The Flying Wallenda Economy
Americans are about to fall off the wealth ladder again — will we stop it this time?
April 5th, 1928 — the crowd attending the Ringling Brothers and Barnum & Bailey circus at Madison Square Garden was blown away. That day, an Austro-Hungarian family achieved instant fame, and a 15-minute standing ovation, for performing daredevil high-wire acts with no safety net. They became known as the Flying Wallendas.
Today, the average American household performs a month-to-month high-wire act with its finances. While this takes place over an economic safety net, there is a catch. The net has holes in it, and any slip can be fatal to household wealth.
Home equity is the largest source of household wealth for American households. After the 2008 crisis, roughly 10 million homes were lost to foreclosure sales — a surprisingly large number had positive equity. One study showed that between 2011 and 2013, 27% to 45% of foreclosed homeowners had positive equity i.e. they were not underwater. Here is what happened next.
The total value of equity in American homes doubled to surpass pre-crisis levels; reaching $19 trillion at the end of 2019, from a low of $8 trillion in 2012. In a classic one-two-punch, those who lost their homes saw wealth destroyed and were then excluded from the wealth rebuilding process (see chart). The average family does not own a stock portfolio, stakes in private equity funds or venture investments — meaning they also failed to participate in the extraordinary appreciation of financial assets over the last decade.
To rub more salt into the wound:
· Credit scores were damaged, in some cases irreparably
· Inability to borrow against the home foreclosed other economic actions such as starting a new business, or funding a child’s education
· Re-accessing the housing market — the nation’s wealth engine — proved hard or impossible
· Many suffered other social, mental and medical problems — some still do
A sudden loss of income, combined with insufficient savings, led to a massive loss of wealth and a huge setback in economic momentum for the typical American family. In case anyone is wondering, this did little to advance the cause of wealth equality in the US. In what has become an all too familiar result, the setback disproportionately affected minorities.
You might assume we learned from that crisis. Surely, people had to be worried about an event that could again wipe out homeowner balance sheets. We all read the reports that 4 in 10 Americans did not have $400 saved for an emergency — what would happen if there was another sudden stop in income? Someone must have worked on a solution in case it happened again.
Enter COVID-19.
We do a lot more handwashing these days. Hold up both hands. Three of your fingers represent the number of households (out of ten) that cited struggles paying their mortgage in 2019. That is before COVID-19, when the unemployment rate was 4% — it is now around 11%.
According to the latest Black Knight Data, 723,000 homeowners became past due on their mortgages in May, pushing the national delinquency rate to its highest level in 8.5 years. There are now 4.3 million homeowners past due on their mortgages. This is up from 2 million at the end of March — in other words more than double. Households have benefited from stimulus payments and increased unemployment insurance, but these programs are not meant to continue forever.
The government has already imposed a moratorium on foreclosures for agency mortgages. On the private mortgage side, banks have played the role of good citizen, allowing homeowners to defer payments. But, there are two things to bear in mind. First, the Coronavirus is not done ravaging the economy; as we have seen unless States can reopen responsibly, parts of their economies will have to be shut all over again. Second, deferments do not represent loan forgiveness; they must be repaid at some point. How soon lost jobs come back is anybody’s guess, but it is safe to say that without a restoration of incomes it will be tough for many to make full monthly payments when they kick in.
It seems inevitable that some form of direct assistance will be coming from Treasury, with indirect assistance from the Fed. Our economy — the hot start-up, record breaking S&P, trillion-dollar valuations economy — is permanently hooked up to a defibrillator that is activated every ten years (see chart).
There is an alternative. First, we need to start thinking in ‘automatic stabilizer’ terms and replace the current reactionary mindset. A solution that prevents the loss of a home to forced sale, should be available to a qualified delinquent homeowner that cannot self-cure — crisis or no crisis. Second, we know what works from the past — principal reductions that reduce the monthly mortgage payment. Third, a permanent fund should be available to create these reductions — in exchange for the reducing the home’s mortgage balance, the fund retains a stake in the home value. If the home appreciates over time, the fund does well. If it falls in value, the fund loses out. Assuming house prices maintain their long-term trendline, the fund — which would be exposed to many homes all over America — should be fine (see chart above) Fourth, proceeds from the future sale of the home, should be recycled to assist other homeowners. Fifth, any solution must be simple to understand and fair, given the risk — prior financial sector forays into household balance sheets have led to well-documented issues. Homeowners, advocacy groups, and regulators will be understandably wary of overly complex structures. Lastly, we must be able to measure whether the solution benefited the homeowner in the long run compared to the next best alternative. The immediate effect is that the homeowner stays put, with a mortgage that is manageable. There is no foreclosure sale — there are no closing or other transaction costs, no relocation costs, no need to find new schools. Most importantly the homeowner retains some equity exposure to the home.
Implementation will require alignment of incentives among all the actors in the system. Certain current options have lopsided incentives, benefiting one player at the expense of everybody else. The right solution requires collaboration and leverages prior successful programs. Many housing professionals we have met, from housing counselors to loss mitigation experts have seen almost everything that has come before. Some have successfully implemented the types of interventions required — that experience is valuable. The emergence of companies addressing household savings through education and technology, advances in the use of data to make better decisions, smarter valuation models, and a better understanding of delinquency issues post the 2008 crisis, means a better solution is achievable.
A safety net is there to catch the acrobat in the event of a fall. Ours has holes in it and if you fall through one, you will likely get hurt. Thanks to the EMTs at Treasury and the Fed, you may not die — but you will have to learn to walk all over again. We must work on a better way.
Chika Okereke is a finance professional and co- founder of an organization focused on keeping Americans in their homes — this time.
