A Better Solution for the Housing Mess

With the housing mess threatening to send the economy into a tailspin, politicians are scrambling to come up with a quick fix. Senate leaders this week announced they’ve come up with a housing bailout bill, including a $4 billion grant to local governments to buy foreclosed homes, authority for states to issue bonds for refinancing sub-prime mortgages, and a $7,000 tax credit for those buying new homes or existing houses in foreclosure. The bipartisan compromise package will cost taxpayers plenty but does little to alleviate the real problem. That’s because politicians are scared to death to put the blame where it belongs.

Everyone is willing to cry foul about the unscrupulous lenders who suckered borrowers into sub-prime loans that ballooned after a couple of years, making payments unaffordable for many. But what about borrowers who behaved irresponsibly in the first place? The fact is, Americans have been living beyond their means for years, and now the bill has come due. As usual, we expect someone else to pay it.

Borrowers have gotten in trouble because they bought houses they couldn’t afford, often with little or no down payment, and accepted loans that sounded too good to be true — and were. Banks used to tell prospective homeowners that they could qualify for a loan on a home that was roughly three times their yearly salary. Banks also required 20 percent down. So, if a family earned $75,000 a year, they could buy a $225,000 house, but they had to have saved $45,000 to put towards the house in order to qualify.

But at the height of the housing boom, some lenders were willing to lend borrowers five — even 10 — times their annual salary. And if the borrower didn’t have the down payment, the lender would finance some or all of it, too, with a home equity loan. Even the closing costs on the sale — amounting to thousands of dollars — could be worked into the loan. In order to keep the payments within reach, lenders set very low interest rates for the first few years on adjustable rate mortgages, which then went up sharply. And those most likely to sign up for such loans were the buyers with the worst credit histories, who couldn’t qualify for more traditional mortgages.

Economists and others warned of a housing bubble about to burst, but builders kept building — even when their new houses were sitting unoccupied for longer and longer periods. And existing homeowners refinanced their homes, taking out their rapidly inflating equity to buy new cars, furniture or vacations.

The whole process operated like a giant Ponzi scheme. But, eventually there aren’t enough new chumps to buy into the scheme to keep it going forever. And as soon as those adjustable mortgages started to skyrocket, borrowers who really couldn’t afford to be buyers started falling behind in their payments.

Now Uncle Sam wants to ride to the rescue. But, at whose expense? Those who will be most hurt by a bailout are the people who scrimped and saved for a down payment on a home they could afford and did without luxuries in order to pay their bills. No one is going to reimburse them for the fall in their home’s value caused by this mess. Instead, they’ll be paying higher taxes so that someone who had lousy credit and didn’t know how to save could afford to buy a home above their means.

The only thing the feds should do now is make it easier for borrowers with good credit histories to buy existing inventory. One of the most effective ways to do that would be to use tax policy to incentivize buyers. The Senate proposal includes a tax credit for individuals who buy houses now in foreclosure or new, unsold inventory, but not much else.

One idea to spur more sales would be to allow individual investors to write off losses on rental property against other income. Under current law, if you own a house you rent out, you can only take losses against profits when you sell. Since the rent a landlord can charge often doesn’t cover the entire mortgage, taxes, insurance and upkeep on the property, many landlords let houses fall into disrepair and aren’t likely to buy newer houses to rent out.

Why not allow those individuals who can afford the down payment to invest that money in buying up existing houses to rent out? If they could get even a partial tax deduction for the difference between the rent they receive and their expenses, it would make owning rental property a more attractive investment. And the government would eventually recoup the tax revenue when the house sold.

Many former homeowners are going to end up back in the rental market. We could help them — and the rest of us — by encouraging other buyers to purchase those homes as rental properties.