We need a housing overhaul

Following up on my last post on cramdown, I want to highlight this opinion piece from the Wall Street Journal.

The author makes the point that many people in the U.S. are saying we need a banking system more like Canada’s, which is in much less trouble than our own. (What does Canada not do better than we do?):

Advocates of increased regulation of U.S. financial markets have concluded that more stringent rules governing leverage and capital ratios account for Canada’s impressive performance. They champion such measures here. In a Toronto speech earlier this year about reforming the U.S. banking system, former Fed chairman and Obama administration adviser Paul Volcker said the model he is considering “looks more like the Canadian system than it does the American system.”

But he says, we would have to re-design our approach to home ownership in this country to make the Canadian banking model viable in the U.S. It basically boils down to too many programs in the U.S. designed to promote home ownership – among them Fannie Mae/Freddie Mac, the fact that mortgages are non-recourse loans (which means a borrower can simply walk away from the house without the debts following him or her), and I would add the mortgage interest tax deduction.

I think we need to unwind our promotion of home ownership and the various structures and programs built upon that goal. It’s important to remember that along with a home often comes debt. And really, in the end, debt is not your friend. And look at all of the convolutions it’s thrown our government into and the bailouts it’s required to clean up this mess.

I’ve said before that, instead of home ownership promotion, I’d rather see an effort to boost wages. With higher wages for a greater number of people, more Americans would be able to participate in the home market, without the added burden of too much debt.

Incidentally, I also see this having positive environmental effects. A lot of environmentalists oppose “McMansions.” Well, if people were more leery to take on housing debt, the prices and scale of homes would likely decline. Other forms of property – row houses and condos – might actually become more attractive.

By the way, according to WSJ writer, national corporate culture played a big role in our current financial crisis. Check this out:

When it comes to comparing the track record of the U.S. and Canadian banking systems, it is worth noting that Canada’s regulations did not prohibit the sale or purchase of asset-backed securities. Early in this decade, Canada’s Toronto-Dominion bank was among the world’s top 10 holders of securitized assets. The decision to exit these products four to five years ago, Toronto-Dominion’s CEO Ed Clarke told me, was simple: “They became too complex. If I cannot hold them for my mother-in-law, I cannot hold them for my clients.” No regulator can compete with this standard.

Tighter leverage limits in Canada may have dimmed the incentives for its banks to pursue securitization as brashly as their American counterparts. But regulations cannot take all the credit. Even with leverage ratios held on average at 18 to 1 (versus 26 to 1 for U.S. commercial banks and up to 40 to 1 for U.S. investment banks), Canadian banks would not be as healthy as they are had they not disposed of their more problematic securitized assets four to five years ago. Nothing in Canada’s regulations banned risk-taking. Good, prudent management prevented excess.

I’m ever so glad for our Masters of the Universe.

Cramdown smackdown

The American Prospect has a good wrap-up of the political situation surrounding the recent defeat of “cramdown” legislation (starring Illinois’ own Senator Dick Durbin).

Cramdown is when a bankruptcy judge can reduce the amount of a mortgage once a person goes into bankruptcy court. Current law forbids a judge from lowering the amount of a first mortgage (although judges can reduce second mortgages).

The benefits to bankrupt homeowners are pretty obvious. They could emerge from bankruptcy with a mortgage that they could actually afford.

The mortgage bankers obviously would lose plenty of money on existing mortgages held by people who are going under (which could further hurt the banks in the short-run, leading to more bank bailouts, presumably).

But the bankers also say that allowing cramdown would ultimately increase borrowing costs because they’d have to protect themselves against people going into bankruptcy.

To which I say, so what?

We actually need less borrowing and debt by American households going forward. It’s the debt overhang of both U.S. households and companies that made this particular financial crisis so devastating. Incomes may collapse, but debt remains the same. Raising the price of mortgages should lead to fewer of them and at lower dollar amounts.

And, by the way, if the dollar value of mortgages declines, house prices likely will, too. Prices will have to adjust to the fact that there would be fewer mortgage dollars available to buy the houses out there. That’s a benefit to first-time buyers and other people who want houses.

Of course, that’s cold comfort to people who bought houses at the peak (like me). Many, many people have seen their home equity wiped out (not me) and severely cut (like me). I would like to see more programs addressing this specific issue, particularly for those who are wiped out (again, not me). I don’t think it should be a permanent policy. It should be an emergency measure – like all of those confounding, multi-billion-dollar Wall Street bailouts. We could design something for households – for the people – caught up in this mess that would allow them to begin rebuilding their economic lives and, in turn, the nation’s prosperity.