January 8, 2011

Home Inventory, Prices & Economy

Quite a vicious circle there!

Disposing off of Banks' foreclosure inventory via Defered Ownership Plans automatically shrinks the supply shock of homes looking for a buyer under normal home buying. So, the vicious cycle of slide in home prices and additional foreclosures unrelated to people’s ability to pay can be stemmed.

The housing bubble, swollen by the "Non Recourse loans" and Smartass ARM financing, has yielded a big foreclosure inventory upon its burst.

The Banks are sluggish in selling off the inventory, even more reluctant to foreclose on any more properties where the occupants have stopped paying their mortgage - because they are now underwater and cannot accept as fiction that 'buying a home can only increase their net worth over time, unlike buying a car'. The logical fear with the banks is that bringing too many units in the market together would cause another price tumble, and there would be more occupants, freshly underwater, stopping their payments and ready to walk out. Needless to add, the banks want to minimize their losses and trying to control how many units they bring out into the market for yard sale. The reversal of Mark to Market helps them avoid booking losses on delinquent property that they haven’t repossessed and resold.

When the speculative prices of homes suffered the overdue fall, the Economy tumbled with home equity financing, and the conventional wisdom was that “Nothing can recover unless prices of homes recover”. Not ringing true anymore. Stable work and income, with affordable payment towards home, medicines and taxes are the best drivers of economic activity and growth, rather than unreasonable, unstable housing valuations led “home equity” loans. The overall economy is recovering but the problem around housing itself still remains. The potential of a vicious home ownership downward spiral, and bankers’ strategy to face it, is leading to rotting homes and neighborhoods, itself a contributor, in smaller measure, to the price-shrink spiral the banks are trying to forestall. And there is an opportunity loss to the wider economy too. Foreclosed houses awaiting resale and those under delinquency do not beget any maintenance expenditures, or remodeling activities, or upgrade.

For the potential buyers, the problem is that the homes are still very expensive, and even with the low interest rates, the payments can still be onerous; while the low interest regime robs bigtime from the retirees that wish to park their waning years' money in safe places.
The blind faith that “the house can only gain in value” having evaporated, potential buyers do not wish to stretch themselves to make the mortgage payment, and be in a situation where one is always one job loss away from losing the home after having made excruciating monthly payments for years.

Therefore, a FRESH approach is needed to clear off the foreclosure inventory and the shadow inventory. It can, and should, be cleared off under a new paradigm of home buying.

A Deferred Ownership Option has to be thought of wrt purchase of a house from a Bank. Here the buyer makes affordable monthly payments for a house for say, a period of twenty years. At the end of the period, he gets the title transferred to him as Endowment. In this approach, the buyer gets a payment scheme that does not stretch him out, but also cannot capitalize on any interim appreciation in the value of the house. So you get only genuine home buyers biting at such a plan, not short run speculators. Further sweetener can be added to such a scheme by attaching a “surrender value” (that grows modestly with time) on the house after five years of successful monthly payments. So, in case the buyer loses a job or is saddled with medical expenses that drain his income, he can let go of the house and get a modest amount of “surrender value” that helps him cope better with his situation.

Disposing off of foreclosure inventory via such a mechanism automatically shrinks the supply shock of homes looking for a buyer under normal home buying. So, the vicious cycle of slide in home prices and additional foreclosures unrelated to people’s ability to pay can be stemmed.


  1. Hi, Ohm.
    You obviously put a lot of time and thought into finding solutions to these problems. I like that.
    I think, until the economy is back on its feet, we should do what FDR did: everything that could possibly help.
    That said, ideas like "attaching a 'surrender value'" make me uncomfortable because they sound like artificial changes. I'd be more comfortable with these ideas if they -- like the Bush tax cuts -- were designed to shut down after 10 years or so.

  2. Hi Art,
    Thanks! What I am suggesting here is not Gov support, so if the Banks do something like this, it is upto them how long they want to sell their inventory like this. It's essentially a new model to look at selling and buying a house between bank and consumer. Kind of like a factory outlet that has a different pricing scheme for the products than regular stores for the brand with different terms and conditions (say, eg "All sales from factory outlet are Final - No Returns").
    In this paradigm, the buyer is not investing-speculating on the house, has much lower payments to make than in a regular buy, but cannot make a profit if prices rebound just a few years down the line. For the bank, it is able to clear the inventory without tumbling prices further (which, they fear, will beget more inventory to them). There is no public money involved in this, so banks can stop offering this garage sale model when they are comfortable.
    Via "surrender value" and "Endowment" i am structuring this after life insurance policy model. One reason one doesn't buy a house when there is no more the wild belief that the prices can only go up is the thought "how sure am i that i will have an emoyment for next 30 years such that I can always pay the (heavy under normal model) mortgage amount?" "Surrender Value" sweetens the deal, and does not involve public money. Anyhow, it's not central to the approach I'm holding out! its an optional feature that banks could weave in if they wanted:-)
    Happy 2011 to you,