Now zip seven years ahead. By the middle of 2006, the median home price climbed to $550,000, a whopping 210% increase. Homeowner incomes in Los Angeles over the same period grew by a mere 20%, to $75,000. Even with lower interest rates and insurance running at about the same cost, buying a house in 2006 consumed a full 65% of the median homeowner's gross annual income. Take out taxes, and the household now has about $15,000 to spend on retirement, utilities, food, clothing, transportation and other needs. Could you live with that amount of discretionary spending? Not too many people could.
More outrageous is that people bought in this market even though apartment rental rates were still at levels much more in line with incomes. When was homeownership granted this Holy Grail status? The fact is, millions of people have successfully raised their families and lived their lives comfortably in housing units owned by someone else. As a former renter myself, I can tell you that it wasn't nearly as bad as is often said. In fact, it's kind of nice to be able to tell someone else to take care of that broken toilet. Homeownership is simply not good for all people at all times.
But I digress. Let us face the harsh reality. The vast majority of people who bought homes over the last few years using all these subprime products did so with dollar signs in their eyes clouding their better sense. The mentality was practically uniform among these folks: Who cares if I can't afford this house, as in two or three years with the price 30% higher I can cash out and walk away? A no-lose deal!
Here is the reality.
* Prices are falling not because of foreclosures; they are falling because they are unsustainably high given current income levels. Nothing is going to stop this process now; we just have to ride it out.
* Most sub-prime borrowers probably won't be able to afford their homes under any loan modification beyond substantially cutting the principle amount -- a bailout no matter how you look at it.
* Given the pace of current price declines, most subprime borrowers are going to be underwater by the end of 2008. This implies that they are unlikely to want to keep their homes unless there's a reduction in the principle amount -- in other words, a bailout. In many ways, these folks would be better off freed from a debt worth more than the asset against which it was secured. Here, foreclosure is the start of a new beginning.
* The threat of blight is nothing more than a red herring. The good news about foreclosed homes is that they cause prices to fall faster, which is exactly what needs to happen. The faster prices get back in line with incomes, the better off we all are, particularly those prudent potential home buyers who properly stood on the sidelines waiting for this bubble to burst to have their chances at homeownership. These are the people we should be rewarding, not the speculators who rushed in for their chance on the roulette wheel and lost.
* Letting people bankrupt themselves out of their imprudent purchase of a home is nothing more than a bailout; don't pretend otherwise. And it will cost taxpayers, as this will cause the already nasty financial losses on Wall Street to skyrocket, as investors are suddenly offered no recourse in trying to recover some of their funds. The net result will be more banking bailouts by the Federal Reserve at taxpayer expense. There is no free lunch.
I realize that I sound very unsympathetic. For most of the people losing their homes today, frankly, I am. They bought houses they couldn't afford and now they pay the consequences by losing those homes. Yet I also know that a lot of people were simply duped into believing that this was a no-lose situation. My problem is that I don't know how to sort out who is who, and I don't think a blanket approach that benefits speculators is the right approach. Luckily, we have courts that allow people to bring lawsuits and class-action suits if they feel they have been truly wronged. Let that system handle the problem.
This rhetoric and spin disturbs me. It paints the gambler as victim and ignores the true losers: those who purchased prudently and as a result got less than they should have; and those who didn't purchase at all, instead standing for years by the sidelines as prices went crazy. You don't need to save any homes. Once prices return to normal, these folks will gladly buy up those foreclosed units and put them to use. Let's focus on these folks for once, OK?
Christopher Thornberg is a founding partner with Beacon Economics.