Housing's Silent Victim

True story: A friend of mine in Los Angeles just got a job offer from a company in Boston. The offer comes with a serious pay raise and status jump from his current job. His expertise is rare, so the position is a score for both the Boston company and my friend.

Unfortunately, he bought a house in Los Angeles in early 2008. Needless to say, he's lost a boatload of money. So much, in fact, the he's hesitant to take the new job in Boston. "I've got two options," he told me a few weeks ago. "Get a great new job but sell my house and get crushed, or stay at my current job making less money, but not get crushed on my house."

That's housing's silent victim: The impact it's had on job mobility.  

I never thought much about this until I dug up some numbers. One staggering example of how far mobility has dropped is shown by annual rates over the past half century:

Source: Brookings Institute/Census Bureau.

Part of the drop over the last decade likely came from the Internet. Innovations from companies like Google (NASDAQ:GOOG), Microsoft (NASDAQ:MSFT) and Cisco (NASDAQ:CSCO) lessened the need to migrate. Jobs that previously had to be in-house are now just outsourced remotely. Think payroll processing.  

But the housing market plays a big role, especially today. A 2008 paper by the New York Fed found that "mobility is almost 50 percent lower for owners with negative equity in their homes." The paper calls it a "lock-in" effect.

The lock-in effect comes not only from negative equity, but also from subsidized mortgage interest rates … which brings up the touchy issue of mortgage modifications.

Washington: Help or hindrance?
Last winter, the government implemented a mortgage-modification plan to choke off a wave of foreclosures. The overwhelming majority of these modifications have been in the form of subsidized interest rate reductions and extensions that lower borrowers' monthly payments. But only a small portion -- 13.2% during Q3 2009 -- actually reduced the borrower's mortgage principal.

Why is that important? Because when a homeowner gets a subsidized interest rate, there's a lock-in effect. They'd rather stay in the subsidized house than move and be subjected to a market rate. That decreases mobility by squashing the incentive to move somewhere that might otherwise fulfill job needs.  

How big a problem is it? An updated summary of the Fed's 2008 paper finds that "each $1,000 in subsidized interest to a borrower reduces the two-year mobility rate by 1.4 percentage points." That, in turn, strangles the job market, since the key to employment is a flexible workforce. Just ask the Boston company that would love to hire my friend, but might get defeated by the Southern California housing market.

What's the answer?
One solution to overcoming subsidized interest's lock-in effect is to gear modifications toward reducing mortgage principal, bringing equity back into the picture. That'd produce a more reasonable incentive for those who might want to sell -- not to mention give those with looser morals the incentive to stay current on their mortgage, rather than just walking away.

But that's unlikely to happen. For one, losses to Fannie Mae (NYSE:FNM) and Freddie Mac would go from terrible to horrific. It's far cheaper to subsidize a monthly payment than it is to reduce an entire loan balance. Banks like Bank of America (NYSE:BAC), JPMorgan Chase (NYSE:JPM) and Wells Fargo (NYSE:WFC) don't want to touch principal reductions for the same reason. They'd have to recognize severe writedowns rather than relying on "extend and pretend," as the saying goes. Unfortunately, these are tough choices that no one wants to make.

What do you think about it all? Let me know in the comment section below.