Posted on Friday, January 21, 2011
Greenport, N.Y. THERE are many factors behind the mortgage crisis, but there is only one simple explanation for why we have failed to solve it. Any effort to help homeowners by forgiving some of their loans is said to create a moral hazard, rendering it politically toxic. But without help, homeowners continue to struggle, foreclosures continue to mount and the housing industry continues to drag down the economy.
Fortunately, there is a way around this problem, and it’s similar to one we’ve already used for the American automobile industry. If structured bankruptcies could save General Motors and Chrysler, why couldn’t “structured foreclosures” save the American family — and stabilize a banking system that remains dangerously undermined by bad mortgage debt?
After all, foreclosures and bankruptcies are similar. Both are legal processes that allow primary lenders to wipe out subordinate claims and gain clear ownership of an asset, then sell it to recoup whatever value they can.
But it’s one thing for a bank to take ownership of a manufacturing plant or inventory; in a foreclosure, the asset in question is also someone’s home.
In this brutal process, the borrower is typically evicted, leaving neighbors living beside a vacant house and a family on the street. To make things worse, the affected family has no incentive to cooperate with the foreclosure, drawing out the process and clogging the court system.
What’s needed, then, is a set of incentives for borrowers to cooperate with lenders in foreclosure filings, just as G.M. and Chrysler did with their creditors in bankruptcy — in other words, a structured foreclosure.
Here’s how it would work. The borrower would lose ownership of his home, but be allowed to remain as a tenant paying fair rent for a reasonable period after foreclosure, with the requirement that he cooperate in the foreclosure. He’d pay fair market rents as published by the federal government, ensuring a clear, national standard. If the borrower couldn’t afford to pay market rent, existing federal rent-subsidy programs could be extended to help tide him over.
At the same time, with borrowers now working with lenders, it would be much easier to gather all the documents necessary to process the foreclosure, unclogging the sort of paperwork roadblocks that have recently encumbered the mortgage industry. Lenders would wind up owning a portfolio of income-producing property that would be readily marketable to investors.
True, the process could force lenders to revalue the homes at significantly lower prices than what they have on their books. Then again, such revaluation is almost inevitable in the current housing market, and instability in the banking sector could be resolved with additional government support.
What’s more, the plan would create a new supply of badly needed rental housing without drawing the sort of community opposition that so often accompanies proposals to build new rental properties. Same house, same family — but a new, financially capable owner. And by shifting many homes to rental properties, it would help thin out the country’s oversupply of housing, which is a significant drag on the market.
But most important, structured foreclosures would bring sanity to a market still suffering from the delusions of the housing bubble. During that time, the usual house price-rent ratio — that is, what people will pay to rent a home versus the monthly mortgage fees they’re willing to pay to buy it — became inflated, so that instead of houses being priced at 10 to 15 times their rent, they were selling for 20 times their rent or more.
Under this plan, however, struggling homeowners who are saddled with mortgages priced at those inflated values can, as renters, choose to pay fair market rents for their homes instead. Over time, this will put pressure on the rest of the housing market to return to a reasonable, sustainable price-rent ratio — a trend that most economists say is critical for getting the economy moving again.
Congress has done a good job of saving big business with structured bankruptcy plans. Now it must to use the same tool to save American homeowners.
THE NEW YORK TIMES, David E. Kapell is the former mayor of Greenport, N.Y.