Beacon-omics 101: Foreclosures remain at the heart of the economic crisis
This article first appeared in the St. Louis Beacon, Dec. 27, 2008 - Recessions don't take a holiday, and Tuesday's numbers on home sales were more proof of what economists have been warning: This is far from over.
According to the National Association of Realtors, sales of existing homes in November fell 8.6 percent, with new home sales falling 2.9 percent. Even worse news for current homeowners: The median existing home price fell by 13.2 percent, probably the largest decline since the Great Depression.
In a commentary provided by the Realtors association, economist Lawrence Yun said that deteriorating conditions in employment, the stock market and consumer confidence had pushed the already-declining real estate market to "another level." He called for Congress and the new administration to provide incentives for homebuyers and to "unclog the mortgage pipeline," which he said is still preventing some buyers with good credit from getting loans.
"Falling home prices would lead to faster contraction in consumer spending and further deterioration in bank balance sheets. More importantly, falling home values would lead to higher loan defaults, including those recently modified distressed mortgages," Yun said.
In other words, even people who have succeeded in renegotiating their mortgages – moving from adjustable rate mortgages to conventional fixed rates, for example – could still find themselves in trouble if the value of their home falls below what they owe on it. And, economists say, until the housing market bottoms out and begins to rise again, the economy will continue its recessionary ways.
Todd Swanstrom, a professor at the University of Missouri-St. Louis who has been studying the regional impact of foreclosures, said he is shocked that more hasn't been done to prevent foreclosures, which have now spread beyond the sub-prime market.
"Of the huge federal bailout commitment of $700 billion, almost none of that to this point has gone to helping owners stay in their homes," he said. "Part of that, I suppose, is the moral hazard problem – that you shouldn't help people who got themselves into trouble because they will be just more likely to get into trouble again."
But Swanstrom, a professor of public policy administration, said the mitigating factor in helping troubled borrowers is that many were hoodwinked into complicated and deceptive loans by a mortgage broker industry that is largely unregulated.
"If people were just greedy, why didn't this happen 15 years ago or 10 years ago? It happened when they invented these mortgage instruments," Swanstrom said.
The real estate markets are crucial to economic recovery, economists say. They point out that the current recession was triggered by massive amounts of loan defaults, which, in turn, undermined the financial institutions that bought and sold them.
In a recent interview with the Beacon, economist Murray Weidenbaum of Washington University said the financial markets spread the risk by pooling these "creative" mortgage instruments, with investors counting on housing prices to continue to rise.
"The people who took on the mortgages, packaged them, sliced and diced them into esoteric securities that not many people understood what they were, including the rating agencies that put AA or AAA on the securities. And then people around the world, not just around the country, bought these things. Well, a high-yield American corporate bond AA, AAA – what's not to like? What's not to like is the rating didn't mean that it's a low-risk bond,'' Weidenbaum said.
At the same time, he explained, the Federal Reserve was pumping money into the economy because of concerns over deflation.
"Money was very easy, so therefore the availability of these mortgage loans was great. And a lot of brilliant people who don't know much economic history said don't worry about the mortgages because, after all, housing prices may come down for a while in some regions, but nationally housing prices never go down, they always go up," Weidenbaum said. "Of course, anyone who lived through the Great Depression will tell you otherwise. But most of these people were born way after the depression of the 1930s."
Swanstrom said the true cost of foreclosure goes far beyond homeowners and investors."There is no doubt that every time a foreclosure occurs, there is a significant loss of value, but also there is a roiling of the social structure, a huge destruction of the community fabric. You have children pulled out of schools, people forced to double up, problems of overcrowding and divorce and depression and everything else," he said. "We have very little research on this, but there is no doubt it's there. We need to put much more effort into prevention. Because every foreclosure we can prevent is going to stop all sorts of problems downstream that we're going to be dealing with for years."
Swanstrom believes it will take political action to circumvent the complex legal contracts that often prevent homeowners from negotiating better terms on their loans that are owned by multiple investors who don't want to deal.
"I'm convinced that the federal and state governments should insist and support efforts to modify loans," he said.
Swanstrom acknowledges that some people should not be helped.
"They got in way over their heads, and they can't afford the mortgage. But there are many, many people who are hardworking, have the monthly payments and have simply gotten a month or two behind, and then are forced into foreclosure," he said.
Swanstrom said that Missouri law has not supported a resilient response to the crisis -- it is a non-judicial state where foreclosure can occur in about one month.
"That's not time enough for people to respond," he said.
Swanstrom warns that the region will suffer the effects of foreclosure for years, through home vacancies and abandonments, particularly in economically depressed areas.
"This will undo decades of hard work in the region that really have revived neighborhoods in St. Louis and St. Louis County," he said.