TCS Daily

The 'Own-to-Rent' Solution?

By Doug Wilson - December 20, 2007 12:00 AM

CEO's heads are rolling, millions of homeowners are facing foreclosure and the public's sense of frustration is palpable: Isn't there something Washington could do to make the mortgage mess go away?

Well, lots of things, actually - though few of them would really help to restore the vitality of the American housing market. Treasury Secretary Paulson, responding to criticism that the Bush Administration was doing nothing, announced a messy plan for a voluntary freeze on "teaser rates" on some high-risk loans that raises more questions than it answers. Meanwhile, the House unwisely proposed new regulation that would raise mortgage costs and narrow access to homeownership in the name of consumer protection. Everyone, ironically, is ignoring a surprisingly simple change in market incentives that would allow moderate-income owners to stay put after foreclosure, even as it speeds the recovery of the housing market.

The outlines of the mortgage crisis are now distressingly familiar. After years of housing-price inflation, lenders grew increasingly casual about the credentials of borrowers even as home buyers grew less wary about commitments to monthly payments they could barely afford. After all, rising prices assured lenders that they could always recoup their money in the event of default, while the never-ending boom meant that property owners could always refinance -- or sell at a profit.

For their part, institutional investors ranging from Merrill Lynch to the Bank of China exhibited seemingly insatiable appetites for mortgages repackaged as derivative securities that could be traded on global markets. The private rating agencies helped out by giving the seal of approval to these complex financial instruments, based on - you guessed it - the assumption that housing prices would always go up.

Happily, Wall Street's efforts last fall to get Washington to bail out the mortgage market with government-guaranteed credit never got much traction. But, eager to do something, the House, led by Democrat Barney Frank, produced a bill that would proscribe a laundry list of aggressive mortgage-marketing practices, bar outright the types of mortgages most likely to lure lower-income borrowers into deals with unaffordable payments, and widen the potential liability of both mortgage originators and investment banks when mortgage-backed securities go south.

It sounds good. But the well-intentioned attempt to micromanage the multi-trillion dollar mortgage market threatens to throw out the proverbial baby with the bathwater.

Remember that the expansion of mortgage brokerage beyond the control of traditional lenders has sharply increased competition. New limits on who can borrow and on what terms would raise mortgage costs - and, as important, put housing credit beyond the reach of millions of Americans. What's more, the new rules would raise the costs of mortgage securitization -- an innovation that has made it possible for American homebuyers to borrow from Japanese housewives, Asian central banks and European pension funds as well as the corner bank.

Secretary Paulson's response to the mortgage crisis is at least focused on helping moderate-income homeowners already caught in the credit crunch. The goal is to freeze interest rates for owners who can't afford to pay more, yet could manage to keep paying current rates. No one really knows, though, how to identify these borrowers; nor does the government have a way to enforce a voluntary deal that depends on the cooperation of dozens of institutional lenders to have much impact.

But, ironically, Dean Baker, an economist at the liberal Washington-based Center for Economic and Policy Research, has proposed a cheap, ingenious fix that would alter both borrowers and lenders' incentives in ways that let markets manage what the Bush Administration attempted to orchestrate in bank boardrooms. He would simply give foreclosed homeowners the right to remain in the houses by paying the fair-market rent (as determined by court-appointed appraisers) to their former creditors.

This "own-to-rent" approach would spare the most sympathetic victims of the mortgage bloodbath without giving them a free ride - along with paying rent, the reality that they had defaulted on mortgages would surely damage their credit. What's more, it would keep many foreclosed houses off the market, reducing the glut that will likely depress housing prices for years to come. And it would give mortgage holders an added incentive to renegotiate terms before foreclosure, short-circuiting the need for the sort of one-size-fits-all fix cobbled together by the Treasury. Not surprisingly, then, its appeal extends beyond liberals to free-market boosters like Desmond Lachman, a resident fellow at the conservative American Enterprise Institute.

Of course, it wouldn't please those who would use the mortgage conflagration as an excuse to go back to a era in which only solid middle-class types with a 20 percent down payment in hand could hope to own their own homes. Nor would it satisfy the impulse to put politicians and captains of finance in charge of sorting out the equities. And that's just the point: Washington should manage the crisis by minimizing the collateral damage - not by eliminating the risks inherent to free markets.

Doug Wilson heads Next Solutions, a California-based advisor to the home-building industry.


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