Michael Olenick: Shocking Economic Insight – Mass Foreclosures Will Drive Down Home Prices

By Michael Olenick, creator of FindtheFraud, a crowd sourced foreclosure document review system (still in alpha). You can follow him on Twitter at @michael_olenick or read his blog, Seeing Through Data

“A lie told often enough becomes the truth.”
– Vladimir Lenin, adopted and reused by Joseph Goebbels

Every doctor knows the fastest way to stabilize a patient is to kill them, because there is nothing more stable than death. While that solution may be fast and inexpensive it’s also sub-optimal. Yet pundits repeatedly posit the fastest way to end the housing crisis is through mass foreclosures. In a strict sense they’re right, that will achieve stability, though so will other policies calibrated to cause less micro and macroeconomic damage .. and a lot less human suffering.

Honest economists explain their reasoning, which is that there is a need to find a market bottom. They argue that in a healthy market sellers should not compete with REO properties and buyers need not worry an oncoming glut of foreclosures will drive down the value of their house. These economists, who remain in the minority, usually preface this is a lousy solution albeit the only one they can think of.

More common are bankers and economists who paint a rosy picture at the notion of throwing millions of families to the street, and millions of homes to the market.

“Once distressed inventory comes down and all of a sudden there’s not enough homes, you’re going to have a real bounce,” said JP Morgan Chase CEO Jamie Dimon in a recent interview.

Dimon surely knows the 2010 Census reports 131.8 million residential housing units for 312.9 million people, including about 17 million empties, so I’m not sure where his housing shortage comes from.

Dimon’s bank is sitting on a powder-keg of $87.6 billion of mostly worthless second mortgages at the end of Q3, 2011, according to the FDIC, so I can see why he’s playing cheerleader for a housing renaissance. But treating people like chumps, by encouraging them to buy in this broken market, crosses the line from puerile to patronizing.

If Dimon’s bank is genuinely bullish on housing then let them show it by dramatically ratcheting up their non-GSE lending. It will be interesting to see how JPM investors react to what I’m sure will be Dimon’s forthcoming announcement that JP Morgan Chase plans to lower credit-standards, increase private mortgage lending, and retain the loans on their own balance sheet.

Every argument housing cheerleaders advance is easily debunked.

Dimon argues household formation is increasing. I argue that’s irrelevant because the new couples do not qualify for home loans. Bloomberg reports that student-loan debt is approaching a crippling $1 trillion, preventing young people from qualifying for mortgages.

Bloomberg’s story focuses on a pharmacist with $110,000 in student-loan debt and a steady job that pays $125,000 a year, but who doesn’t qualify for a mortgage. It isn’t only employed professionals: the Bloomberg article goes on to note the Federal Reserve reports the number of 29-34 year old’s who qualified for a first mortgage declined from 17 percent ten years ago to 9 percent in 2009-2010. That is, young people are forming rented households.

This meme, that it’s a great time to buy a house, is relentless.

In a Bloomberg story along the same lines, Potomac Gap Shows Court Foreclosures Delay Housing Recovery, former Fannie Mae chief economist Thomas Lawler compares Maryland and Virginia house prices to argue expedited foreclosures increase home prices.

Asking Fannie’s former chief economist his thoughts on housing is akin to asking Francesco Schettino, Captain of the domed Italian cruise ship, his thoughts on maritime safety. Let’s ignore that though and focus on Lawler’s conclusion, which the data doesn’t support.

Lawler argues that Virginia and Maryland have virtually identical characteristics, yet that house prices in VA rose .8 percent last year while MD prices fell 3.6 percent. Lawler attributes this to the fact that MD is a judicial foreclosure state — where foreclosures require court approval that move through the system slower — whereas VA is a non-judicial state, where banks can simply auction a house after a default.

I have a simpler answer: house prices in MD ran up considerably higher than those in VA during the bubble so prices in both states are now adjusting towards the mean.

Specifically, according to the FHFA’s Housing Price Index (HPI) data Maryland house prices rose 17.7% higher from Q1, 2000 to Q3, 2007, when prices in both state’s peaked. Prices in MD are still 10.8% higher than those in VA, even though, by Lawler’s reasoning, they should be the same.

If anything, the data suggests judicial foreclosure is dampening home price declines in MD, by slowing foreclosures and the drag they place on home prices.

Less foreclosure inventory in judicial foreclosure states, thanks to slower foreclosure processing, reduces supply and stabilized home prices is a simpler explanation, though it’s seldom explored. I’ll refer to it as the Linda Green House Price Stabilization theory.

Obviously, people cannot continue to live in houses they are not paying for forever. But crafting public policy to figure out how to work with these people, which has the least impact on both the economy and the families involved, requires an honest and forthright dialog that just isn’t happening.

My own home state of FL is an economic disaster zone thanks largely to foreclosures and other housing related dysfunction. I often find myself spending the evening discussing housing finance.

It is not uncommon for those current, or with paid-off houses, to launch into a harangue about their irresponsible neighbors and demand that they’re thrown to the street immediately. But when I ask these people to quantify how much they’re willing to pay to punish their neighbor the answer is always zero.

I explain there are two options. One option involves modifying their neighbors mortgage, arguably giving their neighbor a windfall but limiting their own home price decline to no more than 10-percent. The other option involves throwing their neighbor to the street, decreasing the person’s home value by more than 10-percent. Nobody has ever opted to throw their neighbor out if it will personally cost them anything.

Dimon argues “indiscriminate blame of both (economic) classes denigrates our society, destroys confidence .. and damages us.” I agree, though argue the relentless “break the borrowers bones,” theme, combined with less than honest discourse about economic reality, is more destructive than frustration-fueled barbs launched towards those like him who pocketed a $21 million paycheck last year while relying heavily on corporate welfare.

Depending on one’s understanding the 50-state Attorney General settlement is worth somewhere between about $5 and $40 billion. Let’s use the higher number: we still have about a half trillion gap to put a long-term floor on the housing market. It’s time for an honest, open, fact-based national dialog about how to make that happen.

This post originally appeared at naked capitalism and is posted with permission.