The True Cause of the Foreclosure Crisis

The Source of the Foreclosure Crisis

The foreclosure epidemic is ongoing. We Chicagoans have personal experience with this. Thousands of buildings are boarded up and vacant on the West and South sides. Paying tenants are actually evicted just because banks don't have proper property management faculties. Vacant properties sit decaying and ill-maintained.

As the city and county consider reasonable proposals, such as maintenance crackdowns and prevention of sudden eviction for paying tenants in a foreclosed building, and unreasonable proposals, such as eminent domain and taxpayer dollars to free property owners of privately accumulated debt, it may be helpful to consider the source of this problem.

Bear in mind the difference between this economic downturn and downturns in the early 2000s, in the early 90s, and before. The difference in number of foreclosures can be explained by the sheer size of the burst bubble, which had been growing over the last several economic cycles. But what is new this time around is the time that foreclosures spend on the market, idling empty and unused.

Remember that in 2008-2009 the banking system was imploding, and would have collapsed without massive portions of taxpayers' money. These actions were unprecedented, and are just the actions that differentiate this downturn from the rest of them. The relationship between unprecedented bailouts and an unprecedented foreclosure crisis becomes more obvious after considering the unfettered market's method of clearing bad loans.

The bailouts saved the banks from insolvency, bankruptcy, and liquidation. But let us consider what would have happened were it not for these egregious and outrageous bailouts. When a company enters bankruptcy, its assets do not disappear. Its employees do not necessarily lose their jobs. Its factories do not shut down. Rather, a bankruptcy judge is entrusted with the authority to help the company emerge from bankruptcy by selling some of its assets and restructuring its debt, including liquidating some debt by forcing investor haircuts. If the company cannot emerge from bankruptcy this way, then its assets are liquidated and the holders of its debt are returned as much of their capital as possible.

With the bailouts and a rule in Dodd-Frank, banks are allowed to pretend to be solvent based on loans which are years in default but never marked down, and assets that remain marked at old inflated values. If these banks were allowed to go belly up and forced to mark their loans and assets at true value, then they would go to bankruptcy court, be forced to foreclose on all the loans that are non-performing (bringing a glut of supply in to the market and dropping the price to real value) and in all likelihood sell their performing and struggling loans and repossessed assets for whatever they would bring (i.e. fire sale). What this means is that the new owners of the loans are not hurt in the same way as the old if the loans stop performing (the debt is already written down and forced out of the system), severing this repeating negative feedback cycle we're in. These new owners would be more willing to renegotiate loans with homeowners. Further, assets more swiftly marked to true book value, or sold for whatever they bring, would swiftly crater in price, avoiding this many-years-long torturous drop and quickly finding buyers at the bottom, allowing the true, bad-debt-free recovery to begin.

Also note that if the FED were not setting interest rates at artificially low levels then assets would drop even further in price and swiftly attract equity capital.


So take notice that this kind of depression is not naturally caused. Although this is not a problem caused by homeowners, who are really not at fault, eminent domain will not solve the problem (just suck up public money and destroy property rights). To end the foreclosure crisis end the bailouts and END THE FED!

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