Keeping People in their Homes?

So here’s the facts on foreclosures right now: the number of people who are behind on their mortgages is going up again; roughly 3 out of 4 of those mortgages is a nice “safe” prime mortgage; because banks are currently avoiding foreclosure where possible, sales of distressed properties are down locally (and prices are up).

There’s been a lot of talk on the topic of foreclosure “prevention.” I’m putting that in quotes because most of these efforts don’t deal with the underlying problem: the homeowner is in a property he/she can’t afford that is unlikely to be worth what is owed any year soon. Here’s an example of some of the thinking:

The situation is particularly difficult in Cleveland, which saw 14 straight years of rising foreclosures before leveling off in 2010. Home values have dropped by 30 percent on the East Side since 2009 alone, according to the county assessor.

Anthony Brancatelli, a Cleveland city councilman who represents some of the neighborhoods wiped out by home seizures, said he worries about the many “ghost” owners who have simply given up and disappeared.

“We’ve got to figure out a way to keep people in their homes no matter what,” Brancatelli said as he watched the HUD secretary speak July 30.

Cleveland has traded back and forth with Vegas for the title of “Foreclosure Capital of America” for most of the last 5 years. There are a couple of things that should strike you as odd about Mr. Brancatelli’s statement. First, how can you keep someone in a home that they’ve already abandoned? Wouldn’t it be better for the property to be foreclosed and resold to someone who will be there (or, bulldozed)? Second, it doesn’t account for the reality that the property is the only thing some owners have left in Cleveland. When the job is gone and the equity is gone, the only sensible thing for the people to do is go as well.

Another strategy to “keep people in their homes no matter what” is converting a failing mortgage to a lease. Citi is the latest player to enter this scene. It’s a little more honest than some of the alternatives, and saves the bank the hassle of manufacturing documents so they can foreclose foreclosing and reselling the property. In some states, it also helps them get around things like redemption periods and lengthy judicial issues.

Some people think the answer is to refinance all the underwater properties at the current way-too-low-for-banks-to-make-enough-money rates. Sure, that might reduce defaults in the short term, but it does nothing more than kick the can down the road. It doesn’t change the fact that the property isn’t worth what’s owed and won’t be for some years. It still leaves the homeowner with a mountain of debt. It doesn’t leave the option for the homeowner to borrow against equity to start a business. It means they still have to go through a short sale if the family moves to an area with more jobs. It doesn’t force the banks and the other mortgage holders to “mark to market.” In some cases, it may even leave the homeowner with a higher expenses in the long run.

The way forward is to make more short sales happen. It gets the underwater homeowner out of debt and puts them in a position to move to “where the jobs are.” It forces a more accurate valuation of the property. It “prevents” foreclosure and still lets the bank come out ahead of where they would be if they did foreclose. It lessens future shocks to the pension funds and insurance companies that invested in mortgage backed securities. No robosigners are required. No court appearances are required. And it works through the so-called “shadow inventory” in a responsible way.

“Keeping people in their homes” is a misguided goal that will prolong the unwinding of our housing mess.

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