Treasury plan to help unemployed homeowners is no help at all

by Stephen Malpezzi, Professor and Lorin and Marjorie Tiefenthaler Distinguished Chair in Real Estate

Readers of the Wisconsin Real Estate Viewpoint will know of our efforts, since early 2009, to think through the best way to tackle the increasing wave of defaults and foreclosures. These foreclosures threaten the fragile stability of house prices, driving them below levels justified by fundamentals—just as circa 2004-2006 a series of bad decisions on financial and regulatory fronts, along with no small amount of "irrational exuberance," drove them above prices justified by fundamentals. In response, we designed something we call the Wisconsin Foreclosure and Unemployment Relief (WI-FUR) plan which provides temporary support to cash-strapped unemployed households to help them stay current on their mortgage.

Let me put a normative statement on the table: in normal times, I would be opposed to a plan like WI-FUR. But these are not normal times: unemployment is still at 10%+, at record duration; a quarter of the nation's mortgages are under water; and house prices are on a knife edge.

If a version of WI-FUR were enacted, some homeowners would be bailed out of bad decisions they made about house purchases and mortgages. More significantly, others would be helped who had made what were, at the time, apparently good decisions; but now they cannot pay previously affordable mortgages; they're unemployed and the value of their homes has fallen below that of their mortgage. (Even if they have positive equity, some unemployed will default because of the income shock, and might end up with a distressed sale rather than a foreclosure; but in today’s environment, large numbers of distressed sales can also lower house prices).

Every foreclosure in today's environment imposes costs on neighbors, the financial system, taxpayers, and the economy as a whole. It's as if houses in our neighborhood have caught fire, some because an irresponsible person was smoking in bed, some because of an unseen short in their electrical system. Before we condemn the smoker, let's put the fire out first before we all burn. (And let's fix the electrical system while we're at it!)

The government’s signature plan to deal with foreclosures is the so-called Home Affordable Mortgage Program (HAMP). Despite $75 billion allocated by Congress to assist up to 4 million distressed households (it was thought), less than 10% of that number of borrowers have received permanent loan modifications so far; and those modified loans are, after the fact, still defaulting at high rates. Some experts predict that up to 2/3 of modified loans will, in fact, default.

HAMP's ineffectiveness is by now well known; see, for example, the July 21, 2010 quarterly report to Congress by SIGTARP (Special Inspector General for the Troubled Asset Relief Program)'s Neil Barofsky; pages 5-7 of the executive summary give an overview. Or see the Government Accountability Office report Troubled Asset Relief Program: Further Actions Needed to Fully and Equitably Implement Foreclosure Mitigation Programs.

The WI-FUR plan, and complementary plans put forward by our colleagues at the Boston Fed and elsewhere in the Fed system, argue for temporary housing vouchers (or loans) aimed at the unemployed, who have become the majority of foreclosures and who are often effectively (if not "de jure") ineligible for assistance through normal HAMP channels.

Recently our friend Karen Rivedal, who writes the Wisconsin State Journal's real estate blog Property Trax, asked me to comment on a recent variant of the HAMP program called Home Affordable Unemployment Program, or HAUP.

When I first heard of HAUP, I was excited, but my excitement quickly turned to disappointment. Among other problems, it requires that unemployed homeowners go through a fairly bureaucratic procedure to apply for what is (more or less) three months forbearance. And that' s merely the application; forbearance may or may not be granted for the 3 months. Remember, at the present time, the AVERAGE duration of unemployment is 9 months and rising.

(The fine print says you can extend beyond 3 months, but it's not clear that will happen, and will certainly not be clear to potential applicants).

The website's FAQs does not even tell people if the differences between the original payments and the reduced payments, are forgiven, or wrapped into the loan. (When I inquired of the experts in Washington, it turns out part of the loan is forborne, adding to the loan amount, but it’s amazing that they ask people to apply without clearly explaining such a key element of the program!)

What if your unemployment lasts more than three months (which is true for most unemployed today?) After two months you are given an application for HAMP, the dog that won't hunt. As far as I can tell, most unemployed will still not qualify for HAMP after they fill out this application.

There are other details that limit the program’s scope, and hence its effectiveness at halting the skid in housing prices. Homeowners can't get relief on the second liens. And if I read it right, HAUP does nothing for the unemployed not receiving unemployment insurance.

My bottom line: Treasury is still spitting on the fire and leaving the hoses coiled up.

The Housing Hangover: How Bad Will It Be?

By Erwan Quintin, Assistant Professor of Real Estate at the Wisconsin School of Business

According to the National Association of Realtors (NAR) sales of existing homes in the U.S. tumbled by 17% in December, the largest monthly decline since the Association began reporting this measure in 1968. Drops of this magnitude usually come with a simple explanation. In this case, we are witnessing the home buyer tax credit hangover that economists have been anticipating for months.

The home buyer tax credit program gives buyers who haven’t purchased a home in at least three years and who meet certain income criteria a tax credit equal to 10% of the purchase price of their new home, up to $8,000. The program was originally set to expire on November 30th, but was extended in early November in both time and scope. The program’s intent was to give potential homebuyers incentives to purchase homes now; and, to some extent, to bring new buyers into the market. The fact that home sales rose at a healthy pace in the second half of 2009 and are now falling is evidence that the program “worked.” The NAR’s report also contains more direct evidence that many first-time homebuyers accelerated their purchases to secure the credit: they accounted for 43% of purchases in December, down from 51% in November.

At first glance, it may seem surprising that sales tumbled while the median home price rose by 1.5%. However, this result is a false positive which is essentially the hangover effect at work. Until last November, the credit was limited to first-time home buyers whose income was below $75,000 for singles, and $125,000 for households. Households who meet those criteria tend to buy cheaper homes. When they left the sample of home buyers in December, median prices mechanically rose.

Most people would agree that the program had the desired effect: it has moved home purchases forward. One could argue that the goal of all stimulus plans (fiscal and monetary stimulus, accelerated depreciation schemes, etc.) is to cause a spending shift. The goal is to borrow from a presumably stronger future to support flagging activity today. All stimulus plans, therefore, are bound to come with a hangover. The hope is that the hangover does not overwhelm the initial gains. (For a more detailed discussion the hangover effect, click here.)

How bad will the hangover be in housing markets? Over the next few months, home sales will benefit from the extending the housing credit program to a broader set of buyers until April 30, 2010. However, the same set of questions will arise in May. As is the case with all stimulus programs, the timing of the withdrawal is critical. If economic conditions have improved sufficiently by May, and a recovery is under way, the losses associated with the credit expiration will have limited effects. If, on the other hand, markets remain dependent on policy support, then a relapse is certainly possible.

Take, for instance, the foreclosure crisis. Foreclosure rates have tripled since mid-2006. Without policy support, however, things may have been worse. One incentive for households who experience financial difficulties to hold on to their home is the prospect of selling their home at a good price in the future. (For more information on this topic, click here.) If it becomes clear in May that selling prospects have suddenly worsened, the hangover could come with yet another foreclosure spike.

As they say in policy circles these days, we need an exit strategy. I would like to recommend the “Wisconsin Foreclosure and Unemployment Relief" program, or WI-FUR, a plan developed by my faculty colleagues Morris A. Davis, Stephen Malpezzi, and François Ortalo-Magné.

What costs more: foreclosures or loan modifications?

Yesterday, NPR reported on increased government pressure on the mortgage industry to speed up permanent loan modifications for homeowners under the Obama Administration's 10-month old $75 billion foreclosure prevention effort. UW's Morris Davis responds:

We don’t need mortgage modifications to stop foreclosures. According to a recent Freddie Mac survey, 57% of foreclosures are related to unemployment – only 20% are related to “excessive obligation”, which could also be unemployment related.

What the unemployed need is temporary assistance. The right kind of temporary assistance for the unemployed – either the WI-FUR plan or the Boston Fed plan – will stop foreclosures.

The most costly thing we can do right now is to offer permanent mortgage modifications to the unemployed. On average, modifications to the unemployed cost U.S. taxpayers about $18,000. If we do nothing, each unemployed person with a mortgage costs U.S. taxpayers about $7,000 (because some unemployed households go into foreclosure, and foreclosures are costly when the mortgage is backed by the U.S. government). The total cost of WI-FUR or the Boston Fed plan is less than $6,000 per unemployed person with a mortgage – these plans prevent foreclosures and foreclosures are costly!

Morris A. Davis is Assistant Professor, Real Estate and Urban Land Economics at Wisconsin. Often cited in the national media for his expertise in current housing and macroeconomic issues, he is a fellow at the Lincoln Institute of Land Policy, is on the academic advisory council of the Federal Reserve Bank of Chicago, and worked at the Federal Reserve Board before coming to the Wisconsin School of Business in 2007.

The Wisconsin Foreclosure and Unemployment Relief Plan (WI-FUR) is a proposal by Wisconsin Real Estate faculty to address unemployed homeowners' risk of foreclosure by supplementing unemployment benefits with an additional housing "voucher" payment. Learn more about the WI-FUR plan.