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SSep 9, 2011

A Hair-of-the-Dog Strategy to Save Home Values

Scott Burns
A Hair-of-the-Dog Strategy to Save Home Values

Michael Castleman has an idea that could do wonders for anyone who owns a house. It could also do wonders for our economy by boosting home sales, and boosting employment related to home building, home buying, and the furnishing of homes. Basically, this is an idea that would have a positive impact on three big factors in our economy— jobs, home values and consumer confidence.

Castleman, as you may recall from last week, is the founder and CEO of Metrostudy, Inc., the firm that does a lot-by-lot review of the new-homes market every quarter. The research his firm does shows that the new-homes market is now thoroughly compressed, wound tight. Any increase in consumer demand would likely result in a major recovery in the new-homes market and rising home prices. His data makes a strong argument.

If his projections of recovery have an Achilles Heel it is this: the new-homes market, currently at record low sales of 300,000 a year, may be experiencing a disconnect from the much larger existing-homes market. There, sales are now running at a rate of about 4.8 million a year. No one has any idea of how many homes are in the shadow market of bank foreclosures and future short sales.

His idea is simple. I call it “the-hair-of-the-dog-strategy”, after the well-known antidote for hangovers. In this case the hair-of-the-dog isn’t more tequila shooters.

It’s more lending.

“We’ve lost two years!” he grimaces. “The throttle for housing is the availability of mortgage money. It used to be the cost of money, but now it is raw availability. Credit scores are down. Credit standards are up. Today, the consumer is in a foxhole, the (home) industry is on its back, and the government is saying we need to tighten down. Worse, if they start forgiving mortgage debt, home prices will drop still more.”

His solution (which a number of others also advocate)?

More lending, not less. And lower interest rates. His basic suggestion: Order the government agencies that now control virtually all mortgage lending to do $1 trillion in new mortgage lending at interest rates like 3 percent.

Here’s his math on the risk and the reward for doing it.

The Rewards. At $200,000 average for each mortgage, that $1 trillion will finance a mixture of 5 million houses.  Some will be re-sales.  Some will be new construction that is sold. And some will be new construction in inventory. The FHA will get paid in fees. The mortgage lenders will get paid for generating the mortgages and servicing them. The realtors will get commissions for selling the houses. And everyone associated with the shelter industry, from carpet makers to Home Depot and Lowes, will benefit from the money being spent on shelter.

Even if this activity was spread over four or five years, it would add enough demand to bring the supply/demand balance of residential real estate back to normal levels— levels that will support stable or rising prices. Castleman, a former marine, summarizes it simply: “We’ve got to get consumers out of their foxholes.”

The Risk. The downside is that some of those loans, even at low interest rates, may go bad. But even that may not be so terrible, according to Castleman’s calculations. If you assume that a whopping 40 percent, of the loans go bad and that the homes are eventually sold for only 60 percent of their mortgage value, the total loss risked is $240 billion.

With total losses for Fannie Mae and Freddie Mac already estimated to reach $400 billion and over $160 billion in losses already booked, Castleman’s idea would be in the same ballpark with what we are facing today, with lenders strangling new lending.

The difference is that there would be an upside.  What we have today is a formula for years of stagnation and homeowner hurt.

If you like this idea, let me remind you of another great but off-the-wall idea for getting the housing market moving. Two years ago economist Gary Shilling offered a brilliant riff on the historical role of our famed “huddled masses”: Give green cards to any foreigner who has cash, wants to move to the United States, and will buy a house.

It’s time to start thinking outside the box.

Filed Under: Government, Taxes & Other Disasters, Mortgages