When it comes to economic data, the hardest thing to find and to keep is a sense of perspective.
A recent front-page headline warned of deepening bank and housing troubles and illustrated the point with some graphs. One graph showed the delinquency rate on residential mortgages and, as we all know, it is rising.
A careful look at the graph, though — and maybe this should be on the WASL — reveals that the delinquency rate, with all of our subprime loans, still hasn’t reached the level that it was in 1985.
There are still some people around who actually survived the U.S. economy of 1985, which, incidentally, despite the mortgage delinquencies, did not collapse. In fact, overall, it wasn’t a bad year at all. Gross Domestic Product grew by 4.1 percent that year, which marks it as one of the better years of the past few decades. Maybe realizing that will help us get some perspective on the bad news thrown at us every day.
That said, there are some significant differences between the housing situation now and what it was 23 years ago. The spike in mortgage delinquencies then was caused by a sharp drop in oil prices, and the economic damage, while devastating, was mostly limited to Texas, Oklahoma and Louisiana.
In recent years the mortgage lending industry redefined qualified borrowers to include homebuyers whose initial equity in the residence was very close to zero. In fact, given the appraisal abuses that are being revealed, in many cases the home owner’s equity was already negative at the time the home sale papers were signed. The mortgage was larger than the home’s true market value.
The cascading delinquencies, defaults and foreclosures have created a large inventory of unsold houses. And while some states such as California, Florida and Michigan are especially hard hit, the impact is felt more broadly than in 1985 because the problem was driven by Wall Street and big banks.
According to the U.S. Census Bureau, at the end of 2007 there were about 2.2 million vacant housing units for sale across the United States, roughly 79,000, or 4 percent, more than at the end of 2006. The problem is still manageable if we act promptly.
Each foreclosure is not only a disastrous event for the family involved; it also places one more house on an already saturated market. The house itself, for the foreclosing owners, is a dubious asset. Until the market turns around, the house will sit there, deteriorating and rolling up maintenance and real estate tax expenses for the financial institution that owns it.
The key figures in this picture are the financial institutions. As long as they are mired in this mortgage morass, they will tend to “hunker down” and take actions that they believe will preserve their capital and liquidity. Unfortunately, while that strategy seems reasonable for each individual bank, when they all do it, collectively, they cut off the air supply for the economy. Businesses cannot get the loans they need to finance their capital investments and current operations.
The Federal Reserve is very aware of this and has been trying to break through the hunker-down psychology gripping our banking and financial systems. Its efforts to do so through adding liquidity have been effective, but extremely short-lived.
Recently, though, Fed Chairman Ben Bernanke tried a novel, more direct approach. Realizing the key role of mortgage debt, he announced that banks could use mortgage debt as collateral to borrow U.S. Treasury bonds. This direct assault on the problem gave an immediate boost to financial markets, but, of course, it remains to be seen if the effect is lasting.
To increase the odds of a lasting effect, the federal government should take a similar direct approach to foreclosures. The Federal Housing Authority should offer to buy houses in any stage of delinquency-default-foreclosure in which the original buyers are still living in the home and can afford to make their original monthly payments.
The homeowners, for their part, can avoid foreclosure and remain in the home by relinquishing their ownership and agreeing to a monthly rent. At that point, the house is transformed into a credible asset, earning cash instead of eating cash.
Subprime lenders made buyers out of people who should have been renters. The instability in the housing market is hurting our economy and the federal government can stabilize it by reversing the process — turning the buyers back into renters.
This is neither a perfect nor a permanent solution. But it will calm down a housing market so that we can regain our perspective. And that will allow us, and the economy, to get back to work. We’ve got a lot to do.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Snohomish County Business Journal.
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