The Nuclear Housing Bailout Option

A couple of interesting bailout-related items crossed my desk today.  I have given up on trying to keep track of all the bailouts, but these both relate directly to our beloved topic of shadow inventory so I thought I’d note them.

First, the White House is trying to ban any foreclosure unless the loan in question has been screened for HAMP, the government’s flavor-of-the-month home loan modification program.  As I understand it, HAMP has been fairly useless, for reasons I will describe below.  But no matter — an extra mandatory step to screen every mortgage for eligibility will further delay the foreclosure process, perhaps resulting in even more delinquent mortgages remaining in pre-foreclosure limbo.

The reason that HAMP and the government’s other varied foreclosure prevention schemes haven’t made much of a splash is that they don’t address the main cause of foreclosures: that many homeowners owe more than their homes are worth.  (Though I suppose the term “homeowner” is a bit of a misnomer in these cases).  If someone owes significantly more than a home is worth, regardless of how low you temporarily get their payments, they still just don’t have much incentive to stay in the home and remain under the burden of that giant debt load.  That is why the government’s efforts to stop foreclosures have largely failed.

So I was very interested to read that the FDIC is going to use its failed banks as guinea pigs to, per the Washington Post, “test whether cutting the mortgage balances of distressed borrowers who owe significantly more than their homes are worth is an effective method for saving homeowners from foreclosure.”

Do you really need to test that premise?  Apparently so.

Widespread mortgage principal reductions for underwater owners are the nuclear option in the government’s effort to bail out the housing market.  That would be the one surefire way to take away underwater homeowners’ incentives to walk.

Such an effort would in the majority of cases consist of reimbursing people for poor investment decisions just because the investment in question happens to be a politically favored one.  But the government has already spent untold sums rewarding the horrific investment decisions of banks and their bondholders — it shouldn’t be too surprising that they would throw the same bone to bubble-era home buyers too.

I suspect that principal reductions are on the way.  The FDIC’s “test” certainly suggests as such.  And this is why I think it’s too early to tell whether shadow inventory or the vaunted “second wave” of foreclosures will ever actually amount to anything.

— RICH TOSCANO