Thursday, July 7, 2011

Violating Contracts for Headlines But No Real Economic Benefit

As a libertarian, I've always though there were two major roles for government, enforcing contracts and security/defense.  That's why it really perturbs me when I see the Obama administration violating contracts for the sake of some headlines.  According to this story, they are getting ready to propose an extension in a couple government programs that would allow unemployed individuals to not pay their mortgages for 12 months before any foreclosure actions are taken against them.  Current programs only allow 3-4 months of relief.  Now I know that being unemployed in this economy is extremely stressful (I was unemployed in early 2009 and did lie awake at night worrying about losing my home) and is currently ruining lives.  But violating a cornerstone of capitalism, contracts, doesn't seem like a great way to do anything about it, neither from a theoretical or a practical basis.

First, let's start with the theoretical.  Our economy is built on contracts between people and between businesses.  Mortgages are contracts where individuals receive loans to purchase a property in exchange for a monthly payment.  The only recourse for the financial companies who provide these loans is the ability to take possession of the property once the person who took out the mortgage fails to make payments.  While this used to sound like a no-lose situation for banks, especially during the periods where real estate prices almost never went down, the recent recession indicates that banks are taking a lot of risk when they provide loans.  Even after taking possession of the property, banks could be underwater by over 50%.  Now they need to worry about whether the government may stop them from foreclosing if the resident of the house is unemployed?  I wouldn't be surprised if they further tightened their lending standards and tried to avoid people who are in industries with higher employee turnover.  This would lead to a weaker real estate market longer term, weakening banks, who are highly levered to the fate of the real estate market, and current/future homeowners (just what we need right?).  Nothing good can come from having banks question their contracts.

Now for the practical problem that I have with this program.  The problem with any government program is that there are almost always unintended consequences thanks to changes in  incentives.  Right now there is quite a bit of incentive to get a job and get off of unemployment benefits.  Usually jobs pay more (though McJobs don't) and at some point the benefits will run out.  But with this program, now a job has to pay more than unemployment PLUS your monthly mortgage payment combined to make sense, at least in the short term.  I could definitely see some people forgoing employment to live off the government and the banks for a little while longer, especially, if they think that foreclosure is only a matter of time anyway. 

My other practical problem with this program is that it, after violating contracts and creating perverse incentives, it will do little to no good.  According to RealtyTrac, banks are already dragging their feet voluntarily with regards to the foreclosure process as they try to give loan modifications and short sales a chance.  The average length of time between the initial default notice (which usually comes after one or more payments is already missed) and foreclosure is 400 days, or a little more than 13 months.  This is up from just 151 days in 2007.  In some areas, like New York and New Jersey, the average foreclosure process takes over 900 days or 2.5 years!  Foreclosure heavy Florida is at 619 days.  I wouldn't be surprised if banks start speeding up the back end of the process in order to take into account the statutory delay at the front end.  So you can easily see this 8-9 month extension turning into only a 3 month extension  in the average state (going to zero in states like NY, NJ and FL) when you take into account that banks have already been delaying foreclosure.

I'm sure Obama knows all this so I can only think that he is pursuing this course simply because he wants to have headlines giving the appearance that he is doing something for the economy.  Once again, we are sacrificing the long term for little/no short term gain.  No wonder our economic situation is the way it is.

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