Mortgage Modification: Bank Bailout by Another Name?

The big talk in Washington these days is helping homeowners. Unfortunately, what passes for help to homeowners in the Capital might look more like handing out money to banks anywhere else.  The basic story isfairly simple. Tens of million of homeowners are now underwater: they owe more in their mortgage than the value of their home. The reason is that they bought homes at bubble-inflated prices earlier in the decade. Economists and other policy wonks insisted that housing was a great buy, even as home prices got ever more out-of-line with economic fundamentals. Needless to say, the Wall Street crew was eager to cash in on the mania, peddling the deception that mortgages have now reset to higher interest rates, leaving many people unable to afford their mortgage payments. However, even at lower interest rates, homeowners who purchased houses at bubble-inflated prices would find themselves paying far more for their homes than they would to rent a comparable house. As a result, these homeowners are effectively throwing money away every time they make their monthly mortgage repayment. They would be much better off renting the same house and putting the savings in a retirement account or some other form of investment.

The gaps between mortgage payment and rent can often be quite large. A study by from the center for Economic Policy and Research calculated that a family that purchased a small home in Los Angeles near the peak of the bubble could save $1,640 a month by renting rather than owning. This comes to almost $20,000 a year. In Phoenix, a family who purchased a house near the peak of the bubble could save $420 a month or $5,000 a year. In Miami, the savings would be $1,940 a month, more than $23,000 a year.

These homeowners also have no reasonable prospect for ever getting equity in their homes. In many cases, they are 20% or 30% underwater, possibly owning $100,000 more than the current value of their homes. Many of the people who never saw the housing bubble are arguing that house prices will return to their bubble peaks. No doubt, these people also expect a resurgence of the Internet stocks of the late 1990’s. In reality, there continues to be an enormous oversupply of housing as reflected by the record vacancy rate.  The huge oversupply is causing nominal rents to actually decline for the first time ever. Once the homebuyers’ tax credit and other extraordinary subsidies end, home prices will resume falling to bring supply and demand into balance.

In this context, it is extremely unlikely that the vast majority of underwater homeowners will ever accumulate a penny in equity. Keeping them in their homes as owners means wasting thousands of dollars a year on excess housing costs only to be forced to arrange a short sale or face foreclosure at some future point in time. So, who benefits from “helping homeowners” in this story? Naturally the big beneficiaries are the banks. If the government pays for a mortgage modification where the homeowner is still paying far more for the mortgage than they would for rent, then the bank gets a big gift from the GOVT, but the homeowner is still coming out behind.

In some cases, the GOVT may pay enough to buy down the principal that the homeowner is no longer underwater, but the bulk of this money is a gift to the bank, not the homeowner. If a homeowner is $100,000 underwater and the GOVT pays the bank $50,000 to write the loan down to the current value of the house, then the bank has pocketed $50,000 while the homeowner is essentially left breaking even. This is very generous to the banks but homeowners have nothing to show ii this story. President Barack Obama has proposed putting up $70 billion to help homeowners in this way. This help for homeowners is likely to end up as a larger subsidy to the banks than the rest of the troubled asset relief program (TARP). The reason is that the rest of the TARP program was a loan. The loans were at below market interest rates–thereby providing a subsidy to the banks—but most of the money is getting paid back.

The original batch of lending to banks was $250 billion. Even if we assume an average interest rate subsidy of 10 percentage points (a very large subsidy), this still implies that the lending portion of TARP only hauled

$25 billion to the banks, far less than the 70 billion that we are prepared to hand them under the guise of helping homeowners. There are simple, low-cost ways to help homeowners who were victims of the housing bubble and lending sharks. The most obvious way would be to give homeowners the right to rent their home at the market price for the next decade. But this would mean hurting the banks rather than giving them taxpayer dollars, and we still don’t talk about hurting banks in Washington, D.C.

Dean Baker is Co-Director of the Center for Economic and Policy Research.

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