Tuesday, May 27, 2008

Own-to-rent, Part II

Megan McArdle offers a number of objections to the "own-to-rent" plan, which I defended earlier. Her opposition seems to be mostly to the particulars of the plan, whereas I like own-to-rent as an idea (I think it gets the incentives right). I agree with some of her objections, but I think she gets a couple things wrong (which I'll address below). First, here are her objections:

1) What is the "fair market rent" to be determined by an "independent appraiser" on a 90% empty exurban development without the legal minimum sales to form a homeowner's association? 2) The tenants may be willing to invest in upkeep, but who fixes the plumbing when it breaks? The servicers are not rental agents. Moreover, they have no legal ability to become rental agents under their contracts. There is no entity in the position to take the role of landlord to these people. This is seen as the biggest--nay, insurmountable--obstacle. The only way this would work is if the government took possession of the homes, i.e. gigantic government bailouts. 3) There will be considerable political pressure on the "independent appraisers" to keep the fair market rental value down, handing the banks a loss. 4) Most of the people with the really problematic loans probably can't afford to rent their house, either. 5) To the extent that they could afford the rents--i.e. that houses were massively overvalued--you're putting a big capital loss on the bank's balance sheet and keeping it there, year after year, rather than writing it off. 6) The worst hit homes are in "developing areas" that are now rapidly "undeveloping", meaning that there aren't adequate services there. Encouraging people to stay in those areas is not, in the long run, a good idea. It also isn't a good idea to make people less mobile during an economic downturn. 7) Some of the worst hit homes are in areas where the tax base will not support the cost of basic services to the developments that the government is encouraging people to stay in. 8) Who gets to vote on the board of the homeowner's association? Are various servicers supposed to send people to represent their interests? Who pays the property taxes? You're sticking banks with a long term asset that neither they nor the servicers are set up to handle at all. 9) Keeping bad assets on bank books for years and years was, many argue, the main factor that made Japan's economy so festive in the 1990s. We should probably not repeat their error.
I certainly agree with item 4 -- many people who can't afford the mortgage payments also can't afford the rent -- but I don't think that's a reason to oppose the own-to-rent plan. It just means that the plan will have a limited impact. If a homeowner won't be able to afford the rent, then he won't petition the judge to allow him to stay as a renter. The majority of homeowners who actually file a petition under the own-to-rent plan will be able to afford the rent. If only a few homeowners can afford the rent, then only a few homeowners will file an own-to-rent petition. I also agree with some of item 8 -- banks/servicers shouldn't bear all the costs of transitioning from a mortgagor-mortgagee relationship to a landlord-tenant relationship. (e.g., hiring a rental property manager). The costs should either be shared by both parties, or borne entirely by the homeowner. I disagree, however, with the following: Item 1: Determining the fair market rent of a house in a 90% empty subdivision is obviously difficult, but there's a reason for that. If state law requires a minimum number of sales to create a homeowners' association (most states don't), and there haven't been enough sales, then the appraiser will determine the fair market rent under the assumption that the restrictive covenants aren't applicable to the unsold houses. In other words, the appraisal will be made with the assumption that the house isn't part of a homeowners association. Item 2: I don't understand why McArdle thinks this problem is so insurmountable. Servicers could easily be required to hire rental property managers to serve as landlords. As I stated above, I'd have no problem with forcing the homeowners to bear some of these costs. As for the legality of servicers becoming rental agents, that's a purely contractual issue. Contracts can be altered. Homeowners also have no legal ability to become renters under their contracts, but the whole point of the own-to-rent plan is to allow judges to alter their contracts. The own-to-rent plan could just require judges to also alter the terms of the contract to allow mortgage services to become rental agents. Item 3: Yes, there will be considerable political pressure on the independent appraisers to screw the banks, but that's why they're independent appraisers. Items 6 & 7: If an area truly doesn't have adequate services (or the tax base to support adequate services), then homeowners in that area won't petition the judge to let him stay there as renters. The "undeveloping" areas will thus be allowed to undevelop. The government wouldn't be encouraging peope to do the wrong thing -- allowing homeowners to stay in undeveloping areas isn't the same thing as encouraging them to stay there. The government also wouldn't be "making" people less mobile; people would be choosing to become less mobile. As I noted at the outset, I think rent-to-own is a good idea, in the sense that it gets the incentives right. It's possible that there are problems with implementation that are big enough to make the whole plan not worth it. But I haven't seen a problem that's a deal-breaker just yet.

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