How to Solve the Housing Crisis

Winston Churchill supposedly said:
"You can always count on the Americans to do the right thing, after
they have tried everything else." This may prove to be an accurate
description of the response to the foreclosure crisis that has followed
the collapse of the housing bubble.

The folks in Washington
have developed a series of complex mortgage modification schemes
designed to keep people in their homes. George Bush put forward the
first plan in the summer of 2007. It was entirely voluntary for lenders
and came with no government money.

Last summer, Congress developed a package that committed up to $300bn in loan guarantees
to support modification efforts. Eight months after the plan went into
effect, there were fewer than 1,000 applications and only 52 completed
modifications.

The most recent set of proposals came from President Barack Obama in February. This plan focused more on giving incentives to servicers, offering them $1,000 to carry out a modification
and an additional $1,000 for each year that the homeowner stays in
their home. This programme also appears to be having a limited effect,
as foreclosure rates hit a new high in the second quarter of this year.

There
is an easier route. In recognition of the extraordinary situation
created by the housing bubble and its collapse, Congress could approve
a temporary change to the rules governing the foreclosure process. This
change would give homeowners facing foreclosure the right to stay in
their homes, paying the market rent for a substantial period of time
(eg seven to 10 years).

This change would have two effects.
First, it would immediately give housing security to the millions of
families facing foreclosure. If they like the house, the neighbourhood,
the schools for their kids, they would have the option to remain there
for a substantial period of time.

Also by keeping homes
occupied, this rule change can help prevent the blight of foreclosures
that has depressed property values in many areas. Vacant homes are
often not maintained and can become havens for drug use and crime.

The
other effect of a right-to-rent rule would be that it would give
lenders substantially more incentive to modify a mortgage. Under the
rule, the lender could still carry through with the foreclosure process
and take possession of the house. The lender would also be free to
resell the property, but the former homeowner would still have the
option to remain as a tenant, paying the market rent for the period
specified in the law.

Since a house that comes with a renter
attached is much less valuable to the bank, foreclosure would be a much
less attractive option. Therefore lenders would have more incentive to
try to work out a modification plan that allowed the homeowner to
remain in their house as an owner.

The main argument that has
been raised against a right-to-rent law is that it would interfere with
the sanctity of contracts by changing the terms of enforcement after
the fact. While it is important to have clear law on such issues, there
is precedent for such changes. During the Great Depression the
government imposed a complete moratorium on foreclosures, a move that
was upheld by the courts.

Perhaps an even better precedent was the bankruptcy reform act that Congress passed in 2005. This act made it far more difficult for creditors to have their debts relieved in bankruptcy.
The reason that this provides a precedent for right-to-rent laws is
that it was applied retroactively to debts already incurred. A person
could have run up $30,000 in credit card debt under one set of
bankruptcy rules only to find that they were now bound by a much
stricter new set of rules. When the topic was changing the rules to
benefit creditors, the sanctity of contracts was never even raised as
an issue.

The foreclosure crisis is a disaster for millions of
homeowners who are seeing dreams ruined and their families' lives
disrupted. The efforts to develop creative mortgage modification
schemes have thus far not been successful in providing much relief.
Such plans are inevitably costly and time consuming.

By contrast,
a right-to-rent law can instantly provide security to millions of
homeowners facing foreclosure. It requires no bureaucracy and no
taxpayer dollars. Perhaps the Obama administration and Congress will take such a proposal seriously now that they have tried everything else.