The Wall Street Journal had continuing news this morning on the lack of progress in getting mortgage companies to reduce the principle owed on underwater mortgages. This whole business about essentially giving people money if they owe more than their home is worth is pretty crazy. Of course it’s no crazier that giving people money if they buy a car or if they purchase a home, but that’s what the politicians seem to think is necessary.
To begin with, being upside down on your mortgage is not an emergency. If you continue to live in the house and pay your mortgage, sooner or later the value will rebound. Home values rising is something that happens over time. Always. It’s just a question of how much time. The government stepping in and telling banks to lop thousands of dollars off a mortgage will impede the process and cause it to take more time to correct itself.
Why? Because you’re telling people there’s a way to get free money. Free money is a terrific incentive for someone to not pay their mortgage. This isn’t too complicated: If a home owner is underwater, but still pays his mortgage, he is not in arrears, probably has good credit and in the long run will come out okay. If a home owner is underwater and can’t afford to pay his mortgage, he must find a way to make the payments or negotiate with the bank to redo his mortgage terms.
If the homeowner can’t do either of these things he must go into foreclosure. The house will then go back on to the market where it will eventually be sold. Demand will catch up to supply, and the unsold inventory of foreclosed homes will be worked through. Home values will slowly begin to rise. The home owner who stuck with his underwater property will again begin to build equity.
(As an aside, the underwater homeowner is in a catch 22 regarding interest rates. If lower finance rates are available the underwater homeowner should be able to take advantage of them. But if the homeowner is underwater, he has no equity and can’t refinance his mortgage. Not surprisingly, banks don’t seem to be in a rush to help the debtors out with lower interest rates. In some cases lower interest rates will have more value than a principal reduction. This is a place where, in certain situations, it would be equitable and logical for the government to participate).
So the two reasons why principle reduction is such a bad idea are: (a) It provides dis-incentive’s for the guy who would continue to pay his mortgage, and (b) it draws out the time line for the economy to work its way through the repair process.
There are also lots of reasons why this won’t work: job loss, sickness, need to relocate, etc. Sadly there really aren’t any solutions where everyone will come out whole and some deserving homeowners don’t take it in the neck. But giving people money because their home value is temporarily underwater sets a terrible example for the guy whose willing to take the long view and work through a market decline.
Politicians never seem to learn that sometimes doing nothing is the best course of action.