What if We Let Foreclosures Happen? Would the World End?

“The housing crisis is at the center of the economic crisis, and if we don’t address housing head on, we can’t fix the financial crisis.” – Ara Hovnanian, November 2008 By now, the real estate industry’s battle cry has become accepted and common knowledge: accepted by consumers, commentators, and politicians alike. We must fix housing, in order to fix the economy! We’ve heard this refrain from the National Association of Realtors, the National Association of Home Builders, the Mortgage Bankers Association, and a chorus of community and consumer groups, too – not just the CEO of a large national homebuilder, lest you feel I’m singling out Hovnanian. But what if our common knowledge on the subject is flat-out wrong? What if – and here’s a world-changing idea – housing isn’t central to economic recovery, at least this time around? Imagine, for a minute, if we actually allowed banks the ability to enforce their legal rights on a non-paying borrower? What if we let the loan terms borrowers agreed to when they took out a mortgage actually mean something? Would it be the end of the world as we know it? Consumer groups, of course, are busy bombarding Congress on this very issue. But at least one study is turning conventional wisdom on its head, suggesting that economic recovery will largely proceed with or without a housing rebound. In a report released last Friday, a cross-functional research team at FTN Financial took a look at key regional U.S. economies in the second half of 2009, and asked whether consumer spending was held back in those states with horrid housing credit. Their findings? Housing performance was completely uncorrelated with consumer spending. This should give a reason for pause: If housing is central to economic recovery, as we’re being told, why is it that consumer spending seems to have so little to do with the state of real estate? A little about the study, for those curious to know: consumer spending was measured using trending in sales tax receipts in key metropolitan statistical areas, and then compared across MSAs that were characterized as having horrible versus more stable housing performance. The idea is pretty simple – if a battered housing market is a drain on the consumer, then areas where housing is relatively worse off should demonstrate a strong negative impact on consumer spending as measured via sales tax receipts. But that’s not what was found. Instead, trending in consumer spending within some of the hardest-hit areas of Florida mapped directly onto consumer spending trends seen in healthier housing markets, including Nashville and Raleigh, North Carolina. “[T]he best conclusion is consumer spending recovery patterns are not necessarily worse in regions with the worst housing markets,” lead analyst Jim Vogel and his team write. “Instead, it is smaller economies that were overly dependent on housing during the boom that remain sensitive to housing credit indicators.” While there are always caveats to a descriptive study such as this one, the import of what is being suggested here is huge: maybe we don’t need to fix housing, after all, in order for the nation’s economic picture to improve. Maybe we can – gasp! – let foreclosures proceed as they usually would. After all, consumers don’t disappear from the economy when they lose their house – they usually become renters, and continue to put food on the table for their families and buy school supplies for their kids, just like the rest of us. (Because they are the rest of us.) Consumer spending typically drives us forward out of a recession; but consumer spending during the last three economic recoveries, as Vogel and his team note, have largely been the result of so-called MEW, or “mortgage equity withdrawal” in the form of refinanced first mortgages and new cash-out second liens. It’s pretty clear that more organic growth in consumer spending will need to lead the charge out of the Great Recession, since mortgages are harder than ever to come by, and we can all but rule out anyone’s ability to obtain a second. And that’s the telling aspect of this reaseach: the study finds evidence that such ‘organic’ consumer spending isn’t strongly dependent on a consumer’s ability to pay their mortgage – meaning Florida is seeing roughly the same growth in consumer spending as Tennessee is, for example, irrespective of the level of foreclosures seen in the state. All of this, then, begs a pretty a important question: are all of the breathless billions that have been spent on foreclosure prevention and mitigation – in the name of promoting economic recovery, no less – really nothing more than political pandering? And here’s an even more interesting thought: are we doing more economic harm than good by tinkering with the foreclosure process? After all, we know that many HAMP modifications are failing, for reasons that have nothing to do with the HAMP program itself – but the program is succeeding in changing borrower’s expectations of what they are entitled to when they find they cannot make a scheduled mortgage payment. (I can’t tell you how many emails I get from irate borrowers claiming that their servicer refused to consider a “reasonable” principal reduction on their loan, a reduction they feel they were entitled to receive.) Rather than keeping consumers in homes they cannot ultimately afford, and setting consumer expectations at untenable levels, would we all be better off by simply allowing a foreclosure to happen, thereby putting the consumer in a position to contribute more of their disposable income back into the ‘real economy’ – and maybe even boosting consumer spending in the process? The questions here are tough ones, to be sure. And the research here is but a start in what should be a more in-depth inquiry over time, too. But the answers to these tough questions just might shed light on a more rational way for us to manage our way out of housing’s darkest days. Paul Jackson is the publisher of HousingWire.com and HousingWire Magazine.