What Happens to Housing After Life Support?

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Nationwide housing prices have risen for six consecutive months. Plenty of people are now asking whether we can finally move on from this three-year housing assault.

Maybe. Hopefully. But as we limp toward economic recovery, nothing depends more on stimulus for its survival than housing. More importantly, much of housing's life support will have its plug pulled in the coming weeks and months.

Here's a look at three of the biggest housing programs, and what their absence could mean for the market.

1. Foreclosure preventions
As of December, more than 900,000 homeowners had trial mortgage modifications through the government-backed foreclosure prevention program, auditioning for another shot at housing survival. Nearly half of these trial modifications have been issued since September -- we're just ramping up, baby!  

Unfortunately, most won't be made permanent (for several reasons). By JPMorgan Chase's (NYSE: JPM  ) early metrics, more than 80% of trial modifications appear destined to fail. So the trial modification process -- typically three to five months long -- often just delays the inevitable foreclosure. This is especially true because the people in the trial program are prime default risks to begin with. The faster trial modifications are ramped up, the farther the can gets kicked down the road.

2. First-time homebuyer credit
Paying people to buy stuff is a clever way to spur demand. Since 2008, as many as 2 million happy homebuyers have been enticed toward ownership by a tax credit of as much as $8,000. Although the National Association of Realtors estimates that only about 18% of these sales would not have occurred without the credit, that's still several hundred thousand extra sales.

But the free money ends April 30. Before then, there's a rush to buy now. And we know how that story ends: Just as the Cash for Clunkers program puffed up GM and Ford (NYSE: F  ) last August, tax-credit-driven sales often come at the expense of future sales. That can lead to a grade-A hangover after the credit is removed; September auto sales fell 40% compared with August.

A similar effect could take place in housing. As homebuilder D.R. Horton (NYSE: DHI  ) recently noted, "We expect [later this year] will be the most challenging as the tax credit support for home sales will have expired." In business parlance, "challenging" usually means "tearful."

3. Federal Reserve buying mortgage-backed securities
In late 2008, the Federal Reserve launched a plan to purchase $1.25 trillion worth of mortgage-backed securities issued by Fannie Mae (NYSE: FNM  ) and Freddie Mac. Through last week, it had purchased $1.18 trillion, and it aims to wrap up the campaign by March.

The Fed's done all this to keep mortgage rates low. Once it stops buying, rates will surely pop. No one knows by exactly how much, but consider this: The value of the entire mortgage-backed securities world (including private-label securities) is $9.2 trillion. A $1.25 trillion purchase over 18 months has represented a tremendous chunk of the overall mortgage market.  

The road ahead
I'm not one to blanketly label all federal stimulus as fruitless and ruinous. But a lot of what's been thrown at the housing market over the past two years has been particularly flubbed. Temporary measures targeted at the wrong problems will likely mean that much of the stimulus here was for naught.

There's one effort that could really make a difference in the housing market: cutting borrowers' mortgage principal, to dissuade underwater homeowners from abandoning ship and walking away.

Judging by your reaction to my colleague Matt Koppenheffer's recent article, most of you equate walking away with cheating on your spouse. On your wedding night. With their sibling. But like it or not, a sizable amount of foreclosures -- about 25%, by one study -- involve homeowners who hit the road only because their home is worth less than the mortgage. Closing that gap and "re-equitizing" homeowners is one of the truest ways you can effectively and permanently stop prices from blowing up.  

Yet no one will dare try it. Why? For one, it's a little late now. Whatever political and fiscal ammunition we had has already been spent on blatantly less effective housing-stimulus programs. Any principal reduction plan would mean sending more obnoxiously large checks from taxpayers to banks. For good reason, no one wants to give more money to Goldman Sachs (NYSE: GS  ) , Bank of America (NYSE: BAC  ) and Citigroup (NYSE: C  ) . Plus, there'd be so much protest that some banks probably wouldn't take the money, even if it were offered.

Better luck next time. And at this rate, there might be a next time.  

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article.Ford  is a Motley Fool Stock Advisor pick. The Fool has a disclosure policy.

Read/Post Comments (14) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 19, 2010, at 2:30 PM, Bristinwolfsong wrote:

    I think you are completely overlooking the amount of housing inventory out there in the shadows. expect another 30% fall at least

  • Report this Comment On February 19, 2010, at 3:23 PM, kjksm1 wrote:

    Giving someone a rate decrease on a home that is worth 50% of the purchase price is not going to work. We will never know what the real value of houses are until we take all these taxpayer-expensed so called stimulus plans and let the free market decide where the price should be.Once the underwater mortgage holders see their peers walk away, that action will be more acceptable. Do you pay your mortgage or feed your kids?

  • Report this Comment On February 19, 2010, at 3:26 PM, cmfhousel wrote:

    "I think you are completely overlooking the amount of housing inventory out there in the shadows."

    How so? Did I somehow come off as a housing bull in this article ?

    I've discussed the negative effects of shadow inventory in this article

  • Report this Comment On February 19, 2010, at 5:33 PM, karate1000 wrote:

    The auto and housing industries have been decimated by "clunker" programs. No offense but I can't believe anyone is crazy enough to buy a new cars in this economy. Considering that a healthy chunk of 2010 Cash 4 Clunkers cars have already been repossessed (i.e. why not just go to local banks and credit unions and buy these repo cars back for half the retail price? If you're going to buy junk at least don't over pay.

  • Report this Comment On February 19, 2010, at 6:31 PM, maccdw wrote:

    One aspect of this entire housing rodeo which is rarely discussed is the consequences of any housing price support. If housing prices decrease, isn't that simply the market at work? My youngest niece was able to buy her first home a year ago when a bank foreclosed on a house she later found. Before the housing price crater, she was unable to afford a home, so she rented. Why do most of us assume that 'stabilizing' home values is 100% good? What about all of the people who now can see home prices within their grasp, for the first time in a generation? One of the great lessons at hand, for anyone buying/selling/financing/investing in a home, is that, yes, prices cannot keep rising to infinity.

  • Report this Comment On February 19, 2010, at 8:13 PM, LessGovernment wrote:

    There is only one long term fix for residential real estate - Deflation.

    Before the current residential real estate debacle will be fixed, more residential real estate debacles will be impacting the market. These additional debacles will be higher interest rates due to unchecked government spending and debt, and the largest generational hand off in history as the baby boomers start selling in the next few years, which will be prior to the current problem being resolved.

    With higher interest rates and with the upcoming generation having less economic opportunity and income than the boomers, there is only one direction, long term, for residential real estate values - down.

    Housing is a good place to put money for a place to live, but for the next ten to twenty years, it will be a bad investment.

  • Report this Comment On February 19, 2010, at 9:51 PM, xetn wrote:

    There is no upside to trying to prop up housing prices or for that matter any price. That is nothing more than a ponzi scheme. Let the free market work and then many more people will really be able to afford a house, if that is their choice. But stop the government intervention; it is just prolonging the inevitable. The sooner this happens, the sooner the economy can begin to truly recover.

  • Report this Comment On February 20, 2010, at 9:51 AM, Gorm wrote:

    Per usual our government is attacking symptoms vs recognizing the core problem, which is overvaluation attributable to a credit binge induced bubble.

    Nothing the government does will incentives, rate reductions, term extensions will correct the core problem of the mortgage worth more than the house.

    The government should save our money and just let the market correct. It is going to happen eventually anyway.

  • Report this Comment On February 20, 2010, at 1:21 PM, acidstainer wrote:

    The housing industry can't recover until people start buying new houses and stop selling the one's they own for less than they are worth.

    Just like stocks, houses are worth what someone is willing to pay for them. And when owners are in a panic sell you can pick up some bargains. The market is still gripped by fear, when the best investment you could ever make was your home.

    But the fact of the matter is that no government stimulus will help until the mindset of the people changes. I have been in the construction industry for 26 years, and during that time costs have risen and profit margins have turned almost non-existent.

    Trying to say that deflation is the only answer is ridiculous. That will only further the death-spiral. The only way to get the economy moving again is to get the construction workers back to work, and in turn they will spend their money, further bringing the entire country out of this mess.

  • Report this Comment On February 20, 2010, at 4:36 PM, tradrmick wrote:

    Writing off home owners debts to get them to stay in the house would be just another step toward socialism. It's already unbelievable how all the banks have been bailed out, I don't think taxpayers would accept anything more.

    If people walk away from their homes and trash their credit ratings, so be it. By setting all these "can't fail" standards, the next risk cycle will just be worse. If you can't lose your home, why not start speculating right now. Buy 2 or 3 of them because if the market doesn't recover, the banks don't want them either.

    Everyone has become so fearful of asset price declines, it's a disgrace. Everyone cheers and parties on the way up and then gets bailed out after the fall back to earth. I truly feel sorry for our children. By 2050 there won't be much left.......

  • Report this Comment On February 20, 2010, at 8:52 PM, LessGovernment wrote:

    My Dear Acidstainer, I feel your pain, but I respectfully have to disagree with your logic.

    The only cure for residential housing is deflation, given the government we have and the financial situation we are in. Here is why.

    The consumer is, was, and always will be the main driving force in our economy because when the consumer purchases something, that purchase creates demand for that product. That demand is what drives our economy. That demand is where jobs come from as employers respond to demand.

    However, the consumer, due to stupid long term trade policies coupled with higher taxes (payroll, income, real estate, sales, use, excise, and other taxes), has had his pay stagnated or cut, his job sent overseas, his sources of credit reduced, and as a result, his discretionary income destroyed. Without sufficient discretionary income, the consumer lacks the economic power to be able to buy enough stuff to keep demand where it needs to be to keep employment where it needs to be to keep the economy going. This is the problem.

    I have been writing members of Congress since early 2007 advising them to stop withholding payroll taxes (7.6% of gross pay) on the workers and stop penalizing employers with employment tax penalties for hiring and keeping workers (the other 7.6% of gross pay as a result of payroll taxes). Congress has not listended, and instead has spent far more money than what this would have cost in their effort to bail out banks, auto companies, and local and state governments. In the process, the national bond debt has soared from 9 trillion dollars in 2006 to 12 trillion now and will be at 14 trillion by the end of 2011. What this will do is raise taxes even more in order to raise the funds needed to pay the debt service costs on the rising government debt. These higher taxes will cause yet more harm to discretionary incomes, reducing demand even more.

    Due to reduced economic opportunity and a drop in real earnings, people can no longer afford houses priced as they were being priced in 2006 and 2007. If they can't afford the houses, you either stop building them, or you have to make them affordable again so you can build them. This is why the only long term cure for residential real estate is deflation.

    With the higher debt load coming that is being created by our idiots in Washington and in the various states, debt service costs will increase, pushing taxes higher and higher. Interest rates will also increase because the federal government along with states as well as foreign governments will all have to compete for funds in exchange for the bonds they will all need to sell, and this competition will cause bond rates to go up, because that is how you get more competitive if you are selling debt.

    Higher interest rates make housing even less affordable so something has to give. If we can't reign in spending and taxes, and if we can't avoid higher interest rates, which I think is what is going to happen in the not too far distant future, then the only cure for housing is the price of housing itself will have to decrease in order to keep housing affordable.

    You can not correct these problems with re-working mortgages or making speeches. The only way to correct this is either create more economic opportunity so more people can have higher incomes resulting in increased demand for goods and services, or you have to deflate the housing market along with all the suppliers of material used to make and maintain housing. This means a roll back of pricing on copper pipe, lumber, roofing, siding, brick, block, concrete, etc., because you can't have high materials costs and still be able to decrease the cost of a house, any more than you can keep the cost of the house the same and expect people with far less discretionary incomes to be able to buy the houses using higher interest rates to finance the purchase. The math just does not work.

    Add in the fact that we are currently flooded with excess housing (supply) that is chasing too few qualified buyers (low demand) and then consider that the supply and demand problems will most likely continue to get worse as long term unemployment continues to take its toll, and you have a very bleak picture of the housing market.

    So here we are. You can't put people back to work until you increase discretionary incomes and allow the consumer to once again start buying stuff, creating the demand that employers will respond to by hiring workers. Discretionary income has to come first. It can not follow increased employment because discretionary income is the cause for increasing the employment.

    Artificially increasing employment does not work, because artificially increasing employment has to be done with debt, and demand created with debt destroys future demand. This is because future discretionary income is reduced by the debt service costs associated with purchases of the past. Debt always kills discretionary spending going forward. Buy a house and take out a mortgage and you can't buy that boat you wanted because the mortgage costs took away your ability to pay for the boat.

    This is a fundamental truth of economics. Our government up until now has refused to acknowledge this and has instead squandered trillions of dollars trying to salvage the economy by dumping money into corporate offices which does nothing to help customers by the products therefore does nothing to stimulate demand.

    The solutions to date have therefore mostly been ineffective and very wasteful, and that waste is making the root problem of a lack of discretionary income all the worse becasue of the higher taxes coming to pay for the higher and higher debts of the government.

    Also, please do not drink Obama's class warfare Kool-Aid of taxing the "rich" whoever they are. It makes no difference who is taxed more. What counts is this. An extra tax burden removes more demand from the system, and thus removes opportunity as well.

    Here is why. You build houses. You might build less houses if you built houses for the "rich" and they are taxed to the point they can no longer afford for you to build them a house. This is the problem inherent with buying votes by taxing Peter to pay Paul. We have done that for far too long and now Peter is not spending and Paul is unemployed and pissed off.

    So back to housing. There are two solutions. One is to increase discretionary incomes and allow increased discretionary funds to spur demand, increase hiring, and a cause a steady rise in the econojy, but our government seems to stupid to understand this, so that only leaves the other solution which is deflation which will make housing and other products more affordable so demand can still return in spite of the reductions in discretionary incomes brought about by higher taxes and decreasing job opportunities.

    Housing in particular is facing the other problem of interest rate led mortgage increases which also makes housing less affordable, so housing in particular will need to deflate even more than other areas of the economy in order to bring about a pricing structure that will enable the lowered affordability (lower incomes and higher mortgages) to still be able to stimulate demand through purchases.

    This is why I think housing is a good place to put money for a place to live, but will be a bad investment for a long time to come. There really is no other currently obtainable solution to deflation because our government will not do what needs to be done. And as long as we continue to waste resources fighting deflation, we only make the problems worse, meaning the deflation will have to be even more severe than what might otherwise have been required.

    One more thing.

    Fire them all in 2010, Republicans, Democrats, and Independents alike. They have all sold us out.

  • Report this Comment On February 21, 2010, at 2:03 PM, PositiveMojo wrote:

    The federal programs have been more a PR pitch than actually having a significant impact on the market. There is still a HUGE amount of uncertainty because of the high levels of "silent inventory". I would say that the future of the economy depends more on the actions of the banks that own the silent inventory than federal programs.

    I know that there is some innovation going on. Some investors with deep pockets are pickiing up portions of the silent inventory. Some financial institutions are making this part of their strategy - which is a win-win for both the investor, the bank and the economy.

    If the banks dumped the silent inventory it would be bad for everyone - prices would definitely take another hit in a bad way.

    If interest rates nudge up a little bit it might be enough to make the fence sitters take action and buy a house sooner rather than later. Then again - it may scare them to death... uncertainty.

    Regardless - as an investor - us Fools have to stay on our toes and be alert! One day at a time and smell the air to see if Rome is burning.

  • Report this Comment On February 22, 2010, at 8:04 AM, LessGovernment wrote:

    I agree with what you are saying Graybear1951. But I suspect those investors with deep pockets that are picking up this silent inventory, are doing so after the silent inventory has deflated sufficiently, which is exactly my point. Deflation is the only cure.

  • Report this Comment On February 22, 2010, at 11:41 AM, shovel99 wrote:


    Maybe I am missing something, but are you, heretofore an intelligent guy, suggesting that we taxpayers pick up the tab to for the Federal Government Banking system to give free money to the overborrowers... many of which are illegal aliens and non-creditworthy... so that they can now "have equity"? The solvent, the honest, the intelligent who lived within their means get to give more money to the Fools? Add that to the $24T "stimulus" package?

    I have a better suggestion: withdraw all US govt. market manipulation from real estate and let the market place set (lower) prices, let people who cannot afford to buy rent... there will be a mushroom of apartment demand and building, boost the economy.... and people will live where they can afford. Just my $.02

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