David Brooks' editorial today in the New York Times puts in perspective a problem we face with a rescue plan for poor planning. From a conservative's standpoint, he explains why we need to fix the problem of excessive loans on undervalued houses using measures we might find unpalatable. I suggest everyone read it. Brooks is a conservative columnist; generally, I find Paul Krugman more realistic, but Brooks makes a good point.
While the magnitude of the problems our nation faces has come upon us more quickly than in prior recessions, we are repeating patterns that we have seen before. The last cycle's bottom was the early 1990's. What we are repeating is housing prices dropping after a bubble had run them to astronomical levels - the difference is that during that recession everyone had hope at each stage that we were at the bottom - it never felt so hopeless. I bought my office in 1991 at what my co-buyers and I assumed was the bottom of the market - the actual bottom was about 4 years away at that point.
Our problems are what to do in a falling market. In a divorce practice, we see these problems repeated on a daily basis with our clients and their spouses. This time, there are complicating factors because of the magnitude of the bubble, and the ease with which large mortgages were created. Generally, the parties fall into one of a number of categories:
Sometimes it's a couple who spent heavily throughout this century, as they were taught to believe they were entitled, borrowing "equity" they thought they had in their homes to fund their lifestyles: A new Harley, a cruise to Europe, a ski condo in the mountains, a Hummer, a solid gold Rolex. Now, getting divorced, the equity is gone, the lifestyle abruptly ending, and they can't sell their homes for what they owe. Neither can keep the house alone, because they were dependent on two incomes, business is down, or unemployment intervenes.
On the other hand, we have those who finally bought into the housing market in 2005, anxious to buy something before they could no longer afford to do so. Maybe they borrowed against a 401k, borrowed from parents, or paid the down payment with credit card advances. Stretched financially, they felt they had no other choice, as prices had escalated dramatically. These have been periodic cycles, where there is such urgency that you can't buy fast enough; next week the house will be gone, and a worse house will cost substantially more.
Then there are those who filled out loan applications with data that was unrelated to reality: Puffing values, and overstating income. Lenders were making loans to people who weren't qualified because the loan brokers made huge commissions, and Wall Street was willing to package the loans and sell them off in slices barely short of gambling. These people could not afford the house under any traditional measure - any financial strain caused the house of cards to collapse.
Finally, there are the couples who bought a house years ago that they could afford, kept it for years, never refinanced as it went up in value, and still have quite a bit of equity left over. Maybe they realized that those tempting refinances didn't really borrow out equity, they just caused their debt to increase. These are the few lucky ones. Some equity and credit intact to be able to go out and pick up a bargain when the market gets lower. In my practice, they are the minority, by a wide margin.
We all want our own home, our territory we can mark where we have some degree of freedom to be ourselves and entertain family and friends. Some approach this with greater maturity than others.
As a society, we need to make decisions about how to solve the problems this situation has created for all of us. If we lower the loans to match the value of the houses, the immature bear no burden for their conduct. When prices eventually stabilize or go back up, do we reward them with the profit? Is that fair to the rest of us, especially where we paid for their ability to keep the house in some way or another - higher taxes and interest rates, for example. Or do we just pay the price by teaching people they can be rewarded for their screw ups.
These are not simple issues to deal with. Maybe this time some idiots win. To the extent we have little choice, Brooks is right, this is something we just need to do.
We can't simply say that we are rewarding people for their mistakes - George Bush already did that in throwing money at Wall Street and the banks with no oversight - we are protecting the rest of us from the mistakes of others. We cannot allow our families and friends to lose their jobs with no prospects for employment, and we cannot allow our banks to fail. We have two severe recessions to serve as examples: The U.S. Great Depression of 80 years ago, and the Japanese' experience at the end of the last century. Doing too little is the risk - if we err, it needs to be on the side of too much.
My hope is that someone comes up with a way of making this seem more fair to the rest of us. If the government endorses a method of reducing loans to equal present value, or lenders forgive some of the debt to avoid foreclosure, there should be a way we share in any subsequent increase in value. Perhaps heavily taxing any subsequent profit if the house sells, rather than the present practice of allowing large profits to be collected tax free when they sell.
I don't pretend I have the answers, but some group of smart people must be able to come up with useful alternatives. Both extremes in the debate need to put aside ideology and solve these problems. Otherwise, we are all lost.
