Financial meltdown: A revived Resolution Trust Corp. could open (front) door to fixing underlying housing crisis

Prof. Jeanne Boeh
Courtesy of Augsburg College
Prof. Jeanne Boeh

As Augsburg College economics professor Jeanne Boeh jogged through Oakdale the other day, she spied a half-dozen unfinished and weather-beaten townhomes that in her mind exemplify why our economy is not moving forward.  

“They’re not finishing these buildings, and if you are living in this neighborhood and trying to sell your home, that’s just not helpful,’” says Boeh, chair of the economics department at Augsburg. “There are all these homes for sale and foreclosure signs on doors. It’s hard for people to move forward, and it just has a demoralizing effect on the economy.”

Like other economists, Boeh (pronounced Bay) is looking at the financial meltdown on Wall Street and contemplating fixes. She keeps coming back to what’s happening on the streets of the nation’s neighborhoods. The housing market, a cornerstone of our economy, is stuck because people don’t trust the prices and valuations they’re seeing. Foreclosures and abandoned developments like the one she saw on her run are a significant part of the problem.

The biggest bailout in history?
On Thursday, the heads of the Treasury Department and the Federal Reserve began discussions with Congress about what could be called the biggest bailout in history – buying hundreds of billions of dollars worth of distressed mortgages and real estate assets, the New York Times reported.

One idea being floated this week by economists, including former Federal Reserve chairman Paul Volcker, is resurrecting the Resolution Trust Corp. The first government-backed RTC was set up to dispose of the bad assets of 700-plus failed savings-and-loan institutions in the late 1980s and 1990s. The idea was to sell the real estate off gradually so as not to flood the market.

The RTC II would buy up the “toxic real-estate paper” (think bundled mortgage securities, subprime loans, etc.) dragging down financial institutions and the housing market.

In an opinion piece in Wednesday’s Wall Street Journal, Volcker, former Treasury Secretary Nicholas Brady and former Comptroller of the Currency Eugene Ludwig elaborated on the RTC fix for what they called the “worst financial turmoil since the Great Depression”: “The fact is that the financial system needs basic, long-term reform, but right now the system is clogged with enormous amounts of toxic real-estate paper that will not repay according to its terms. This paper, in turn, is unable to support huge quantities of structured financial instruments, levered as much as 30 times.

“Until there is a new mechanism in place to remove this decaying tissue from the system, the infection will spread, confidence will deteriorate further, and we will have to live through the mother of all credit contractions. This contraction will undercut the financial system, and with it, the broader economy that so far has held up reasonably well.”

Their proposal: “We should move decisively to create a new, temporary resolution mechanism. … This new governmental body would be able to buy up the troubled paper at fair market values, where possible keeping people in their homes and businesses operating. Like the RTC, this mechanism should have a limited life and be run by nonpartisan professional management.”

Real-estate ‘toxic spill’ harming Twin Cities, nation
In the interim, the toxic spill of bad real-estate paper has a hold in the Twin Cities and across the nation. So-called “lender-mediated” properties (those in foreclosure or awaiting a “short sale” to avoid foreclosure) accounted for almost 22 percent of for-sale listings in the Twin Cities housing market in the second quarter, according to a report (PDF) by the Minneapolis Area Association of Realtors.

Lender-mediated homes accounted for 25.8 percent of closed sales in the second quarter, more than three times what they were a year ago at the same time.

In a two-year comparison of second quarters, the report found that the median home price fell 11.9 percent to $207,000 for the overall market. Other slicing and dicing of the data found that the median price for lender-mediated properties declined 11.7 percent, compared with 3.4 percent for “traditional” properties (those not in foreclosure or up for a short sale).

Edina Realty broker associate Aaron Dickinson, who co-authored the report and tracks the market through his blog, is interested in how the federal bailout would work but says he’s most concerned about keeping distressed properties occupied and maintained and neighborhoods and communities intact.

“It’s very clear that something like this (the bailout) had to happen on the institutional side,” he said today. “But there’s still a problem on the retail side, on the borrower’s side. This might keep banks from failing, but it’s not keeping neighborhoods from failing. … You have to address the problem at the dirt level, too – you can’t just address this from packaged mortgage notes. … If you obliterate values in a neighborhood, even people who are good credit risks and keep their homes up … will up and leave themselves. You can’t forget about people in their homes and the neighborhoods.”

Boeh thinks RTC II could help restore confidence in the housing market.

“It seems to me a reasonable solution because we’re never really going to recover until housing prices stabilize and people feel secure about what they’re buying,” she says. “To say foreclosures are not really affecting housing prices because foreclosed houses are in a different group, that’s silly. … Why would I buy a house if it’s going to cost me $30,000 more than a house that is in foreclosure? Some people have suggested that the government buy these houses and tear them down. That’s silly. A Resolution Trust Corporation would offer an orderly transition.”

Enough of the silliness, Boeh says.

“Every piece of evidence says we won’t work off this essential ‘overhang’ of houses for at least another nine months,” she says. “If people are not buying houses, they’re not buying dishwashers and refrigerators. … This is one reason we pay so much attention to sales of cars and houses – they are important drivers for the whole economy.”

Casey Selix is a news editor and writer for MinnPost.com. She can be reached at cselix [at] minnpost [dot] com.     

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Comments (3)

  1. Submitted by Chui Chui on 09/19/2008 - 12:59 pm.

    It will be an unprecedented quagmire far worst then Reagan’s voodoo economics.

  2. Submitted by Bernice Vetsch on 09/19/2008 - 03:02 pm.

    In the late 1980s we were not also borrowing $12 billion a month to finance a war of choice, corporations had not yet outsourced millions upon millions of American jobs to countries where they could pay people 50 cents a day with no benefits, and anti-union/anti-worker zealots were not yet part of the federal government.

    I wonder if it might not be better to let the whole thing crash and start over rather than bail out the folks who, with the aid of Phil Gramm and other anti-regulation zealots, were able to be so “creative” in their product development and sales that they were able to “create” the current mess.

  3. Anonymous Submitted by Anonymous on 09/25/2008 - 09:21 am.

    Americans are skeptical about the proposed $700 billion bailout, and rightly so. The bailout focuses on mortgage-backed securities, not mortgages. The bailout is an expensive attempt to restore “confidence” in the markets, with little guarantee that confidence will be restored. One of the reasons we’re in this mess is because the link between mortgage-backed securities and mortgages has been broken, and this bailout plan will do nothing to repair it.

    Instead of bailing out mortgage-backed securities and the firms who own them, let’s bail out mortgages. This IS guaranteed to trickle up.
    • A few analysts suggest that the markets can indeed weather the crisis on their own. If they are right, assisting these firms only rewards bad behaviors, and may do nothing to little to help the underlying economy and the millions of Americans who are struggling. The problem is a balance sheet problem, not a solvency problem—not enough cash to cover bad assets which they don’t know how to value.
    • Homeowners are typically viewed as individuals (no big deal if one mortgage goes down to foreclosure) but should be understood collectively—together they hold 51.6 million mortgages and $15 trillion in debt.

    The plan:
    • All homeowners currently facing foreclosure (about 1.25 million) receive $50,000 (or the max of their mortgage) to refinance and buy down their debt. Price tag: ($63 billion).
    • Remaining homeowners with incomes up to $100,000 receive $15,000 to buy down/prepay their mortgages ($512 billion).
    • Homeowners with incomes between $100k and $150K receive $7,500 to buy down their mortgage ($72 billion).
    • Congress passes a law: no foreclosures or resets for three years. After this period, all homeowners are on their own. (It’s projected that a million more foreclosures could be coming down the pike due to interest rate resets.)
    • Numbers can be adjusted to help those w/o mortgages and/or those who’ve already lost their home.

    The benefits:
    • In the process of refinance, banks/lenders get three benefits: assets are correctly revalued and bad debt taken off their balance sheets (a major sticking point in the current bailout plan—how to revalue the assets; my plan avoids this problem because homes are reappraised in the refinancing—the only accurate way to revalue the assets); cash and liquidity as a result of all the prepayments; and a projected $112 billion savings from prevented foreclosures.
    • Credit markets are reactivated.
    • Small banks that made prudent loans, and homeowners who have kept up with their mortgages are rewarded too.
    • Home prices stabilize because less supply is flooding the markets.
    • Homeowners are partially compensated for the tremendous loss in home values over the past two years.
    • Homeowners get to keep their homes, stabilizing communities and tax base.
    • Seven times the amount of money from the recent stimulus package ($100 billion to individuals) is put back into the economy.
    • Investors hardly know what they own and where as a result of the securitization. They’d be hard pressed to reach out to homeowners (if the past two years is any indication). However, homeowners know who their lender is and they can initiate action. Added benefit is local jobs.
    • Renters and homeowners with no mortgages get no cash assistance, and this may be perceived as unfair. But the likely benefits to their jobs, and home values and pension funds are far greater than the current plan.
    • It’s administratively more simple. We have the infrastructure in place to refinance loans. We don’t have the means in place to implement the current plan. Note that the RTC was slow in getting starting, and if all the hype is correct, we can’t wait.
    • AND: An American value is to help each other when we get into trouble, but we’ve lost faith that w”we’re all in this together” (with the current bailout as key evidence).. We got into this mess collectively, and we’ll get out collectively. However, for those who are being helped, let’s remember that many came before them who were not. We saw the mortgage crisis as an inner city crisis of poor people who made stupid decisions. Now we know that it can happen to all of us. So in exchange for being helped, we have a reciprocal responsibility to understand the plight of others and be willing to help them as well. This cannot be one more form of entitlement that Americans come to expect. With the right rhetoric, it might provide a powerful course correction for how we view an act on our collective responsibility to one another.

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