The next catastrophe in residential real estate may be caused by the government's solution to the last catastrophe in residential real estate—and this time tax payers are directly on the hook for the losses.
A combination of federal programs now allows homebuyers to purchase brand new houses for a dollar down—including fees and closing costs—while immunizing homebuilders from the risk of mortgage default.
Sarah Ryley, writing for The Daily, documents the situation in Coral Gables, where a company called Adams Homes is doing just that. (A nifty animation illustrates the complexities.)
Here's a thumbnail sketch of the moral hazard involved:
If a homebuyer hasn't put any money into a home purchase, in the form of a down payment, their mortgage payment is essentially no different than a rent– except the homebuyer gets unlimited upside on the deal. If the property appreciates in value, the homebuyer can sell house and pockets the profit. If property depreciates in value, the homebuyer can drop the keys in the mailbox and walk away with no real downside. And for the homebuilder the deal is risk free because the government is backstopping the loan.
Not surprisingly, the details of the program have begun to cause alarm. From the article in The Daily:
"'This is a recipe for a new, massive wave of foreclosures,' warned Jack McCabe, founder of Miami-based McCabe Research and Consulting. 'That’s what got us in this problem in the first place, giving 100 percent financing and not requiring the homeowner to have any skin in the game.'"
"'These [programs] are terrible,' said University of Texas-Dallas economics professor Stan Leibowitz, a leading researcher on the transactions. 'Allowing people into homes with zero down leads to much higher defaults than average. Government budgets are in bad enough shape that they cannot afford to be subsidizing homes that are likely to go into default, costing taxpayers more money.'"
The losses caused by such programs are beginning to mount.
The Daily article cites government statistics demonstrating that The Federal Home Loan authority, which has assumed the "lion's share of the risk," incurred $7.6 billion in losses last year. That number represents more than a 180 percent increase in annualized losses for the FHA.
It would also seem to encourage the development of additional housing inventory—while there is still excess capacity on the market in the form of foreclosed homes.
One homebuyer sums up the rationale: "We looked at foreclosures, but bought this one because it’s brand new. New appliances, stainless steel, new carpet." And adds, "I’m glad we went with this, because a lot of [the foreclosures] were trashed."
And a realtor states the case more plainly: "Why not get a new home if you can get a new home?"
Welcome to the next round of market distortions in housing.
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