To bail or buy?

September 27, 2008 12:12 PM

If the credit crisis is caused by falling housing prices and excess housing inventory, why doesn't the government just buy up 2,000,000 houses at an average of $350,000 each ($700,000,000) and hold them until housing values rebound. If you're going to artificially prop up home prices, this seems just as efficient as handing the cash to banks.
posted by Crotalus to work & money (20 comments total)

The credit crisis is only caused indirectly, not by falling housing prices and excess inventory, but by bad mortgages; and by bad financial manipulations undertaken by holders of massive mortgage-backed securities and their derivative financial instruments, on the assumption that mortgages would mostly be repaid.

The fact that so many can't pay their mortgage is one cause of the credit problem. The inability to repay - causing buyers to exit the market - also caused it to be that housing prices fell and too much housing inventory is on the market. But fixing the latter doesn't fix the former.

Here's an analogy: A pipe breaks. The water pressure in the pipe goes down because the water all flows out. Also, a wall near the pipe suffers water damage. Repainting the wall doesn't raise the water pressure in the pipe. In other words, the things you describe are symptoms of the underlying problem; band-aiding those symptoms doesn't fix the underlying problem.
posted by ikkyu2 at 12:21 PM on September 27, 2008

There has been a similar suggestion where the government would step in and buy the loans and modify them to "zero-am" status. This would greatly lower the payments for people and let them stay in their homes. The catch? When the prices rebounded (fat chance they'll ever get to current levels) the home owners would reap none of the benefits of the appreciation when they sold. Joe-six pack "the investor" would not be pleased about this, although he would get to stay in his home for the time being.

My vote? Do nothing. Bail no one out. Stop trying to be France (nothing wrong with them I like the French!) and be the Capitalist society we like to pretend we are. We shake off the mal-investment quickly and then people who really know what they're doing (and really know the risks) will buy when -- wait for it-- it actually makes sense to buy! When buying is supported by fundamentals and not psychological bubble-think.

What was the quote about Capitalism? Something about "Capitalism is a great system, we should give it a chance."

You have an interesting idea however, I will say. If you're going to bail someone out, how about the people who live nearer to Main Street.
posted by No New Diamonds Please at 12:36 PM on September 27, 2008 [3 favorites]

Practical/non-economic answer: How large of a bureaucracy would it take to physically go out and buy those homes? Even if somehow done through the bank (i.e. "just give us all the deeds to your foreclosed properties"), you would then need to maintain 2 million homes.

They fall into disrepair pretty quickly without those small repairs that crop up. You need to heat them or the pipes will freeze in northern states. They probably lose value through disrepair a lot more quickly than their value will climb on the market.

You could rent them out, but there's still maintenance, insurance, and staffing. I don't see how the state taking control of 2,000,000 properties could ever be practical or cost effective.
posted by Brodiggitty at 12:39 PM on September 27, 2008 [1 favorite]

yes, falling house prices aren't the root problem, the root problem is that mortgage lenders gave money to people who aren't going to pay the money back to the people who own the notes, and the underlying property security these notes can't cover the loss.

But you have the right general idea, in that I can think of a market intervention the US Congress could take to revert home prices to their 2005 peaks. . .

Home prices are determined largely by the purchasing power of the buyer. This purchasing power is proportional to monthly income less higher priority expenses like taxes, transportation to work, health care, savings, etc.

But this purchasing power is also inversely proportional to the cost of borrowing, and this is somewhere Congress could indeed throw $700B at to change.

By simply (?) changing the mortgage income tax deduction to a tax credit, every borrower and buyer would instantly receive TRIPLE the tax benefit. On a $320K house with a 6% APR, this increases the tax benefit from ~$800/mo to over $2000/mo. This $1200 increased subsidies would instantly realign the housing market, increasing the $320K price level all the way back up to $550K or so.

($320K under current law has a monthly carrying cost of around $1700/mo . . . with this tax credit idea a $550K mortgage would have an expense of ~$2900 -- applying the extra $1200 subsidy would reduce the carrying cost to $1700/mo).

Since the mortgage interest deduction is around $100B/yr, tripling it would result in another $200B/yr expense.

As a Georgist, I feel we should tax housing more, not less, to cut this fucking stupid speculative bubble markets off at their knees, so I hate even mentioning this, but I do think this would be one solution.
posted by troy at 12:41 PM on September 27, 2008

If you're going to artificially prop up home prices

The goal of this program is NOT to artificially prop up home prices. No one (not even baby jesus himself) is going to stop home prices from falling. Home prices are a reflection of buyers' willingness to pay for homes, and banks willingness to give buyers mortgages. While this program will help banks survive, banks themselves have changed their lending standards and it won't cause buyers to suddenly go out in the market and start buying homes. We have a glut of houses in the US right now. Homeowner rates reached historical highs, and many, many people bought second homes as investment properties. This glut alone needs to be worked through, meaning more downward pressure on home prices. And the entire ballgame for mortgages has changed because a) Mortgage brokers who put the wrong people into homes they couldn't afford are gone; b) Banks won't buy crappy mortgages anymore (because they don't have investors lined up to take the mortgages off the banks' books.

The goal of this program is to create a temporary piggy bank to store all the crappy securities on the banks' books, so banks can get back to doing what they do best: lending to each other and lending to Main Street (businesses, entrepreneurs, homeowners, car owners, etc). This temporary piggy bank will let some very, very large (and largely hidden institutions) have confidence in the US banking system, so they will again lend money to the banks (and decent rates).

The piggy bank will be filled with some crappy stuff, which has already been marked down significantly by the banks (leading to distrust of the banks in the first place). BUT, a lot of this crappy stuff may not be so crappy after home prices settle, and investors can make some sense of what those securities are worth. This may not happen for 6 months to a year. In the meantime, banks can continue to lubricate the economy, without risking a deep, deep recession.

Right now investors who would normally buy this crappy stuff are afraid to, and so are just waiting it out. That is hurting banks. So instead you have vulture investors lowballing the banks, knowing that they'll make out like bandits once the dust clears. This is called distressed investing. TARP supposedly will prevent this kind of lowball investing. Also, lowball bids hurt the banks because it reduces the banks' ability to lend in the future. Banks aren't able to get investors to more "capital" in the institution because investors don't trust the banks. That's why WaMu failed. Once these crappy securities are off the banks' books, investors will once again have confidence in the banks' books, and will give them capital, or equity, which will allow banks to resume lending at low rates.
posted by SeizeTheDay at 12:50 PM on September 27, 2008 [1 favorite]

A thing is worth what someone will pay for it. The problem right now is that the market is spooked and almost no one wants to buy, which means that most of the houses out there have an effective worth of zero. The goal of this program is to make the market start moving again. The government is going to buy, and buy a lot, and the hope is that this will make others start to buy again, too, so that eventually the government can once again sell what it will buy in the short term.
posted by Class Goat at 12:56 PM on September 27, 2008

That's why WaMu failed

WM failed because they were the king of "pick-your-payment" loans which they were carrying on their books (as opposed to packaging and selling off as MBS or whatever).

They were also, apparently, allowed to book the interest THEY WEREN'T getting from their negative amortization products as income, which supported their P/E valuation and dividend payout, while at the same time critically undermining the capitalization of the bank.

WaMu's innovations were a major reason why what sold for $350K in 2000 was selling for $700K+ in 2006. Good riddance.
posted by troy at 1:10 PM on September 27, 2008

C.G., your appreciaton of Pauson's proposal is somewhat off-base. It is a reappearance of the MLEC, but this time with public money instead of the bankers'.
posted by troy at 1:13 PM on September 27, 2008

They were also, apparently, allowed to book the interest THEY WEREN'T getting from their negative amortization products as income

Every bank with an option-ARM portfolio did this. A very notable bank still does. Don't think of WaMu as special here. I don't want to derail this thread. Needless to say, I completely disagree with your assessment, but if you'd like to discuss it further, we should take it to MeFiMail, and leave this thread alone.
posted by SeizeTheDay at 1:13 PM on September 27, 2008

Although the crisis was triggered by failing mortgages, the scale of the crisis and of the bailout is set by the bets made by investors on those mortgages. Shallow analogy: If my friends and I bet millions of dollars we don't have that you can afford to buy dinner tonight, and you can't, then the government buying you dinner doesn't save us from having to welsh on our bets, and it's going to be hard to get anyone to take our markers in the future.

And if we can't borrow money we can't run our other businesses, which since 1999 include being your bank, so maybe your ATM stops making the happy money sound.

But don't panic! Please? We're shitting ourselves panicking, but we really need you not to. Thanks!
posted by nicwolff at 1:29 PM on September 27, 2008

I think that's a great question. What's being forced on us is this dogma that only by handing hundreds of billions to the bankers can the "economy" be propped up, but I think a lot of people and unions have suggested there are myriad strategies to deal with this. To answer the question about why Obama, McCain and the various players suggesting any of this: they're all owned by the bankers.
posted by history is a weapon at 1:53 PM on September 27, 2008

OP: serious people are (somewhat) seriously proposing an even more radical idea: buying the houses and then demolishing them. Permanently removing supply does wonders for the supply-demand price equilibrium (if you want prices higher). I think it's ridiculous, but OP's hardly alone.
posted by MattD at 2:42 PM on September 27, 2008

The fact that so many can't pay their mortgage is one cause of the credit problem. The inability to repay - causing buyers to exit the market - also caused it to be that housing prices fell and too much housing inventory is on the market. But fixing the latter doesn't fix the former.

Sure. But couldn't The Man step in with a program that says "In danger of foreclosure? The Gubmint will buy $X or X% equity in your home and force a renegotiation of your remaining mortgage," with some mechanism to get as much as possible of The Gubmint's money back out when the house is sold.
posted by ROU_Xenophobe at 3:06 PM on September 27, 2008

No!

The root cause is unsustainable housing prices, which historically have been about three times median income. That ratio rose nationally to about five times median income, and in high growth areas to as much as ten times median income.

Simply put, people could not afford the mortgages without the option ARMS, teaser rates, lax verification of income, borrowed funds for down payments, etc. All that stuff needs to come to an abrupt end. It largely has. But if Congress has their way, the banks will start that train moving again in the name of returning housing prices to their 2005/6 peaks.

But not every American is meant to own a house at all instants in time.

No national leader in Congress, the White House, the Federal Reserve, or the Treasury has admitted the following basic truth: until home prices return to a sustainable multiple of household income, no amount of financial magic will make the pain go away. Every solution thus far has just slowed down the clock, forced banks to hide their bad assets in Level III accounting, or off-balance sheet vehicles, while homeowners are squeezed dry by inflation and vanishing credit, equity, and employment.

Congress ought to act prudently, and accept that in the coming years interest rates for mortgages must rise, housing prices (in previous boom areas) will fall, and folks who can't afford their houses might lose them. Responsible homeowners, and borrowers seeking conservative loans backed by sufficient down payments, won't be punished, beyond losing the ability to magically withdraw equity from their houses through HELOCs. In other words, there will always be a market for financing sustainable house purchases, regardless of the shameful fear-mongering now coming from the Senate leadership and the Treasury.

On the other hand, if Congress enacts either of the bailout proposals presently on the table, trust will not be restored to our financial system for a very long time. The funding costs for the government will go through the roof, we will lose the ability to fund basic research and small business growth to jump start the economy and interest rates on mortgages will likely go up anyway (with housing prices falling) due to the contraction. Everything will get more expensive through inflation. We're back in the same place, but poorer, and angrier.

Specifically to the Republican plan: there's already a market for insuring debt. It's called the credit default swap and it's a huge part of the problem. If the market isn't willing to insure mortgage debt for just a few percent, the government has no business doing it either. We're the cavalry; you don't send us in first to get slaughtered!

The Democrat plan, to me, is only different from Paulson's proposal in the quantity of red herrings, such as executive pay, the schedule of handouts to the Treasury, the loose language about "accountability." I'm not sure most of the Democrats favor any kind of bailout, but the continual media blasts from Senators Schumer, Dodd, and Frank are making this seem like a done deal.

Bottom line: this shit is shameful. If I wasn't working overseas I'd be camped out protesting in DC and NYC on alternating weekends as often as I could. Everyone ought to think very deeply about all of this, educate yourself, and write/call/fax your representatives, whatever conclusions you come to. The choice here is an extremely important one. Some reports are that the calls to Congress are between 100:1 and 300:1 against any form of bailout. Make sure your representatives cannot claim they weren't warned before acting and taking a stance here.
posted by fatllama at 3:18 PM on September 27, 2008 [1 favorite]

^ people holding an opinion on this generally don't know a fucking thing about anything.

One conspiracy theory holds that this is all a plot by JPM and "Friends of Hank", plus perhaps the Red Chinese, to take over the US financial system.

I see it as a reanimation of the failed MLEC idea from a year ago, but with public funding behind it this time, and I *do* believe this MLEC is perhaps necessary to restructure the financial system going forward onto a sounder financial basis.

the "bailout" aren't about "propping up home prices" but rather recapitalizing the credit markets by taking a healthy chunk of the bad debt off everyone's books (with the taxpayers' money) and holding it in quarantine.
posted by troy at 4:00 PM on September 27, 2008

@troy, if you think investors are afraid of lending to banks now because they are holding potentially bad assets, what do you suppose will happen to 10-year treasury rates when foreign governments and fixed-income investors know that the US government is holding said garbage?

Best case w/ bailout: the plan frees up banks to lend, re-inflates housing, the government is made (mostly) whole, and in 5 years we're back to where we started with unsustainable housing prices, everyone is priced-out without clever lending schemes, etc. etc. . Best case can only be accomplished if the government's books during this are transparent beyond reproach, thus centralizing all the trash in a common and open valuation scheme, and that private investors are willing to quickly bid them up in just a few years. A gamble, especially when Paulson wants the government to pay higher-than-market "hold to maturity" prices. Also, we must rely on banks not hoarding cash instead of loaning in what will clearly be a sharp recession.

If this debt, which includes second-mortgages, HELOCs, auto loans, and credit card debt all acquired during the housing bubble, were such a hidden gem, there's already plenty of liquidity, i.e. the Fed's entire balance sheet, in the system to fund investors' bottom feeding. It ain't.
posted by fatllama at 4:24 PM on September 27, 2008

re-inflates housing

nothing is going to "re-inflate housing" other than the return of suicide lending programs, much lower interest rates, and/or increasing take-home pay (either intrisic or engineered via tax policy).

I agree that this debt is dead loss. The issue is that it's about two or 3 trillion worth of dead loss. As I have opined here . . . when I type this number, my brain is simply incapable of processing its real-world import.

However, the events of this month have clarified things. Hard to believe a month ago I was saying that Lehman had a 50% chance of not seeing 2010 in its current state.

Things are moving downill FAST now and with a credit market seizure we're looking at G.D II. The bailout just gets us to eg. what Japan went through in the 90s.

As for borrowing costs, we printed $10T from 1994-2008, we can print some more. Inflation comes from too much money chasing too few goods. There are two ways to get into this state: print too much or don't produce enough. I'd rather err toward the former than the latter.
posted by troy at 4:40 PM on September 27, 2008

(taking it to MeFi mail)
posted by fatllama at 4:54 PM on September 27, 2008

Agreed- the crisis isn't one of housing, it's one of credit. The irrational exuberance in the credit market caused the bubble in house prices. When the housing bubble popped, or at least flattened, credit markets tanked because they were depending on the market to continue increasing 10% a year.

Housing prices are still too high, by historical standards. Raising them further does nothing for the American people.

The reason the credit market needs to be propped up is two-fold. One, people live in these houses. Letting the bad mortgages fail and forcing foreclosure messes up a lot of people's lives. Two, credit is very important to our economy. What I heard is that the reason this became such an important issue all of a sudden is that the Fed types were watching the short term credit markets, and bond issues were going unpurchased. At any price. Investors did not trust that they would be paid back. Short term credit is very important because a LOT of business depends on it. Say, for example, Home Depot is expanding a location. They build the new building next door, and they're ready to switch over. But for customer service purposes, they want to close the old store tonight, and open the new one tomorrow. That's logistically impossible. They need to stock up the new store first. So they want to borrow $10 million for 30 days to buy that stock and they'll pay it back as they move the old store's stock in. So they try to issue some bonds. Nobody buys them. They raise the interest they'll pay. Still nothing. That's the problem.

Buying the bad paper is a bad idea, but it's the best option we have, I think.

And the inflation issue is not there, because credit contractions cause deflation (a decrease in the money supply). Billion of dollars have disappeared in the past few months. So pumping billions back in just stems that tide, or cancels that out.
posted by gjc at 10:39 PM on September 27, 2008

[a few comments removed - please do not turn this into a referendum on the mortgage snafu and bailout, thank you.]
posted by jessamyn at 5:41 PM on September 29, 2008