What About the Rental Option?

All the plans we’ve heard to date for solving the housing portion of the financial crisis are focused on keeping people in their homes by reducing the costs of mortgages until even the unemployed can afford one. That’s the kind of populist thinking that got us into this mess in the first place.

Let’s be honest: Not everyone should be a homeowner. Regardless of whom you want to blame for how we got here, some of us are facing mortgage payments we’ll never be able to make even under renegotiated terms and reduced interest rates. Even in what Conservatives call an Ownership Society, those without the cash flow necessary to build equity are better off as tenants rather than be burdened with the debt of ownership.

Instead of the government purchasing bad loans, as Senator McCain once suggested, or buying up the loan derivatives, as the Paulson plan originally intended, or just handing money to financial institutions for them to use for “whatever,” let’s create a program similar to the depression-era Reconstruction Finance Corporation (RFC) to federally fund state and local governments to acquire the underlying properties of defaulted loans at a steep discount and then turn around and rent those homes to the current occupants. Besides, it looks as though it’s going to be impossible to refinance any of the securitized loans. They’ve been bundled, chopped into traunches, then bundled again and there’s no way to figure out who holds which mortgages. (I’ll bet that’s something that won’t be permitted once the dust settles from all of this.) Regardless of who they are, the mortgage holders (lenders, insurers and hedge funds) will feel some of the pain for their indiscretions, but it will stabilize and put a stop to their losses, allowing the credit markets to finally move forward.

People who stand to lose their homes and who would otherwise be out on the street become renters, which of course they should have been all along. This eliminates the problem of those homeowners who continue to pay their mortgages feeling like their neighbors are receiving an unfair bailout. And setting a value on the real estate is far simpler than trying to find the fair price to pay for credit-default swaps on securitized loans. The federal government would set standards for the program and provide oversight.

With an average pre-slump U.S. home price of $215,000 and a 25% discount, $700 billion allows us to acquire nearly four million homes, even including a 10% cost to administer the program. Why fund state and local governments? Because the closer you get to the properties, the better a landlord you can be. Yes, as landlords the cities and states will have to manage and maintain these homes, but that’s much easier at the local level than from Washington. We can learn a lot from both the strengths and weaknesses of the RFC, created in 1932 and rolled into Treasury in 1953.

To make sure our governments don’t stay in the real-estate business for the long term, after a two-year cooling-off period, the homes would first be offered for sale to the then-current occupants, then auctioned randomly over a five-year period to avoid further depressing the market with a sudden glut of even more homes for sale.

We won’t solve the housing crisis so long as we pretend that families who can barely make ends meet can afford the increased burden of building equity. It’s those “affordable” but unrealistic zero-down principal-only loans are what got us into this situation. So long as we pretend that we can make home ownership inexpensive enough for everyone, we’ll never dig our way out of this hole. Allowing people to rent the homes they currently occupy not only keeps roofs over their heads, it’s also simple (as compared to other options) and solves our housing-crisis problems directly. It removes the bad-loan problem from the books of financial instututions without rewarding them for their misconduct.

(Seven weeks ago I blogged a draft of this idea, which I followed up with an op-ed submission to the NY Times. Of course, lacking a Nobel Prize, I wasn’t likely to be successful, but I had to try, right? The above is an updated version of the article I submitted to The Times.)

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