From a small northwestern observatory…

Finance and economics generally focused on real estate

Proposals for fixing housing

with 3 comments

John K. McIlwain is the Senior Resident Fellow/J. Ronald Terwilliger Chair for Housing at the Urban Land Institute (ULI) in Washington, D.C.  I don’t necessarily agree with everything he says, but he stimulates some interesting thinking in a piece this week titled “Fixing the Housing Markets:  Three Proposals“.  (click on the title to link to the article itself.)

In summary, he proposes:

1.  Renting federally held REO

2.  Creating a mortgage interest credit

3.  Divide mortgages for underwater homeowners into a “paying” first and a “delayed” second.

He admits that in the current political climate, none of the above stands a ghost of a chance (nor would any other solution, good or bad), but even though I might disagree with some of what he says, I’m a firm believer in the old In Search of Excellence adage:  ready, shoot, aim.  Really excellent organizations (and government entities — which are rarely even CLOSE to achieving excellence) have a proclivity for doing SOMETHING.  The Marine Corps calls it the “70% solution”, which dictates that you attack as soon as you think you have 70% of the information needed for success.  Why not 100%?  Because fate favors the side with the initiative and momentum, that’s why.

So, please indulge me for a moment to comment on McIlwain’s proposals, but DON’T take my criticism as an indication that I wouldn’t vote in favor of doing exactly what he proposes, because in the current climate, a half-good idea is probably better than no idea at all.

1.  Rent federally held REO — Well, even McIlwain admits (or at least implies) that the government is a terrible landlord, so he would propose turning this over to the private sector via pools of “privatized” REOs.  What he’s essentially saying is to sell these REO’s (currently about 250,000, and expected to grow to a million) to investors with the caveats that they be held off the market as rentals for a period of time, AND that there be adequate maintenance to keep them from turning into slums.

My ONE disagreement with this is that less government involvement is usually better than MORE.  Plenty of investors stand ready to buy REOs right now, and the resale market is sufficiently poor that these investors recognize they have to be in it for the long haul.  Local planning ordinances are usually adequate vis-a-vis slum prevention IF they are enforced properly (as is not always the case).  There is no reason to believe that additional Federal caveats would improve the situation.  In short, this is actually being accomplished already, and deserves facilitation by the government, not regulation.

2.  Mortgage interest credit — McIlwain notes, and we concur, that the current mortgage interest deduction benefits taxpayers earning over $100,000, but hardly those earning less.  He suggests replacing this with a flat 15% tax credit, which would have the double-barrelled effect of raising the effective tax rate on those earning over the 15% marginal break-point, but directly benefitting dollar-for-dollar those below that break point.  It’s an intriguing idea, but would require the Realtors’ and Mortgage Bankers’ buy-in.  In today’s troubled market, it’s difficult to see how they would agree to anything that tinkers with the status quo.

3.  Divide mortgages for underwater homeowners into a “paying” first and a “delayed” second.  As much as I like this one on the surface, it ONLY works for homeowners who plan to stay in their houses until prices rise (on average) about 20%.  We don’t see that happening for quite a few years, so this essentially just kicks the can down the road a bit.  Even that, though, is an improvement over the status quo, and keeps homeowners in their homes for the time being.  The real problem, of course, is how to deal with the “delayed” paper on banks books.

In short, McIlwain’s proposals at least stimulate some conversation about solutions for the terrific vacant REO problem.  One big issue is lack of credit for suitable property managers — banks are loathe to loan on “second” homes today, and investment property (REOs turned into rental homes) is a troublesome loan to get.  I would propose that the agencies/banks holding paper on vacant homes simply privatize it immediately — if a bank holds a $100,000 loan on a vacant house, then a reasonably creditworthy investor who is willing to start amortizing that loan should be able to walk in, pick up the keys, and walk out the door.  Sure, this would violate all sorts of down-payment caveats in place right now, but it would get interest payments moving again, provide much-needed rental housing, and get some local entrepreneurs busy managing otherwise dead assets.

Written by johnkilpatrick

February 1, 2012 at 2:34 pm

3 Responses

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  1. John:

    Being right of Atilla the Hun and Genghis Khan on the political spectrum, I do surprisingly find appeal on allowing first trust deed cram-downs in bankruptcy court on primary residences. This was originally proposed by those on the very left side of the aisle.

    Of course the banks won’t like this as it is a very sudden, harsh, and fairly radical proposal. This would likely expose some banks to failure. But does anybody really care anymore? This is probably what is needed given the scale and depth of the problem. The above “solutions” are simply trimming around the edges of the problem.

    I definitely think this would pull the band-aid off and let the wound get some air and quit festering under all the delay tactics you see by the banks and the governments to let the market clear. They wish to delay because they believe the market will come back and enable them to not have to book their losses. They do this at the risk of dragging out the housing malaise for a decade or longer.

    First Trust Deed BK cram downs on a primary residence removes the “moral hazard” element in my opinion. Only those truly needy will risk the trials and tribulations of bankruptcy court and setting forth all of their assets and liabilities to the court in order to set their housing situation on more firm footing.

    Be interested in your take on this. I don’t like government solutions either. But this is a solution that would largely be managed by the judicial branch rather than the legislative or executive branch that would have a substantial market impact and really help clean things up much more quickly than what is happening right now.

    Charles E. Jack IV, MAI

    February 1, 2012 at 3:03 pm

  2. Charles —

    Remember that McIlwain is ONLY commenting on REOs already owned by the Federal government. That problem is getting big in a hurry, and the foreclosure process is set up specifically to avoid the bankruptcy courts (which DO NOT have the bandwidth to deal with this problem).

    In short, it’s a mess, and at the core of McIlwain’s thesis is the idea of letting the private sector step up to the plate and take this mass of dead assets off the government’s hands. With that I fully concur.

    johnkilpatrick

    February 1, 2012 at 3:21 pm

  3. I agree it’s a mess. Big messes need bold solutions but I also think they need to be quick and relatively simple. In order to be politically expedient, solutions also need to be easily understood and communicated to the populace. Regrettably, there is no avoiding pain no matter what you do.

    McIlwain’s solutions are elegant but they are fairly complex under the hood and probably only appeal to over-educated real estate geeks like ourselves. (Sometimes I just have to be honest as to what I am… :-)) I doubt politicians will find a lot of appeal in these relatively complex solutions.

    Perhaps setting up a huge bankruptcy court infrastructure to deal with first trust deed cram-downs on primary residences is a proposal that needs serious debate right now. I’m not sure what you mean by the “foreclosure process is set up specifically to avoid the bankruptcy courts”. In Nevada (arguably the “Ground Zero” of foreclosures in the country) the bankruptcy court is used quite frequently to deal with foreclosures – many of which are primary residences.

    With comments like Romney’s about letting housing hit the bottom, I see no quicker way to get everything over with than setting up a massive bankruptcy court infrastructure nation-wide and just getting the show on the road. After all the whooping and hollering is done with in bankruptcy, we will have a much healthier market.

    Charles E. Jack IV, MAI

    February 7, 2012 at 10:45 am


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