January 26, 2011

Going underwater? Learn to swim

With the housing boom and bust of the last years a fairly new phenomenon has been born, I am talking about 'underwater mortgages'. People were blind and naive to think that the housing market will incessantly go up. Banks, mortgage intermediaries, real estate salesmen, governments and even some economists (that is the most unbelievable part) helped uninformed people think this was true and was going to be for ever after. Of course they all had their own interests in making this fallacy last as long as possible, making the mother of all bubbles grow forever. "Buy a house! It pays by itself" Can you already see the problem with this?

The bubble obviously was busted, it happens inexorably. Real estate prices dropped sharply worldwide, with the typical exception of some highly-demanded residential zones in big cities (but the people owning those houses are usually richer so they do not seem to have problems paying their mortgages religiously). This sharp and unexpected price drop altered the financial plans of lots of middle-low to middle-upper class families, putting them in a situation where they owe more money than the good they financed (their house) is now worth. 

Going for a dive

Some families really have had bad luck with this, they were responsible with their purchase but now they house is simply less valued by the markets now. 
Some owners were not that responsible and went for houses they could not possibly afford in their actual financial situation, they did that with the forecast of their investment/house being worth more and more money every year. Some others went even further by refinancing their mortgage to have some extra income to buy shiny things, withdrawing equity from their ever-growing houses. As you can see, no real money was used in any of the former cases, people were simply believing in the biased predictions and forecasts they were reading everywhere... They are all underwater now.

Learning to swim

So what do you do when your mortgage goes underwater, in the USA you can 'simply' return the keys to your house and go elsewhere to start anew. No questions asked in most of the cases. But that makes the problem for struggling homeowners bigger, as the banks do not want to have houses in their balances, they have to pay taxes for them and they do not help them earn more money. The bank then decides it needs to sell these assets as soon as possible to take them out of their balance, making prices go down again. That, in turn, makes more mortgages go underwater because of the decreasing prices.

What happens if you do not want to start a new life elsewhere or your country's regulation does not let you return the keys and make your debt go away? You keep paying your mortgage religiously and wait for the economic recovery to make the prices go up again. That is when you have a job of course... If you lost your job due to the crisis and you have a mortgage to pay you must learn to swim, nobody is going to throw you a life jacket.
And by learning to swim I mean doing what you have to do to find another job, because there are other jobs, but maybe they are not in the zone you bought your home... That is the main problem with the housing bubble, homeowners are reticent to move for a job. Not only they have their life and their home where they are (we all do) but they have a heavy load over their shoulders, a mortgage. 

Allow me a harsh allegory, today having a mortgage is like swimming with a rock attached to your feet, it makes it quite difficult... But there are is a solution for this. You can tell someone who is on the shore to hold that rock while you swim. You could rent your mortgaged house to cover expenses and go where you can find a job meanwhile. Convincing homeowners that renting is not bad seems the only 'easy' solution to their immobility regarding job search. 


Behave like the strong countries.

Mortgaged homeowners are reluctant to move and that restricts their job-search span seriously. This inability to move, to swim, effectively increases unemployment rates. We named briefly this problem in an earlier post, and now thanks to an IMF paper (PDF)  we can see it plotted in a graph:


From the graph you can extract a crystal clear conclusion, countries with a higher homeownership rate are the ones with higher unemployment. It would be highly inaccurate to say this and stop talking though, as unemployment is much more complex than that; it is affected by the structural problems of the country too, a bad public spending policy, leaning too much in seasonal or uncompetitive economic sectors... But homeownership is an important factor too

Countries with low unemployment rates and strong economies like Switzerland (CHE), Germany (DEU) or Finland (FIN) are also the ones with low homeownership rates. This increases worker's mobility, making them able to fill the gaps in the job market wherever they appear. A quick look to what this countries have in common makes one see that they have not been subsidizing housing or mortgages as the high-unemployment ones do and keep doing. They did put themselves in this ugly position, but if they remove mortgages subsides now they risk making the situation worse, they have a tough call now. 
To lower unemployment rates not only the economy and thus the job market has to get better, but heavy changes are needed in the housing fiscal policy too. 

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