In the middle of a foreclosure crisis, what happens to the guy who's still paying his mortgage?
Noted banking analyst Richard Bove recently coined the phrase "The Guy (or Gal) Next Door Effect" to describe the difficulties that befall the blameless homeowner who continues to pay his mortgage — despite being surrounded by others who are in default.
Bove's point is essentially this: With all the focus on those who are delinquent or in foreclosure, how is the homeowner who is still making his payments impaired? "The over concentration on the guy who's losing the house is missing the point," he says.
"It's the guy who's not losing his house—the guy next door—that we should all be thinking about. No one seems to be considering the position of the guy who lives in his house and continues to make his payments."
Here's the nub of the problem. Foreclosures and vacancies damage the value of home prices in a neighborhood for everyone who lives there, whether they are delinquent on their mortgage or not. According to Bove, the value and desirability of a community—and hence the price of housing in it—is determined by a diffuse set of interrelated criteria: "Good school systems, safe streets and neighborhoods, and good amenities—in the form of restaurants, shopping malls, etcetera."
It is well known that empty houses in a neighborhood attract a significant number of problems: Property crimes like vandalism rise, nuisances like teenagers throwing parties accelerate, and more serious problems like fires in vacant houses increase.
But what may seem less apparent, at least on the surface, is why homeowners who are delinquent on their mortgages are a drag on the prices of surrounding homes—even if those homeowners have not yet left their houses.
Bove explains: "When a homeowner is behind on his payments, he's not maintaining his house. He's got the house out on the market for sale.
And [because of his precarious financial situation] he keeps lowering the price. He's willing to take almost any offer. And eventually the house merits a lower and lower price—because the homeowner doesn't have the money to fix it up and properly maintain it."
And then the downward spiral begins. As Bove ominously explains, "The tax base contracts— and then the essential services are distressed."
In short, "If there are a large number of people in a neighborhood who can't afford the houses that they're living in—whether the houses are ultimately empty or not—the neighborhood deteriorates in condition."
Bove cites, as an example, a community on Florida's Gulf Coast called Fish Hawk, where there were approximately 65 foreclosures in a single week. Needless to say, the community experienced a major deterioration in the quality of life for the remaining homeowners. (To cite just one data point, the shopping plaza in the center of Fish Hawk suffered an 80% vacancy rate within just a few years of the explosion in foreclosures.)
"After a while there were roving bands of teenagers roaming the streets," Bove says, "because the community couldn’t afford to support their local police force. It became a little like Lord of the Flies:
They weren't bad kids—but they were out roaming the streets with no one there to control them."
Bove believes that extending the process of foreclosure—keeping people in their houses after they are delinquent—is part of the problem, not part of the solution.
"Ultimately, it snaps back on the community itself—because the tax base is declining," he says.
"What happens is you get a deterioration in the essential services in the neighborhood because nobody can pay for them—whether the homeowner sits in his house or not. Basically speaking, the neighborhood starts to lose its attractiveness. It's simply against the interest of the city not to facilitate the foreclosure process as quickly as possible."
So what can be done to fix the problem? Bove has two very pragmatic suggestions.
Remedy One: "Get the house foreclosed on as quickly as possible. The faster the foreclosure process the better—because you need to get the house resold to someone who will be able to afford to maintain it."
Bove's general framework here is to think about the neighborhood as a whole, instead of focusing narrowly on helping the homeowner who cannot afford to pay. He makes two related points in support of his first proposed remedy.
First, the very fact of getting a new homeowner into a vacant house injects fresh new capital into the neighborhood.
"When someone moves into one of those vacant houses, they have to put up a lot of money to get the house into an acceptable condition," Bove says.
With the infusion of fresh cash into a neighborhood, the downward spiral unfolds in reverse. Property valuations rise, the tax base expands, and tax payments are made by homeowners in a timely fashion.
Second, in Bove's opinion, it's not such a great financial catastrophe for a former homeowner to move out of his old house and into an apartment: "That person now has a better situation financially, and is now better able to contribute to the community," Bove says, because "the homeowner's cash flow position improves immediately."
And, equally important, the home owner is no longer burdened by the weight of debt from a house he can no longer afford. Considering that the homeowner may have been upside down in his mortgage—owing more to the bank than the house was worth—that alone could potentially make for a major improvement in his financial situation.
Remedy two: Instead of providing aid to the person who can no longer afford to pay their mortgage, society should instead focus on providing aid to the distressed communities at large.
As Bove puts it: "Provide aid to small businesses in those distressed communities. Provide aid to the school systems, so that they don't need to raise taxes and further burden the communities they serve.
Put those support dollars into maintaining the overall ambience of the communities themselves.
"Remember," Bove says, "when people go into a community and see for sale signs, uncut grass, and dirty streets, they don't want to live there."
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