401(no)(k): Why Retirements Should Not Be Used to Pay Mortgages

The Century Reader: Foreclosure Home for $1.00?

For those of you who are not avid readers of the Detroit News, there was a really well done opinion piece on a new proposal put forward by U.S. Sen. Johnny Isakson, R-Ga., and U.S. Rep. Tom Graves, R-Ga.  The writer for the Detroit News, Brian O’Connor succinctly lays out the proposal as follows:

Right now, if you’re strapped you can take a loan against your 401(k) through your workplace. You have to pay it back within five years with interest, but you’re paying it to yourself. About 85 percent of plans offer loans.

If you’re desperate, 89 percent of plans offer hardship withdrawals. Even though you don’t have to pay the money back, it’s a pretty bad deal: You have to pay income tax on the amount withdrawn and a 10 percent penalty if you’re younger than 59-1/2. For most people, it means at least 25 percent of the money withdrawn goes to penalties and taxes, not to saving a home from the bank.

But here’s where the plan backed by Isakson and Graves fails to the point of uselessness: It allows for outright withdrawals, not loans, but it only waives the 10 percent penalty — you’re still on the hook for taxes, ranging from 15 percent on up to the top bracket of 35 percent.

The plan also limits your withdrawal to a maximum of $50,000 or half of your account balance. So, if you withdrew $50,000 and were in the 25 percent tax bracket, you’d skip a $5,000 penalty but still pay $12,500 in federal tax, plus your state income tax. And unlike taking out a loan, all that money would be due April 15, and it would all go to the tax collector.

O’Connor goes on to point out that 401(k) funds are protected in bankruptcy, which is a point I want to highlight.  Why?  Because if you decide to declare a personal bankruptcy as a way to restart your economic life (which probably means you will lose your home), at least you can hold on to that nest egg in your retirement fund.  That can’t be tapped in bankruptcy to satisfy your creditors.

I’ve already written in a prior blog about my experiences of foreclosure prevention in NYC:  most homeowners are all too willing to run up their credit cards, poach the kid’s college savings fund, dip into their 401(k) and borrow from Aunt Tilly before they give up the home.  This frequently leaves homeowners in a very precarious financial position, and (even worse) frequently does very little to address the underlying economic difficulties in their lives (usually loss of income).  I think it’s just plain bad policy to provide further encouragement to distressed homeowners to act so clearly against their own self interests – especially when lenders and servicers have failed to similarly extend themselves and meet distressed homeowners halfway with timely, accurate and equitable workout solutions.

Personal as Political 

And here’s what really kills me about this proposal:  this solution essentially advocates that homeowners (AKA taxpayers, AKA workers, AKA consumers, AKA citizens) again make a substantial and unprecedented personal sacrifice in an effort to pay back a lender (AKA bank, AKA institution, AKA federal bailout recipient) for a home that is distressed, when that same lender (and the bank that controls it) have frequently failed to provide adequate servicing and support to the homeowner.  This presumed “systemic” response (which as O’Connor notes would really provide very little value over a traditional early 401(k) withdrawal for most people) again puts the burden of attempting to resolve the foreclosure crisis on distressed individuals, and apparently does nothing to address either the problematic history of the mortgage bubble (and all the very messy ways that home mortgages were improperly extended, packaged and securitized), nor the myriad current problems within the mortgage servicing industry (such as problematic denials, improper foreclosure proceedings, and the lack of an effective appeals process).

It just really gets my Irish up.  And I can’t help but point out that the maximum 401(k) withdrawal amount of $50,000 is the exact same amount that many distressed homeowners should have qualified for under the recent Emergency Homeowners’ Loan Program.  In other words, the federal program which suffered from such enormous administrative ponderousness that it only disbursed $432 million of the $1 billion allocated for distressed homeowners should now be replaced by a meager incentive to allow those same distressed homeowners to sack their own retirement savings funds.

That is not really what I would call an effective systemic solution.

For now, let’s hope that the proposal by Isakson and Graves gets all the attention it rightfully deserves. We can do better.

Why Foreclosure Buybacks Are (not) Wrong

Why Foreclosure Buybacks Are (not) Wrong

I happened upon this posting yesterday and I while I try to maintain a position of anti-snarky-ness, I found it very difficult to find any common ground with the perspective that foreclosure buybacks are wrong.

Allow me to explain.

Things are so really ugly out there right now in foreclosure land that some homeowners in Detroit are resorting to an usual strategy:  they appear to be going into default and allowing the bank to foreclose, then purchasing the property back at the foreclosure auction on the courthouse steps (frequently through a family member or similar sympathetic confederate).

The author cites the following:

The Detroit News reports that in the past year “about 200 of nearly 3,700 Detroit properties sold at auction last year that appeared to be bought back by owners, some under the names of relatives or different companies and many for $500. The total in taxes and other debts wiped away was about $1.8 million.”

I should note that the author appears to be a mortgage broker who is no doubt losing possible commissions the to so-called “buyback artists” he discusses in his article.  No doubt he would prefer they all do short sales (ugh).  We’ll leave aside the author’s obvious self-interest for the time being.  Let’s also leave aside the following:

  • That the banks clearly are dying to unload these properties if they are actually selling them for $500 a pop (they’ve essentially written these properties off as worthless);
  • That if they aren’t sold at auction they go into the bank’s REO portfolio where they would likely rot, causing all kinds of mischief for the bank, the neighbors and the city of Detroit; and
  • That if these properties are going to sell, they are going to be bought by somebody – so why not the former owner who actually has a personal stake in the well-being of the property and the community.

Taxes and “other debt” of $1.8 million are being “wiped away” in the auctions, depriving the good citizens of Detroit of much needed municipal revenues.  That is a concern.  While 200 “buybacks” are significant, that’s just over 5% of the total foreclosed housing stock sold at a given auction in Detroit.  Furthermore, according to the very lovely Detroit Drilldown provided by Social Compact, there were a total of 6,259 foreclosures in 2010 (and a total of just under 59,000 since 2005).  We’re talking about 500 properties “bought back” per year, if the ratios hold.

In doing the math, that $1.8 million loss comes out to about $9,000 a property.  Last time I checked, it costs about $10,000 to knock down an abandoned property and turn the foreclosed home into a vacant lot.  Detroit as a city clearly comes out a winner when property owners “buyback” foreclosed properties based on the cost of removal of blighted and abandoned properties alone.

Never Fear, Buybacks Won’t Go Mainstream

I actually think this is a very clever and viable solution for homeowners in unaffordable mortgage products, but it’s a niche solution.  It’s never going to be the solution for the foreclosure crisis.  Why?  Because in order for such a solution to obtain, you need an extremely weak housing market, and very little competition among purchasers.  Markets like this do exist in cities with long-term population decline (like Detroit), but these are the minority of housing markets (despite weak real estate prices across the board), and appear to be fairly limited to “rust belt” cities in the midwest.  And I can say “rust belt” without irony or derision because I was born in Dayton, Ohio.

Sheriff refuses to conduct evictions in Philly.

Furthermore, most homeowners in my experience don’t actually want to risk the credit damage of foreclosure, the trauma and logistical challenges of vacating the home when the sheriff shows up, or the risk of losing the home at auction to another bidder.  While this may be a solution for some, it’s just not going to become the kind of trend the author wants to portend.

They Are All Cheats and Liars

I believe good policy is based on how people think, and not on how people feel.  What the author here is really saying is:  these homeowners are cheating the system.  They are breaking the covenant of the mortgage agreement and taking advantage of weaknesses in the system for their own personal gain.  They are systematically ripping us off, and we deserve to have our rights protected against the likes of these malefactors.

This should sound familiar.  First off, dear reader, I hope it will remind you of claims made about so-called “strategic defaulters” – where underwater mortgage holders were purportedly defaulting on their mortgages, then buying the marked down house a block over and walking away from their initial home.  This did happen, but at nowhere near the scale the punditry might suggest.  In my experience in NYC, I never met a single one of these strategic defaulters.  On the contrary, I met hundreds if not thousands of homeowners who valiantly fought mortgage default by wrecking their 401k’s, poaching the kid’s college savings fund, maxing out the credit cards, and generally robbing Peter to pay Paul.  People, ultimately, really don’t want to lose their homes.

But this should also remind readers that brokers, mortgage originators, banks, servicers, and foreclosure mill attorneys HAVE been systematically taking advantage of the system.  This is not just about “robo-signing,” but also the lack of ability to show standing, poor document handling during modification, and dubious origination practices.  Again, let’s leave aside a whole host of other issues between those who securitized mortgage backed securities or sold credit default swaps against them in their relations with their counterparties.  Those are deep waters and the subject of a soon-to-be-post.

It might be tempting, therefore, to toss “buyback” homeowners and less than scrupulous financial sector actors into the same bucket, or to paint them both with the same black brush.  But I believe there are important differences for “buyback” homeowners:

  • They are not acting out through multiple, serial transactions a pattern of neglect, manipulation or abuse – they are acting instead in (what I would call rational) self-interest on a single transaction that is saving their home;
  • The net outcome of a buyback looks like it’s ultimately of benefit to all parties: banks get rid of a property they don’t want, homeowners get to keep a property they do want, communities avoid an eyesore and keep a neighbor, and cities avoid costly abandoned properties that they then have to deal with at a net loss;
  • Contracts are built to be broken.  That’s why the terms of every contract include elements that dictate what happens when the contract IS broken.  What these homeowners are doing is actually legal.  And intelligent, given their circumstances.   While it’s possible to raise the question of whether such actions should be governed by other terms that make it more difficult or impossible, that is a policy discussion or a matter between contracting parties.  As I hope I make clear above, for public policy purposes buybacks appear to provide a net win for all parties.

So, I don’t buy it that buybacks are wrong.  On the contrary, they appear to me to be a viable solution, if a limited one, and should probably be encouraged by local authorities and advocates where possible.  I would be surprised if we hear a lot more about this issue itself, but it’s as good an opportunity as any to highlight the differences between systematic abuse and practical, strategic revision.

Foreclosure: The Ugly Stepchild of Affordable Housing

NY Daily News: Advocates say funding needed to prevent foreclosures in New York

It’s no surprise to anybody who spends time on affordable housing that single and small multi-family homeownership (defined as 1-4 housing units / home) has never been a big part of housing policy per se.  In spite of all the polemic about the role of Fannie and Freddie in the mortgage crisis, and all the fallout caused by those nasty public and private issuances of mortgage backed securities, the fact that there was a housing bubble does not mean it was the consequence of housing policy.  Quite the contrary – the housing bubble appears to have occurred without any real reference to housing policy.  In spite of calls for more affordable housing by various political leaders (on both sides of the aisle), the housing bubble was clearly the result of economic policy (artificially low interest rates, lack of regulatory oversight) and a global surplus of cash looking for “value” investments in US mortgage securities.

But there is a big reason why single and small multi-family homeownership (S&SMF, for short) has never really risen to the top of the pile in terms of housing policy, and this reason has a direct bearing on the difficulty in finding foreclosure prevention solutions now.

Retail vs. Wholesale:

Most affordable housing (certainly in NYC) is built by large developers as affordable rental housing.  Whether the development is dedicated exclusively for affordable housing, or affordable units are included as part of a much larger development (sometimes as a condition for permission to build at scale, sometimes because the developers want to subsidize a portion of the development), a whole industry is dedicated to this type of affordable housing development.  There was bubble-related speculation in this market as well, but the causes and implications of this are much different (and the subject of another post to come).  It is this industry, working in close coordination with NYC’s Dept of Housing Preservation and Development (as well as other state and federal agencies), that is striving to meet Mayor Bloomberg’s promise of creating or preserving 165,000 units of affordable housing by 2014 (http://on.nyc.gov/pU3Awp).  The goal is laudable and appears achievable.

When it comes to S&SMF, however, city policy has extended no further than some support to assist low-income homebuyers in covering closing costs, or in current efforts by Restored Homes (a city-affiliated nonprofit, www.neighborhoodrestore.com) to acquire foreclosed homes, fix them up and sell them to low- and moderate-income homebuyers.  At best, such efforts have yielded a few thousand homeownership opportunities, and the REO acquisition program has a target of just 100 homes.

Why are affordable rentals so much easier to develop than affordable homeownership opportunities?  Because:

  • Affordable rentals are bigger and taller, and pack a lot more folks in less space, so they cost less per unit to build; homeownership is built one parcel at a time and holds fewer people per square foot, so it costs more to develop.
  • NYC is expensive: it takes more income for individuals to afford even an “affordable” home, so there’s more demand for affordable rentals, which don’t require closing costs or higher monthly income levels.
  • There is enormous demand for affordable rental housing (NYU’s Furman Center put the vacancy rate at a meager 3% in 2008, http://bit.ly/pMMOD8), and while lots of folks would love to own homes, high entry costs keep demand down.
  • There are lots of both nonprofit and for-profit developers of affordable rental housing who specialize in high-density building.  They are a highly organized sector in frequent communication with each other, with public officials, with banks, and with lots of other important stakeholders.  The homeownership sector has relatively few nonprofit partners (such as Neighborhood Housing Services, www.nhsnyc.org), and no organized developer community.
  • The administrative burden of developing housing is much reduced on a per unit basis when you build large, because you can centralize functions for building development, qualifying residents, dealing with repairs, handling inspections and so on.

The elephant in the room in all these considerations is, of course, money.  The low income housing tax credit, the federal section 8 program, state level bond financing programs, city subsidies, banks seeking to meet Community Reinvestment Act requirements – all are much better aligned to invest in rental housing.  While experimentation has taken place to use existing subsidies to encourage homeownership, the high cost of housing in NYC and the barriers noted above have dramatically diminished outcomes and most programs have withered on the vine.

All this is to say that the preponderance of resource and capacity is aimed at rentals, and has been for a long, long time.  It’s a huge and thriving industry, and I believe it’s poised to go through another round of expansion in the very near future. Which leads me to my key point….

OK, now let’s talk about foreclosure.

Crisis?  What crisis?

Every year, thousands of affordable housing developers (again, mostly developers of rental housing) gather for the annual New York State Association for Affordable Housing (NYSAFAH) Conference convening in NYC.  We all pack into the massive ballroom at the Marriott Marquis for speeches and policy talks, a chance to see old friends and make connections.  I love this event, really, and I wholeheartedly support NYSAFAH’s annual policy goals.

NYSAFAH Annual Luncheon at the Marriott Marquis

I spent several hours and heard lots of colleagues (both on stage and off) talking about the challenges of securing public subsidy, the price fluctuations of tax credits, the implications of prevailing wage debates in the state, the latest developer casualties of the down market – all indulging our somewhat ghoulish fascination with the current muddle in our corner of the world.  The thing that bothered me was that not once did foreclosure come up as a topic.  It was not addressed by any panel, not considered in any policy position, not covered in any analysis of current trends.

This bothered me for several reasons, but I’ll cut right to the chase:

Seriously Delinquent Mortgages in NYC

This really gorgeous chart comes courtesy of the Federal Reserve Bank of New York (click here for the link to the FRBNY publication).  As you can see, we’re talking about 29,000 homes currently in foreclosure proceedings, and another 19,000 that are over 90 days delinquent.

So, round numbers, there are almost 50,000 properties where homeowners are currently at risk of displacement.  In addition, let’s assume that another 50,000 tenants in these same properties are equally at risk of displacement (I’m making this guess based on a study by NYU’s Furman Center that’s now a few years old, but that estimates tenant displacement to be about equal to homeowner displacement – check out this really excellent recent update by Josiah Mader at Furman:  http://bit.ly/n1jTWk).

Even allowing for the three years it currently takes to go through a foreclosure proceeding in NYC, we’re talking about some 100,000 residents at risk of displacement today.  We don’t know what this number will be like, although we know that the current sluggish economy is going to continue taking its toll on homeowners (loss of income being the primary reason for mortgage distress).

I believe this number alone has very significant implications for affordable rental housing in NYC.  Remember that 3% vacancy rate that I mentioned earlier?  Even then that number was dropping as pressure built on affordable units in the outer boroughs, and it’s very far below the national average of 10%.

Where will all those displaced folks go?  Many of them will be “recycled” into S&SMF properties that have come through foreclosure into new ownership, but bear in mind that these will now be distressed properties in distressed communities.  Why?  After 3+ years of neglect during the foreclosure proceeding, followed by bank ownership and sale to a speculative purchaser, many of these homes will be converted to strictly rental properties at high risk of illegal conversion, poor maintenance, and distressed tenantry.

Many others will continue to put downward pressure on an already incredibly tight rental market where my NYSAFAH colleagues are looking for opportunities to build and expand.  What does this mean for my development friends as we sit in the Marriott ballroom?  I think it means that we, as a city, are not really ready for the level of residential displacement that is still little more than a trickle.  It means that communities distressed by foreclosures today could become communities distressed by small holder slumlords tomorrow.  It means that those high density neighborhoods where affordable rentals are concentrated (along with the most capable nonprofit partners, and the most robust developer activity) could receive disproportionate attention and resource in comparison to those low density homeowner neighborhoods where such supports are far more fragmented or altogether lacking.

I believe we need to begin developing more aggressive policies today that include the following:

  • A much stronger inspection regime for properties both in foreclosure and post foreclosure, to insure against illegal conversions and other important code and maintenance violations.
  • Greater protections for tenants during and after foreclosure, including outreach to let them know of their rights and obligations.
  • Incentives for new purchasers of foreclosed and distressed properties to keep existing tenants (and even former homeowners) in place, to limit displacement and better insure some personal investment in maintaining the properties.
  • Coordinated dialogue and fresh thinking among developers, policy makers and public officials to understand how our various housing markets could interact for better or worse during this period of substantial displacement.
With all credit to the work that’s been done by many of my colleagues to create a rich environment for affordable housing development in NYC, we must now consider how to invest this talent and capacity into the new frontier of S&SMF foreclosures.  This is an area that has received too little attention for too long, the ugly stepchild of housing policy is not going to go away any time soon.