The housing market is correcting, the neutral term for prices declining and foreclosures rising. The correction is the painful hangover after the wild party.

The urge to do something to make things better has taken over at all levels of government. But what to do, and will this will make things better? Various patches and bailouts of borrowers and lenders are in discussion or under way. A mild solution is to encourage borrowers and lenders to work out more affordable payments.

Stronger solutions involve the government buying the loans from lenders and then backing up new loans. These might make things better for some on the receiving end of the assistance. But in the short term and long term, the patches and bailouts may do more harm than good.

The goal of “keeping people in homes” is easy to understand. But this requires “keeping people in loans,” and that’s the problem. These borrowers likely have a home worth less than the mortgage. Prices will not be rising soon, and are likely to continue falling. A foreclosure amounts to cutting one’s losses and not throwing good money after bad. Some borrowers can continue to pay the mortgage but choose to default, showing that some know this is a better option.

This story continues below
Advertisement

Borrowers in trouble have illustrated their precarious finances. Pipes burst, roofs leak and cars break down. Oh, and those utility bills. Living under this financial cloud is not good. Maryland’s newly created Lifeline Refinance Mortgage program allows up to a 50 percent debt-to-income ratio for 30- and 40-year loans.

Traditional underwriting standards of no more than a 36 percent ratio (for borrowers with good credit) suggest this “lifeline” may be the opposite for financially strained households. This program even offers “interest only” loans. The irony of the state brokering “solutions” that look much like the cause of the problem is remarkable.

Homeownership ties people down geographically, curtailing job options for those seeking better employment. In a weak job market, people need more mobility, not less.

Anne Shlay, a sociologist at Temple University, makes a similar and compelling argument. She finds that the research shows that for low-income households and neighborhoods, homeownership does not provide the claimed benefits to which policymakers falsely cling. False beliefs are not the basis for good policy.

As Maryland spends its nearly $1 million grant from Congress for homeownership counseling, Marylanders should hope the objective is not to do whatever it takes to keep people in loans when the best advice for many may be to move to rental housing. With renting, the monthly payment is lower, and the pipes and roof are the landlord’s problem. Facilitation of short sales, where the lender takes what the house is now worth from a new buyer rather than the higher loan balance, avoids foreclosure and more quickly gets the house in a new owner’s hands.

There is even a silver lining to this dark cloud. Allowing the downward price adjustment to reverse the excesses of the housing bubble is a fast-acting affordable housing policy that will benefit millions of future homeowners.

No one seems to be speaking for potential homeowners who are closed out of the market with existing inflated prices. Given the choice between a return to prices from a few years ago over two or three years rather than a decade will get the housing market back to normal sooner. Patches and bailouts slow that return.

What are the lessons to learn from the mortgage mess? Borrowers need to be more financially literate and responsible. Regulators should assume borrowers are not. Lenders should return to underwriting standards such as a decent credit history, verifiable income, sustainable debt-to-income ratios and maybe even a down payment. Regulators should also devote attention to that return in spite of the distraction of creating patches and bailouts.

Experience is a harsh teacher. Bailing out lenders and borrowers will shield some from the cost of their mistakes. Unfortunately, the cost of this is not learning our lessons, making it likely that we repeat the mistakes that got us into the mess in the first place.

Douglas Lamdin is a professor of economics at UMBC. His e-mail address

is lamdin@umbc.edu.