In Which I Support Government Bailout of Foreclosed Homeowners

According to the Zillow Blog, 1 in 7 American homeowners are now “underwater” on their mortgage. So the Zillowites ran a survey of 1300 homeowners. And found interesting answers:

One question we asked was:

Do you think homeowners who are currently facing foreclosure because they took out an adjustable rate mortgage or other loan that they can no longer afford should receive government assistance in order to be able to stay in their home?

Nearly half (48%) of homeowners said no. Meanwhile 28% support government intervention, and 24% “don’t know.”

Thank goodness that at least 48% of American homeowners still believe in capitalism. But the title of that post is “Foreclosures Are No Longer a Subprime Crisis”. The author goes on to ask:

But what about homeowners who didn’t take out a “creative,” or risky mortgage? Are there really many homeowners out there with good credit, a solid down payment, and all the right intentions who are at risk to default on their loans? Zillow’s Q2 Real Estate Market Reports point to dozens of U.S. markets where the stage is certainly set by fast-growing rates of negative equity.

Take the Miami-Ft. Lauderdale MSA, for example. The median down payment in 2006 was 10%, or $30,873 based on the median home value of $308,731 when that market peaked in Q1 2006. Since the peak, Miami home values have fallen 26.8% , meaning the average buyer that year has not only lost his down payment, but is now underwater on his mortgage by nearly $52,000. Should this homeowner now lose a job, or fall behind in payments, he’s in dire straits.

The implication is that we should in fact be supporting some sort of a government bailout for these “responsible” homeowners who are in dire straits. Whatever you might think of those idiots who did the no-money-down ARM’s and such, we ought to rescue the homeowners with good credit, a solid down payment, and all the right intentions who are at risk to default. That’s the implication.

You know what? I’m on board with a government bailout. By all means, let us rescue these honest homeowners who were victimized by a horrible housing market. They’ve already lost all of the equity in the house — at least the example in Miami did. If they should lose a job or fall behind in payments, why… that’s a terrifying situation. Sign me up. I’m all for it.

There is a condition, however, that I would have to insist on. (You knew there would be strings attached, right?) Here it is:

If you take taxpayer money to bailout your house, you forfeit all future gains.

Here’s how it would work.

A homeowner can get a low-interest government loan to restructure their existing mortgage. Using the example above, the home was valued at $300K; homeowner put down $30K, and financed $270K. The home is now valued at -25% from that peak, so $225K. The government will pay the bank $270K to buy the mortgage from the bank; it will then issue a low-interest 30-year fixed rate (say at the discount rate, which is what the Fed charges money center banks, currently at 2.25%) loan for $225K to the homeowner, eating the loss of $45K. The bank gets its principal back, although no profit on the loan. C’est la vie. It’s better than foreclosure and REO. The homeowner is able to stay in his house, and has payments that are way below market.

At the same time, the government computes what the market rate would have been for a 30-year fixed rate mortgage for the full $270K by the homeowner, with his FICO score, etc. It computes the difference between that loan and the government loan it just gave to the homeowner. Using today’s prevailing 30-yr fixed rate of 6.36%, the expected interest payments over 30 years would have been $335,448.27. The government loan, $225K at 2.25% over 30 years, comes to interest payments of $84,619.34. The difference is $250,828.93.

If the house is ever sold, the homeowner’s gains are limited to $225K plus the interest paid on the government loan to date. All amounts over that would go to the government. If the homeowner sells the house in 2012, he would have paid $21,190.27 to the government in interest. His gains are limited to $246,190.27. Everything over that amount goes to the government: you forfeit your future gains.

If the housing market should turn around, and the house’s value goes back up to $300K, then that appreciation goes to the government. If the appreciation is so much that it will cover the difference between a private mortgage and the government mortgage, then the homeowner is able to get that.

So for example, say our rescued homeowner sells his house in Miami after living there for 20 years, paying a 2.25% government mortgage. In the year 2028, his house in Miami is now worth $600K. The homeowner is able to get the $225K original valuation plus $74,608.17 in interest payments. That comes to basically $300K. The difference between the private mortgage @ 6.36% and the government mortgage over 20 years is $226,113. That goes to the government. The remainder of $74K ($600K – $300K – $226K) goes to the homeowner.

If the home is sold for less than $270K, the homeowner will end up owing the government the difference, which it will take directly out of paychecks, tax returns and any other direct transfer programs.

The principle is the same as the bailout.  If we, the public, are going to insure people against loss and risk, then by golly, we should get the rewards of the transaction.  In a normal capitalist economy, people are allowed to fail, because they’re allowed to succeed.  A private homeowner who weathers the storm can come out the other end and make the money back — because he’s taken on the risk, he takes on the reward.  If we’re going to have a program that makes people whole for risks, for job loss, for anything bad that could happen, then we should by rights be able to reap the rewards of taking that risk ourselves.

If the public rescues homeowners because house values dropped, then the public should benefit when house values rise.

With that proviso, I can support a government bailout.

-rsh