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Two ways to respond to the foreclosure crisis

By Michael Konczal

Let's discuss two different policy designs for how to fight the worst parts of the ongoing foreclosure crisis, one successful and one not. We'll then discuss a great new report from the National Community Reinvestment Coalition that details many of the best local and state policy responses to the foreclosure crisis.

Los Angeles

The first comes from Los Angeles. Foreclosures are lose-lose-lose situations. They hurt lenders, borrowers and communities. The community losses are devastating; there are the well-documented spillover effects, where foreclosures drive down value of neighboring properties, forcing more properties deeper underwater, depressing economic activity. They also destroy municipality budgets. As an Urban Institute study, "The Impacts of Foreclosures on Families and Communities: A Primer" (May 2009), found, the costs can be high:

At $20,000 a pop, three vacant, unsecured and abandoned properties is the same as a teacher's salary. And that's even before we get to crime and the "broken-window" style disorder that waves of abandoned properties generate in a community. (If you haven't read it again recently or seen it at all, it may be a good time to re-read Alex Kotlowitz's New York Times magazine feature "All Boarded Up," a look at these foreclosure problems for Cleveland written in March of 2009. It could only have gotten worse.)

Given the high economic and social costs, the Los Angeles City Council, led by community activists including Alliance of Californians for
Community Empowerment
and others, as well as city workers who are members of SEIU Local 721 and L.A. Council member Richard Alarcon, did the sensible economic thing: They proposed a tax on abandoned and unkempt properties.

The details: "L.A.’s City Council recently passed a 'foreclosure registry' ordinance, requiring lenders to maintain foreclosed properties or be fined $1,000 per day, up to $100,000 a year. Lenders will have 30 days to fix problems before fines set in."

What a sensible and elegant policy solution. This encourages banks to find suitable negotiations with homeowners to keep people in their homes. It has a serious stick to require banks to actually obey the law when it comes to the destruction of blight in neighborhood.

It works because everyone is well-incentivized to do their jobs; the city will collect money, which it loves to do, if the banks don't comply. Citizens have a means to report blight, which they want to do to keep their neighborhoods well functioning and safe. In fact, cool online innovations like SEIU's "Hoodwinked LA" Web page, which allows citizens to track foreclosed properties to report to city officials, have been created to empower people. And banks will avoid destroying neighborhoods out of neglect lest they pay a tax, which they had no incentive to do previously. The thing practically runs itself.


Compare that to the Home Affordability Modification Program (HAMP). Here Obama's Treasury team took a system that had a terrible design and doubled-down on it. Servicers aren't modifying mortgages. There's an active empirical debate we'll cover next week over whether or not servicers are not modifying mortgages because of information problems or becomes of adverse incentive structure -- or if you don't speak economics, whether or not the servicers are dumb or corrupt. What was meant to be a passive, thin, pass-through vehicle with obvious conflicts of interest now has to actively manage a giant portfolio of troubled mortgages. And they are either unwilling or incapable of acting as a fiduciary for investors and getting mortgages back to being current and working.

What does HAMP do? It gives a lot of money to servicers to nudge them into being slightly nicer with their modifications.  It takes the worse features of the current system and hopes that it'll work with some money greasing it. Unlike the L.A. Tax, this approach does not line up anyone's interests. The servicers are turning down the money; less than 2 percent of HAMP's budget has been spent, and modifications aren't hitting any kind of the numbers they were designed to hit.

And instead of empowering people, it leaves them entirely at the mercy of a mortgage monitoring system that was already falling apart before the crisis, leaving homeowners worse off than they were before they started. And it leaves bankruptcy judges twiddling their thumbs and government officials nothing to do but come up with excuses for why the program isn't as bad as it looks.

States as the next battlegrounds

As people look back at the first two years of the Obama administration, the "liquidate the homeowners" approach of bleeding out foreclosures, protecting bondholders/too-big-to-fail banks and propping up housing prices will probably be remembered as an across-the-board mistake, politically and economically. But the exploding foreclosure fraud crisis and the move by state attorneys general to investigate gives a new opening to push for state- and municipality-based efforts. Some reform-minded state attorneys general survived the elections, some lost. But the battle continues on.

With that in mind, the National Community Reinvestment Coalition released a report, “Rebuilding Communities in Economic Distress: Local Strategies to Sustain Homeownership, Reclaim Vacant Properties, and Promote Community-Based Employment,” (pdf) outlining many of the success stories at the local level from the past several years that community organizers, activists and others have had in fighting the foreclosure crisis.  It covers the Los Angeles efforts at vacant property registration ordinances and taxes to force upkeep mentioned above, the Slum Abatement and Blight Enforcement Response (SABER) Team of Tucson Arizon, a cross-departmental coordination of enforcement and prosecution of slum and blight laws, receivership programs in Baltimore, Maryland, and many, many others.

I was just thinking the other day that I didn't have a resource that compiled many of the local-level policy innovations that are trying to fight the worst parts of the foreclosure crisis, and then someone showed me this report. One would like to see a Democratic administration that backs these local and state efforts in a constructive way now that Congress will shut down -- will we see it?

Mike Konczal is a fellow at the Roosevelt Institute. He blogs about finance, economics and other topics at Rortybomb and New Deal 2.0, and you can follow him on Twitter.

By Michael Konczal  | November 5, 2010; 10:00 AM ET
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The LA solution is so elegant... You can talk morals and the rationality of the lose-lose-lose of foreclosure but loan servicers are obviously not concerned with the justness of the system -- the Mortgage Bankers Association strategically defaulted on their HQ while encouraging homeowners to live up to their obligations.

But more technically, the system has entered a tragedy-of-the-commons-like situation where was is in the decision maker's (loan servicer's) interest for each individual property is not in the interest of the entire community -- including the loan servicer in the medium/long run. So, make it not in the loan servicer's interest in the immediate. Perfect.

I love how it empowers local government and individuals. I am just sad that I don't think that something like that would fly in our state in almost any county or municipality... it is so anti-tax. We just passed a constitutional amendment saying there could be no tax levied on a real estate transfer. It didn't get much coverage and what little it did was focused on Joe the homeowner getting to kept all the gain on his well-maintained suburban home when he sells it... but I would be surprised if banking interests had not been behind that one, no tax can be levied to the transfer from homeowner to bank in foreclosure. I voted against it on principle: we are one of the lowest-tax states in the country, we just went through a brutal round of municipal employees, and on election day a water main on our street burst for the umpteenth time in 10 years because they just keep patching it (and the street) and the main just breaks somewhere else. Not the time to be reducing the options for revenue generation...

Posted by: kcar1 | November 5, 2010 12:15 PM | Report abuse

"Foreclosures are lose-lose-lose situations"
Really? What about for the people that get to buy the homes at market value? What about for the banks that get some portion of their principal back instead of no payments? What about the fairness for the people that have been making their full payments, even though they may be underwater until they knock down some principal? What about for the housing market which is allowed to return to a less manipulated level and function?

Keeping people in "their" homes is not a civil goal for the people that put 0% down and are now not making payments. They are just renters with a tax break. Shut them down.

I had a 5-year ARM, the rate just adjusted downward 3%, thanks to LIBOR being under 1%, slicing a huge amount off of my monthly payment. As long as interest rates are low, we are already getting a huge gift from the Fed, forget Fannie and Freddie.

What we really need is modified bankruptcy and tax laws to get people out of these houses quickly while not totally destroying their credit or forcing them to recognize a cram down as income. A quick reset in values will really make home affordable, meaning we need to spend less to buy new mortgages.

Posted by: staticvars | November 5, 2010 1:44 PM | Report abuse

How come nobody wants to put the original down payment back on the table? Homeowners in foreclosure should get 75% of their original down payment back, OTHERWISE THE DESIRE to foreclose on a homeowner and then put a new homeowner and get their down payment becomes irresistible to the banks.

SEVENTEEN INCOME STREAMS are created when a bank forecloses on a homeowner. And if one adds up the total, it appears to more than pay for the home, while the banks get to keep the home.

Posted by: AlessandroMachi | November 8, 2010 3:19 PM | Report abuse

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