One in Ten

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March 6, 2008 8:19 p.m.

The latest numbers are out: One in ten homeowners has no equity in the family home. The data show that about 15% will be below water if prices continue to slide, owing more than their homes are worth.

So what’s the plan here? One in ten homeowners could just walk away right now. Indeed, most of them, if they were the rational maximizers so prominently featured in classical economic analysis, would stop paying now, put the money in a savings account, and wait the 90 days or two years or whatever until the lender could force them out by foreclosure. In non-recourse states, they could just pocket the money and walk away free and clear. In other states, they might need bankruptcy or a last-ditch deal with the lender for a short sale. The economics shift when the homeowner has no equity to protect.

If they walk, the national — and world — economy will seize up. Think about it: If millions of homeowners suddenly quit paying their mortgage, many investment funds would be bust. Corporations that bought those assets (and borrowed against them) would also go belly up. Sure, the investors would own the homes — eventually — but If millions of homes suddenly came on the market all at once, the price declines would be huge. Most wouldn’t be able to survive long enough to pick up the pieces.

The investors who hold those mortgages can avoid that if they are willing to share the pain and acknowledge that their loans are only partially secured. Like practical lenders have done for thousands of years, they could decide that getting a steady, partial payment is better than no payment at all. So far, however, the investors are holding tight, even as Fed Chairman Bernake asks them please please please renegotiate these crazy mortgages.

The only proposal on the table that would make the investors renegotiate their mortgages and either get people into mortgages they can afford or get them out of the houses is the amendment to the bankruptcy laws. Last week, the Republicans filibustered the bill, and a cloture vote failed, but no one is giving up yet. Professor Lynn LoPucki had a terrific op-ed in the Atlanta papers this morning, and USA Today had one yesterday.

The industry has tried a scare tactic, claiming that the bankruptcy bill would cause all mortgages to increase by 2 percentage points. The press dutifully reports the number, although some have begun to cite Professor Adam Levitin’s work that shows the industry numbers are bogus. Chairman Bernake was asked about the industry numbers and, after some fumbling, he admitted that he didn’t know of any data to support the industry claim.

The mortgage industry has blocked the bankruptcy amendment, but the question that puzzles me is why anyone is listening to the mortgage industry’s herd of lobbyists. These are the people who said the industry didn’t need regulation, that high-risk mortgages could be turned into low-risk bonds, and that everything was perfectly safe — right up until it all came crashing down.

How bad will the mortgage numbers have to be before Chairman Bernake says it is time to stop asking and start acting? Bankruptcy is not the only answer, or even the best one. But asking the investors pretty-please to renegotiate these loans isn’t working. And if we don’t start getting some action soon, more families, more neighborhoods, more jobs, more retirement funds will go down. Like it or not, we’re all in this boat together.

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