Major cause of downturn: failure to help homeowners
Katherine Porter and Susan Wachter work on opposite sides of the nation, but they share common ground on one issue.
For a country that fell into a recession primarily because of a collapse in the housing market, the two experts say, America has done a lousy job of coming up with a plan to revitalize home ownership.
National statistics show how persistent the slump is.
This year, median existing home prices nationally were $171,900, down more than $100,000 in current dollars from 2006, before the recession hit. More than 8 percent of all mortgages are delinquent, including 24 percent of riskier subprime loans. More than 4 million homes have been foreclosed on.
Ms. Porter, a law professor at the University of California at Irvine and an expert in bankruptcy and foreclosure, said that when the economy was knocked sideways in 2007, "We heard so much about institutions that were 'too big to fail,' in terms of the government bailing out companies like Citibank. But it seems like homeowners are too small to save."
She said it is striking to her that the Obama administration's vaunted Middle Class Task Force makes no mention of housing or credit problems anywhere on its website. The task force, headed by Vice-President Joe Biden, focuses on such issues as job creation, education costs and taxes, but "it's completely silent as to credit, and yet, being in consumer debt has become this important shared characteristic of middle-class life in America."
Ms. Wachter, a real estate professor at the Wharton School at the University of Pennsylvania, said "no credible housing reform plan has yet emerged from the administration or Congress," despite the critical role of home ownership in middle-class economic life.
She said her research shows that the primary cause of the housing market slump was lax underwriting standards that led to riskier and riskier types of loans, many of which were issued not to buy homes but to refinance them.
In an interview in her office in Philadelphia earlier this year, she cited three egregious types of mortgages that were being handed out at the height of the housing bubble in 2005 and 2006.
One was "teaser ARMs" -- adjustable rate mortgages that might give homeowners a 5 percent interest rate for two or three years and then bump it up to 7 percent -- just enough to force thousands of borrowers into default.
Another was "option ARMS" -- adjustable rate mortgages that basically allowed borrowers to pay "whatever they wanted, whenever they wanted," with any unpaid monthly principal and interest being added to the total.
A third was "stated income" mortgages, in which borrowers simply told mortgage brokers what they were earning, but never had to document their pay.
"The shift to these kinds of mortgages, combined with a failure to validate the creditworthiness of the borrowers, were the major factors that led to the crisis," she said.
At the very time these types of loans were being issued, Ms. Wachter said she and fellow researchers presented a research paper at the American Economic Association in 2007 that showed how similar easy credit in Asia had played a key role in the collapse of housing prices there in the 1990s.
Because it wasn't clear how many of the riskiest mortgages were being issued in the U.S., though, investors who bought bonds backed by those mortgages did not know how shaky they were until it was too late.
Why didn't more people see that trouble was on the way?
Economists Robert Shiller and George Akerlof, in their book "Animals Spirits," said the housing boom, like other bull markets, was caused as much by irrational exuberance as it was by any rational analysis of economic trends.
These "animal spirits," first described by economist John Maynard Keynes in the 1930s, are "why people paid small fortunes for houses in cornfields; why others financed those purchases; and why the Dow Jones average peaked above 14,000 and a little more than a year later fell below 7,500," the two men wrote.
It was the collapse of the bonds backed by risky mortgages that led to the plunge in the stock market and the beginning of the recession.
And while the federal government was quick to bail out banks and insurance companies that were caught in the crisis, it did not launch any similar rescue program for homeowners.
The Obama administration did promote some loan modification and loan refinancing programs, but they fell far short of expectations, mostly because banks' participation in them was voluntary, Ms. Porter said.
The government's main plan, the Home Affordable Modification Program, was expected to lower payments for 3 million to 4 million homeowners, but by September, it had helped only 850,000 households, the Treasury Department reported.
One reason for the shortfall, Ms. Porter believes, is that because mortgages have been resold to thousands of investors in the bond market, "very diffuse ownership means nobody is putting any pressure on the mortgage servicers to do what makes the most sense."
Others say that the federal government could reinvigorate the housing market if it were more aggressive in helping tens of millions of homeowners refinance their mortgages at today's record-low rates.
Glenn Hubbard, dean of the Columbia University Business School and head of the Council of Economic Advisers under President George W. Bush, has advocated a streamlined refinancing program that he says would save a typical homeowner more than $2,000 a year in housing payments at today's interest rates, and achieve overall savings of $50 billion a year, which would create a huge economic stimulus.
Besides programs to help existing homeowners, Ms. Wachter said there is a desperate need to ease credit for qualified home purchasers.
America has gone from profligate lending during the boom to overly restrictive policies today, she said.
"People are not getting loans today who should be getting loans," she said. "It's almost as if people don't want to lend anymore. And to have a 20 percent downpayment requirement is absurd. I think 10 percent is where we've traditionally had it with mortgage insurance, and that's what it should return to."
Ultimately, she said, the federal government needs to come up with a transparent plan that would set clear underwriting standards for home loans, insuring that borrowers could afford to repay their debts.
Establishing responsible lending standards, she said, would help prevent future "housing pricing booms whose collapse puts the banking system, homeowners and the overall economy in real danger -- a danger that we have not yet escaped."
First Published December 5, 2011 12:00 am