Over the last few weeks Alejandro Lazo of the Los Angeles Times has written about new mortgage problems looming on the horizon.  On September 14, 2011 he discussed the toxic combination of relatively high interest rates and heavily underwater property values as presaging the next wave of residential foreclosures.  He observed:

A total of 10.9 million homes with a mortgage were in a negative equity position at the end of the second quarter, constituting 22.5% of all residential properties with a mortgage, according to Santa Ana research firm CoreLogic.  That was only a slight decline from 22.7% during the first three months of the year. And of those “underwater” homeowners in the second quarter, 3 out of 4 were paying interest that was above the market rate, the data show. . . . Economists consider high mortgage payments on homes that are underwater, or worth less than the debt owed on them, to be more likely to lead to foreclosure. Homeowners in this situation can feel hopelessly trapped and more willing to give up paying.

He made a great point:  the next wave of residential foreclosures is on its way. 

By the way, there is a wave of commercial real estate foreclosures headed our way.  Those who live in the Los Angeles area must have an inkling of this as they drive around the southland and see all of the “for lease” and “available” signs everywhere.  However, that was not Mr. Lazo’s focus.

Yesterday Mr. Lazo looked at the federal government’s recent move to gradually extricate itself from the mortgage business:

Uncle Sam is about to take a first tentative step out of the mortgage business by lowering the size of home loans that the federal government will guarantee, and it’s already hitting California neighborhoods with higher costs and bigger down payments.

Where does that leave us?  Those of you that are familiar with my previous discussions on mortgage debt and the federal government’s role in the current mess will not be surprised to learn that on one level I think it is a good thing for Uncle Sam to reduce his presence in the mortgage and real estate markets.  If he does, it will help the housing market to get to its natural level more quickly than it would with his meddling.

While Mr. Lazo is quite correct that a reduction of government interference will lead to lenders requiring larger down payments, this will reduce the likelihood that people lacking the income to make the monthly mortgage payments will get into houses they can ill-afford.  Putting someone in a house with a loan that requires 75% of that person’s monthly income to cover the mortgage payments is part of the kind of folly that led to the current financial mess. 

While one version of “compassion” says that the government should step in and guarantee home loans for people who can’t possibly afford the monthly payments – it was this sort of compassion that led to the option ARM meltdown – true compassion does not put people into this sort of untenable financial situation. 

My sense is that housing is still overpriced because sales continue to drop.  The ridiculously high home prices a few years ago were created by government interference into the natural market mechanisms, and it will take some time for the prices to drop to their natural levels.  Once the market returns to the natural sensible setting where only those who can afford to make the monthly payments will get a mortgage, house prices will have returned to their natural levels.

By the way, it doesn’t take great perspicuity to see that government interference in the market created unnatural incentives that led people to do things they otherwise wouldn’t have done.  After all, humans respond to both incentives and disincentives.  Unfortunately, while the underlying policies may have been put forward with the best of intentions, they led to unintended but very destructive consequences. 

The truth is that any governmental policy should be based on the way people really are, not on the way some theoretical model says people ought to be.  As the nightmarish socialistic/communistic experiments of the twentieth century Soviet Union, 1940s National Socialist Germany, 1970s Cambodia and Ethiopia, etc.,  . . . amply demonstrate, humanity cannot be reengineered to fit theoretical models.

Unfortunately, the United States has had its share of failed social experimentation (though thankfully, without the breathtaking mass murder of the aforementioned hellholes).  As I detailed in previous posts, the Community Reinvestment Act was the failed social tinkering that led to the housing debacle.  Perhaps a much needed extrication of government from the housing and mortgage markets will slowly undo some of the damage.

That said, while I am very optimistic about the spirit of the American people, I am less so about the government’s willingness to back off from the real estate and mortgage markets.  Too many of the people involved have the “hall monitor” mindset that makes it impossible for them to go gentle into that good night. 

This came home to me years ago while I was in law school.  During a friendly conversation, one of my fellow students decried the supposed problem of “urban sprawl”, and told me that he thought a legitimate role for government was to “force people to live in downtown metropolitan areas and use public transportation, rather than live in suburbs and drive their cars.”  He never explained to me why he thought that government officials were in a better position to decide where and how people were supposed to live than the people themselves.

In any event, I will not be surprised if Uncle Sam changes his mind and gets back into the mortgage business.  Stay tuned.