Right to Rent: Helping Homeowners Without Throwing Money at Banks

We got into the current economic crisis because many very smart people with outstanding credentials were unable to use simple arithmetic. If they knew arithmetic, they would have been able to see an $8 trillion housing bubble that was right in front of their faces.

The basic story was incredibly simple and obvious, at least as far back as 2002. After just following the overall rate of inflation for the hundred years from 1895 to 1995, house prices began to hugely outpace the rate of inflation in the mid-90s. Not coincidentally, this run-up in house prices paralleled the run-up in stock prices.

As was the case with Japan, the United States had a stock bubble and real estate bubble growing side by side. Unlike Japan, where the two bubbles crashed simultaneously, the crash of the stock bubble fed the growth of the real estate bubble in the United States. By 2002, nationwide house prices had increased by almost 30 percent above their trend levels. By their peak in 2006, they had increased by almost 80 percent above their trend level, creating more than $8 trillion in housing bubble wealth.

The inability of economists and the financial industry to see this enormous bubble was the basis for the current crisis. Remarkably, most discussions of housing policy still ignore the bubble.

It is often argued that we need to stabilize house prices. In many markets this is a desirable goal. However, in many markets in California, Florida, and the Northeast, where the bubble has not yet fully deflated, it would be counter-productive to try to sustain house prices at bubble-inflated levels.

Prices in these markets will eventually fall to their trend levels; the only question is how fast. Unfortunately, many of the same policy wizards who wanted low and moderate-income families to buy homes at bubble-inflated prices in the years from 2002-2007, would still want them to buy houses at bubble-inflated prices today. They somehow think that the best way to accumulate wealth is to own a home that is falling in value.

Even worse, they want to use lots of taxpayer dollars to keep people in homes in which they have no equity. Representative Barney Frank is one of the key villains in this story. His top priority is to use the TARP money to pay banks for their bad mortgages, so that people can stay in homes with no equity.

This one is really baffling as economic or social policy. Should we pay a bank $20,000 in order to keep a homeowner in a home in which they have zero equity? How about $30,000? How about $50,000?

It costs a bit more than $3,000 a year to pay for a kid's health care under the State Children's Health Insurance Program. We can all understand the benefit of health care for kids. Is it worth 17 kid-years of health care to keep someone in a home in which they have no equity?

There is a simple no cost, no bureaucracy alternative to Frank's plan to hand tens of billions to banks. (Remember, the banks get the checks under Frank's plan, not the homeowners.) We can simply temporarily change the rules on foreclosure to give people facing foreclosure the right to rent their homes at the market rent.

This is extremely simple and can go into effect the day after Congress passes the rule change. Judges or the court officers handling a foreclosure would be required to ask the homeowner whether they want to stay in their house as a renter. If they say yes, there would be an appraisal of the market rent of the home, and the homeowner would then have the option to stay in the house for a substantial period of time (e.g. 10 years), paying the market rent.

This would immediately give the homeowners facing foreclosure security in their housing. If they like the house, the neighborhood, the schools for their kids, they would have the right to stay there. It would also end the problem for neighborhoods of empty foreclosed houses. And, it would give banks real incentive to negotiate terms that allow people to stay in their homes as owners.

This proposal is very simple and costless. It is also possible to build onto this proposal with mechanisms that facilitate the transition to renters or allow buyback options as Bernard Wasow of the Century Foundation and Daniel Alpert from Westwood Capital have proposed.

But, the key point here is that it is simple to find a way to help homeowners that doesn't help banks, if we are prepared to give the issue a bit of original thought. Fear of original thought among our top policy experts was the problem that got us into this enormous mess. We should not let the same group of failed experts perpetuate the damage that they caused by their fear of thinking.