Foreclosure prevention, or foreclosure delay?

The New York Times reports details of the Obama administration foreclosure prevention initiative today, and it looks like it is only delaying the inevitable. The plan pays lenders a flat fee to reduce loan interest rates to no more than 38 percent of a family’s gross monthly income. Then the government pays the actual cost of reducing the interest rate further to 31 percent of the gross monthly income. This rate would remain for five years, then will rise one percent a year until it is back to its original amount. Let's crunch some numbers, shall we?

According to the National Associate of Realtors (NAR), the average home price in the US as of February 4th is $213,100. According to the census bureau, the average family income in 2007 was $50,233. While figures are not yet available for the current average, we would have to assume it is lower, given layoffs and wage reductions that are so common right now. Let's be conservative and call the average $45,000. Let us further assume that the family has one of those "bad" mortgages that started with low payments but quickly increased them to, 8%. That would be a monthly mortgage payment of $1,562.92 or $18,755.04 per year. This mortgage payment represents 41% of the family's gross income.

Under the Obama plan, the family's mortgage payment would be reduced to $1,162.5, roughly 5.15% interest. That rate will remain in effect for five years, then rise 1% until it is back to 8%, just under eight years total. By then the family will be back in the same boat.

Obviously, the plan hopes that inflation will cause salaries to rise so that the restored mortgage payment will by then be only 31% of gross family income. In order for that to happen, the family income has to be $60,500 by 2017. That is a 34.4% increase in family income over eight years. But according to inflationdata.com, the inflation rate in January was 0.03%. For the family to reach the magic 31% mark, inflation would have to increase substantially. If it does, inflation will not only raise wages, but also the cost of gas, food, clothing, etc. So the family's extra income will be at least partially eaten up by those increases, leaving less for the mortgage.

My question is...are we really solving the problem or just delaying it? Many of the families this plan is designed to help bought at the top of the real estate market. Now that home prices have fallen so drastically (17% in the last year alone, according to NAR), most homeowners who bought in the last several years owe much more than the home is worth. Home prices have fallen so drastically, and the economy is so sluggish, it appears likely that in eight years these rescued homeowners will still owe more than the home is worth. And unless they increase their income past inflation levels, they will again be paying too high a percentage of gross income for their mortgage.

One advantage of this plan is that it stops the bleeding now. Given our current situation, that is not a bad thing. But the plan will not "fix" the problem, as we will see after five years when those mortgage interest rates start to rise again. And those properties will continue to be a sword of Damocles hanging over the real estate market.

Bailout Double Standards

CNN ran an interesting commentary this morning by Frank Micciche, managing director of the Next Social Contract Initiative, a bipartisan think tank. Micciche's basic premise is that it's easier to get billions for banks and the auto industry than to get a small grant. "Small nonprofits and community organizations that receive federal grants will tell you that the paperwork and scrutiny that comes with even the most modest federal award is often so exhaustive as to nullify the benefits of the grant," Micciche says. "Not so, apparently, if your request is in the billions."

This is why I don't support the bailout - not so much because it isn't needed, but that it would not be effectively executed. Does anybody know where the $350 billion went that Paulson gave away in TARP I (other than executive bonuses, that is)? And with Chrysler and GM asking for another $21 Billion, do we know what they did with the $17 billion they recently got?

Too much money is going too many places with too little oversight and only a hope of success. Let the banks and automakers go to bankruptcy court and use that bailout money instead for direct support of those who lost their jobs in the meltdown.

TARP I cost over $1,150 for every man, woman and child in the country (not counting interest) and nobody seems to know where it went. The Obama administration estimates that bank bailout will cost taxpayers $2.3 trillion ($7,570 per person). And Bloomberg News recently pegged the entire cost of the all bailout funds (including banks, automakers, stimulus package and mortgage rescue) at $9.7 trillion ($31,712 per person). If you have a family of five, your family's share is $158,560. As the Bloomberg article points out, that's "enough enough to pay off more than 90 percent of the nation’s home mortgages." Here is the math and links to the numbers:

TARP I $350 billion/305,878,088 = $1,150
Bank Bailout $2.3 trillion/305,878,088 (US population) = $7,570 per US citizen
Bailout Total $9.7 trillion/305,878,088 = $31,712 per US citizen
Family of 5 $31,712 * 5 = $158,560 for a family of five

An interesting question is what would happen if the government actually did use that money to pay down mortgages? That money would flow right to the banks, making them flush with cash and ready to lend again. With the mortgages paid down or, in many cases, paid off, consumers would be able to use that mortgage money to buy cars and TVs, giving a boost to manufacturers. But most important, the US taxpayers would actually get something of real value for their bailout money.

Of course, it will never happen. And the bailout would unfairly help mortgage holders over renters, who would still be on the hook for their $31K. But at least there would be tangible, predictable results.