going to disappear. After a
foreclosure, one family moves out, and another moves in. We see the sad
faces of the people moving out, but we don’t as often see the happy
faces of the new homeowners moving in. Nevertheless, those happy faces
are out there, and we should not discount them.
Here is more. I take the case against foreclosures to be the following. The people getting kicked out lose their credit ratings and in the medium term they spend less. The people moving in presumably have higher credit ratings but they probably aren’t rich. They transfer a big chunk of their liquid wealth to a possibly-low-propensity-to-spend financial institution. So foreclosures lower nominal aggregate demand and in times of a downturn this can be bad.
Landsburg’s title may just be provocative but I would make a distinction between the case for allowing foreclosures (I do not advocate that the federal government rewrite the mortgage contracts, although renegotiation could be made easier) and the case for foreclosures. I should note he is quite correct to insist that foreclosure victims are hardly among the world’s — or even America’s — neediest cases. If you think government can do anything well at all, ask what it can do for underprivileged young children. On both justice and efficiency grounds the greatest potential gains lie there. And continued home ownership is not the main thing they need.
There’s a pretty strong efficiency justification for having the government promise to step in when people get robbed, even if the robbed are not objectively poor post-robbery. To the extent that this crisis was caused by lender fraud (I know it was also caused partly by borrower fraud), there’s your justification for intervention.
As I document here foreclosures DO NOT leave homes as they were before the foreclosure. The home on my street was abandoned and destroyed by a frozen water pipe. OThers are vandalized. Others in places like Buffalo and Cleveland are abandoned, destroying entire neighborhoods.
I find myself in complete agreement with Tyler (and I don’t often agree with him). With the incentives legislators operate under, it is very unrealistic to expect them to be able to correct for problems like this. If taxpayer money is going to be spent, there are undoubtedly better things to spend it on.
The reason foreclosures are a good thing, is that banks will eventually clearance sale houses (when their regulators force them to do so), foreclosures put assets in the hands of an entity that is evaluated by their return on assets. The government should make foreclosure (and REO sale) a faster process (to reduce the transaction costs Buzzcut mentions).
I’m about to be a newlywed with a high disposable income, but I’m not going to buy into a market with 4% cap rates, especially with non taxible investments yielding 5+% now. Cap rates should be 8% with the subsidy in this market.
There is a negative externality due to foreclosures–it lowers the market value of surrounding houses even though these people are making timely repayment. The credit for this arguments goes to Congressman Barney Frank. He mentioned this in the Lunch with Financial Times column. I am surprised that this does not gets mentioned enough.
There is a negative externality due to foreclosures–it lowers the market value of surrounding houses even though these people are making timely repayment.
What you’ve just described is a pecuniary externality due to foreclosures, not a negative one.
Paul:
Well, it is affecting the surrounding homeowners negatively by lowering the value of their houses even though they had nothing to do with the default of their neighbor. This is a classic example of externalily–third party is being affected and negatively.
Asif,
It’s not a negative externality for those who can now afford to buy the house at a lower price.
Asif was not clear enough in his argument on negative externalities to identify whether it should be labeled pecuniary or technological. If his argument is that the foreclosed house represents an increase in supply and thus lowering of price, then it is pecuniary. If his argument is that potential buyers prefer to not live next door to a foreclosed unit because of that label, then it is technological.
Either way it sounds like I should make my neighbors pay me a bribe to continue making my mortgage payments. Notice they would only care if they were presently putting their house on the market today.
“Well, it is affecting the surrounding homeowners negatively by lowering the value of their houses even though they had nothing to do with the default of their neighbor. This is a classic example of externalily–third party is being affected and negatively.”
It is a negative externality but it is exactly balanced by an equal positive externality (namely the cheaper price someone who is buying will pay for the house).
I would separate the notion that foreclosures are a good thing individually (versus a government intervention to keep people in homes by rewriting their contract) and the notion that they are good in aggregate for the economy. In order to assume the latter, we have to posit that people moving into homes that were foreclosed upon have at least the same desire for those homes as the people who left them. then we have to assume that the process by which new owners are found is relatively costless and that problems in the credit market don’t lead those new buyers to paying more for the house (as the supply of credit is limited) than they should.
Even given all that, we have to accept a ‘broken windows’ notion of welfare here in order to see foreclosures as goods based on the gains of the new owners.
“None of these foreclosed houses is going to disappear.”
There was an article recently in the Las Vegas Review Journal about how approximately 50% of the foreclosures here have been trashed — either by angry vacating owners or tenants, or by vandals who break in to steal things (appliances, fixtures, copper pipes and wire ripped from the walls, etc.). These houses have effectively “disappeared” because the amount of work to make them livable again will be quite costly.
I hope — and encourage — everyone underwater on their mortgage to “walk away”; let’s get these prices adjusted downward…sooner rather than later.
You who whine about the “negative externality”: Did you whine about the “positive externality” of your neighbor’s home as a “comparable” on the way up? I don’t think so. Whenever I hear the term “granite countertop”, it makes me want to puke.
I looked to buy in 2002 and again in 2004. Anyone with common sense could see it was a bubble; I used to google “housing bubble” and read news stories about the insanity loooooong before Ben started the “housing bubble blog”.
Instead, I put my money in QQQQ and SPY and rode that pony uphill for 3 years — I’ll let you in on a big secret: while the housing bubble was inflating so was a liquid, well-diversified portfolio of equities. Then flipped to cash beginning of 2007…have been buying commodities and riding oil, food, and precious metals uphill. (Now, anyone with a brain is betting on HeliBen trying to inflate his way out of this mess!)
Can’t wait to buy a house for peanuts. {Of course, with oil at $103 today, I think I’ll just wait a while longer…}
Sadly, the one thing I can’t do is keep the governments hands off the money I earned in capital gains, as everyone is so eager to bail out all of these greedy fools (or idiots) who used their homes as ATMs.
save_the_rustbelt,
Then why not go into the banking business and reform it? Morons are easy to compete against.
More likely, they have no way of quickly liquidating their assets when faced with a very large and unexpected number of foreclosures, as is happening now. Of course, these entities are not always banks, especially today when many other sorts of businesses own mortgages in the form of securities. What has happened is that firms have popped up which specialize in buying foreclosed properties in bulk from these businesses and selling them, lessening the bank’s losses.
Actually, moronic bankers are not easy to compete with, just as moronic hedge funds (Andrew Lo’s Capital Destruction Fund example, for instance) are not easy to compete with. Moronic bankers get more business. It is only when the moronic business model fails that there is a relative benefit to being sensible, and then suddenly all the other banks will be sensible too.
The problem is really the moronic investors who enable the moronic bankers. And yes, it is easy to compete with them (in the sense of making better returns over time), but not by going into banking.
“The people that bought these houses can’t afford to repay the loans. So they got to live in a house they couldn’t afford for a little while.” That’s true in some cases, but in a case where the value of the home went down drastically, they actually got to live in a house they could afford, if only it weren’t so overpriced. In some other cases, they got to live in a house that they could afford plus rack up lots of charges on their home equity line of credit. In still other cases they got to live in a house that they could afford so long as they didn’t get divorced, or lose their job, or become disabled, or any of the many other common triggers to a home foreclosure.
In many cases it’s probably a combination of things. From what I’ve read the majority of foreclosures are at least partially caused by a large drop in the homeowners income, though. This whole “living in a home they couldn’t afford” meme seems overhyped.
>affecting the surrounding homeowners negatively by lowering the value of their houses<
It will lower the current market price, but not the value. Assuming that there isn’t a cascading spiral.
Housing is primarily consumption, and only secondarily a leveraged investment. A 3000 square foot box of air is still a 3000 square foot box of air.
Did the intrinsic value of beanie babies decline or just their speculative market prices? I have a lot sitting around in a box somewhere in the basement.
Speaking of moronic banking executives, what incentive do they have for acting sensibly? Acting senselessly (in regard to the long-term) will return large profits in the short term, and if/when their policies result in negative concequences, they can either escape, having already earned huge amounts of money through their salaries and other methods, or they can wait for the government to bail them out, which seems to be a near-certainty now. There seem to be few, if any reasons to NOT run the company into the ground.
Back in the days when thrifts were mutual the relationship was easier to see. People opened savings accounts. The thrift institution pooled the funds and made home loans with a mortgage as security. Without mortgages, even with a low default rate, the thrift would perish. The thrift owed a duty to its depositors to mitigate losses by reclaiming and selling the security.
Nothing has actually changed in this story. The servicer owes a duty to its investor to mitigate losses. But the fact is that the secondary market and the mortgage securitization system, once thought so efficient, made the whole structure collapse. The thrift manager knew his customers, their families and was well aware that he would have to live with this credit (an the asset securing it) for thirty years. This awareness bread caution and good judgment. But when the big operations took over, the broker or mortgage banker didn’t have to hold the mortgage and note in portfolio — it was sold. Anything that the predatory broker could do to get the deal closed and shipped was considered fair game. There was little or no responsibility for bad appraisals or anything else that could be passed off. Then the out-of-town predatory servicers took over. The whole mortgage crisis is the result of misconduct, mostly by underregulated brokers with no accountability after the sale, that would not have been tolerated by either bank regulators or boards of directors. The mortgage foreclosure is not the problem. It is the conduct that let many of the mortgages come into existence that had to be foreclosed.
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