The Moral Dilemma: Who Should Be Bailed Out in the Housing Bust

There has been a lot of discussion lately in the business press about who should be bailed out in the housing bust.

The Fed is bailing out investment banks (ala Bear Stearns.) But many analysts believe it won’t be enough and that the government will have to actively intervene in the housing market. There are several choices for the intervention, including these:

1. The government can mandate that banks simply write off the excess mortgages. Basically, if you bought a house two years ago for $700,000 but now it’s “worth” $500,000, the bank would write off the $200,000- so the homeowner isn’t on the hook for the larger amount.

2. The government could buy out mortgages directly. Some aspects of this plan have the government “loaning” 10% of the house’s “value” to the homeowner so that they have equity in the house. The loan will be low interest and must be paid back- over time, of course.

Not sure what each of these will do to “save” the housing market. If you don’t allow prices to come down, then it cannot correct. Housing prices are simply unaffordable compared to incomes.

How many of you are paying more than 30% of your income towards housing costs?

Me too. I’m raising my hand.

That is historically abnormal. Imagine making $80,000 a year and buying a home for $160,000. That used to be the norm in most parts of the United States. Until it gets back to “normal ratios” in most parts of the country, the housing bust won’t be over.

The question is increasingly turning to: who should get bailed out?

Obviously, the investor buying five houses or condos shouldn’t be bailed out. But if that investor goes into foreclosure, doesn’t that foreclosure bring down home prices in that neighborhood or building all the same as a foreclosure by a non-investor? Of course it does.

And what about foreclosures on upper income homeowners. It isn’t just the subprimes which are going down. Increasingly, I’m seeing foreclosures on million dollar homes.

Take this house in Glencoe, Illinois, an extremely upscale suburb north of Chicago. Million dollar homes are the norm in Glencoe. The median household income is $164,000.

It’s a new construction home that was sold in February 2006 for $1.89 million. It has been on the rental market for $6,000 a month.

It’s a 4 bedroom, 4.5 bath home.

It recently went into foreclosure for $1,778,574.

Should this homeowner be offered help from the government?

It will be interesting going forward. The cries for a full-fledged bailout are growing as the number of foreclosures rises to records in some parts of the country.

The moral hazard is great. But the risk of doing nothing could be greater.