We have created a housing hybrid in America, refashioning the single-family home into a mini debtors' prison. Almost 11 million dot the landscape. In Las Vegas and Phoenix, over 50 percent of homeowners live in one.
“Understandably, most [underwater] owners … live shackled in what the Chinese call fang nu—slaves to their house.”
Forget the notion of the home as "castle," protecting the owner from greedy landlords. Forget too the expectation that a physical nest will morph into a nest egg. For 22 percent of people who hold mortgages, those notions are anachronistic—relics of a long-ago era before unemployment soared, the Dow plummeted, and credit default swaps surfaced. In today's jargon, these owners are underwater—they owe more than the value of their homes.
But underwater is a misnomer. People underwater either swim or drown.
These underwater owners linger, trapped in their very own debtors' prisons. Their task is Sisyphean: they work, pay the monthly debt to the lender, yet see a perpetual gap between payments and value. The payments can seem like an extortion episode from The Sopranos.
Exit strategies are few. If an owner sells the house for less than the mortgage, the owner must pay the lender the difference. Owners will still need to find someplace else to live.
An owner can walk away from the loan and join the "strategic defaulters," who defaulted not because they could not pay but because they did not want to. Their house was a bad investment. The advantage of this maneuver is real: strategic defaulters save money. Sometimes they can rent a comparable home. But they risk a lower credit rating, which could bar them from buying another home for up to seven years.
Understandably, most owners do not grab either of these solutions; instead, they live shackled in what the Chinese call fang nu—slaves to their house.
One owner's misery is personal; when over a fifth of mortgage-holders are shackled, the personal misery becomes national. For the country, these homes are an economic shackle, hobbling the housing market. They also distort the labor market: people offered jobs far afield stay put, reluctant (and unable) to leave their underwater homes. Since the recovery of the housing market will undergird any broader recovery, we must address these debtors' prisons.
The solutions will force lenders to throw out their textbooks.
First, lenders can recognize the wisdom of short sales, accepting less than the face value of the mortgage. Currently banks do accept short sales but only after protracted negotiations. One advice columnist recently advised sellers eager to unload an underwater house to keep trying—on the third try, a bank might relent. A short sale will put the house on the market, opening it to another buyer, letting the seller move. Lenders could proactively set prices for short sales.
“Lenders may be reluctant to morph into landlords, but they already own millions of empty units.”
Second, lenders can reduce the principal as part of loan modification. Consider a commonplace scenario. The value of a house has dropped 30 percent from its mortgage. The owner has already lost whatever equity she sank into the down payment. There is very little chance of an immediate surge in value. The owner cannot sell the house, is considering abandoning it, and has cut back on maintenance, which depresses the value further. If a few houses on a block are underwater, the blight will depress the values even of well-kept homes. Accepting this new reality, lenders might allow the entire mortgage payments to go toward the reduction of principal.
Third, lenders can transfer the mortgage-holder's status from "owner" to "renter." Often the owner has so little equity in the house anyway that the lender is in effect the owner. But making this shift from "owned" real estate to "rental" real estate will unshackle the occupant from the house. When the owner-turned-tenant makes his monthly payment, he will not be seeing a Sisyphean gap. If the rent is too high, the occupant will move. If the rent is low enough, he will stay. The occupant is free to decide. Lenders may be reluctant to morph into landlords, but they already own millions of empty units. At least the rental units will be generating revenue. Sometimes goals dovetail: in this case, the country needs rental housing as much as underwater owners need rescue.
Tony Soprano was not compassionate; the plight of his debtors would not have moved him. But he was pragmatic. I suspect that he would have modified these loans, releasing homeowners from their prisons.