Debating for the underwater and underemployed

This article evaluates two reports which consider the impact mortgage loan modifications have on a negative equity homeowner’s ability to relocate and find employment.

Do mortgage modifications drive unemployment? There are two camps out there debating the question.

The affirmative: “Modifications are bad”

A recent paper released by UCLA is of the camp arguing mortgage modifications perpetuate rising unemployment rates. Loan modifications, which reduce an underwater homeowner’s monthly mortgage payments to a lower percentage of his monthly income, give homeowners the impetus to stay put on their negative equity properties, the paper states. This arrangement is a poor choice by negative equity homeowners since it reduces their ability to sell – and thus their mobility – and prevents them from relocating to labor markets with better job opportunities. Think: throwing good money after bad.

Loan modifications for homeowners can add 0.5% to the unemployment rate within ten months and continue the rate at that level for 30 months. This house-lock condition caused by loan modifications has contributed to the current slower-than-average recovery. [For more information on the relationship between modifications and unemployment, see the UCLA paper Labor Market Dysfunction During the Great Recession.]

The opposition: “Modifications make no difference”

The camp on the other side of the debate insists there is no association between mortgage modifications and unemployment. A paper released by the Federal Reserve Bank of Minneapolis (FRBM) echoes this camp’s belief, suggesting negative equity homeowners are just as likely to move as positive equity homeowners.

It also notes a rational reality that extreme negative equity homeowners are the most mobile of homeowners since the inverted loan-to-value ratio (LTV) decreases the likelihood of prices recovering enough in time to recapture lost value. [For more information on the lack of correlation between negative equity and homeowner mobility, see the FRBM paper Negative Equity Does Not Reduce Homeowners’ Mobility.]

The concluding remarks: “It’s complicated”

Neither the affirming nor the opposing arguments are conclusive statements about the relationship between real estate and the labor market.

First consider the UCLA argument in light of the 42% decline in mortgage modifications nationally in the first half of 2011 compared to first half 2010. [For more information on the decline in mortgage modifications, see the August 2011 first tuesday article, Loan modifications walk the plank, California homeowners don’t have to follow and the May 2011 first tuesday article, Permanent loan modification refusals coming to a location near you!.]

Next note a poll which we here at first tuesday conducted to gauge what our readers are seeing in terms of the modifications being made this year in California. What the poll indicates is only around 25% of the readers who voted personally knew someone who got a modification. [For more information on who is seeing modifications in California, see the first tuesday poll, Do you personally know any homeowners who received a permanent mortgage loan modification this year?]

So based on this modifications-affect-jobs theory, employment in California should have improved since there are less modifications this year and our readers confirmed modifications are not skyrocketing off the charts.

So answer this: Why does unemployment continue to linger near levels from one year ago?

This tells us something else is at work besides reduced (or non-existent) modifications. The bigger reason for California’s unemployment and the underwater homeowner’s inability to sell is really quite simple: lack of jobs. The government must make the first move to add jobs to the economy. Jobs will not only trigger the real estate market recovery but it will boost consumer confidence and encourage businesses to create jobs and hire. [For more information on the reason for California’s lack of job growth, see the August 2011 first tuesday article, Jobs are scarce whether or not you can sell your home.]

The final addendum: “But there’s a remedy”

The modification-unemployment debate, though not characterized by fully cogent arguments, poses an important issue which begs for attention: What is an underwater and unemployed (or underemployed) homeowner to do?

In California, we have roughly 1,350,000 fewer employed individuals today than at the peak of employment in December 2007. State unemployment stands at a frightening 12.4% as of July 2011, and another 10-15% of our population are willing to work but have given up the present fruitless task of looking for a job. [For more information on California’s unemployment, see the first tuesday Market Chart, Reeling from California’s lack of jobs.]

These work-seeking masses may look towards loan modifications as an exit strategy, however modifications at best only relieve distressed homeowners by temporarily reducing their mortgage payment – aspirin for the chronically ill. At the end of the day the homeowner is still deep in debt beyond the value of his balance-sheet assets, that is unless the modification just happened to include a principal reduction, or better yet, a full cramdown to the home’s current value (alas, if only).

Modifications tempt underwater homeowners who see the mirage of unending real estate price appreciation wipe out the excessive debt on their negative-equity home, which is most certainly a bad bet. A negative equity property simply does not generate net income or savings. (Ever wonder why it’s called “negative equity?”) [For more information on the use of homeownership as a lucrative investment, see the August 2011 first tuesday article, Homeownership: a piggy bank investment.]

Underwater homeowners still able to pay their negative equity mortgages and thus do not qualify for a short payoff on the sale of their home at a price less than the mortgage amount (read: short sale) have choices when it comes to dealing with their stiff-necked mortgage lender:

• if their loan-to-value ratio (LTV) is below 125%: check the state of their net worth using a balance sheet in order to determine whether the lender will qualify them as a hardship case on an application for modification (or a short payoff); or
• if the LTV exceeds 125% or they do not otherwise qualify for a modification: exercise their right in California to strategically default, stay put and save the money no longer spent on mortgage payments. Then, when the home is sold at a foreclosure sale some twelve months later, they can rent a comparable home at a greatly reduced monthly payment and save the remainder or spend it on goods and services, all of which will improve their standard of living and California’s economy in the process. [For more information on how brokers and agents can help negative equity homeowners, see the April 2010 first tuesday article, The underwater homeowner, his future and his agent: a balance sheet reality check, Part I and Part II.]