This first appeared on the business blog of The Atlantic.
Dear Treasury Secretary Geithner,
First, kudos on your decision to stay on for the rest of your boss's term. I know Goldman is aching to get you on board, but you'll have plenty of time to make money when you're in your 50s. Now that you've committed to another year, let's talk for a minute about one of the most important problems you face: how to fix the housing market.
I'm glad to see that the Treasury has recognized two key facts about the housing market. For starters, the economic recovery won't take off until housing has hit bottom and begun to rebound. And as far as what Washington has done to try to fix the market up to now, none of it's working.
What Isn't Helping
Let's learn from those lessons, shall we?
Lesson #1: Be Aggressive -- Little Carrots Don't Work
Your Home Affordable Modification Program ("HAMP") had so much promise. It sought to prevent between 7 and 9 million foreclosures! That was ambitious, and well, it won't even come close. You guys will struggle to break a million permanent modifications.
Honestly, I was a little surprised at just how poorly the program performed. When the details came out, I thought that servicers would jump at the opportunity to get free money from the government to modify mortgages that would just have ended in foreclosure anyway. But it turns out that the carrots you offered weren't big enough. So whatever action you take, it must be aggressive.
Lesson #2: Stop Trying to Prevent Foreclosures -- Mortgage Modifications Aren't Working
In fact, let's take this a step further: mortgage modifications are turning out to be a huge headache. Banks and servicers are barely cooperating. And once you manage to find a handful of borrowers who even qualify, one in four is re-defaulting.
I know what you're thinking: but what about principal reduction? That's the key to sustainable mortgage modifications, right? In theory, yes. But in practice banks and servicers hate them. They don't want to incur a big, immediate loss by writing down a mortgage. They also worry about the slippery slope effect, where Joe and Jane want a principal write-down because their neighbors Bob and Barbara got one.
If servicers are determined to foreclose, then it isn't easy to change their minds. But you can work with that.
Lesson #3: Ignore Consumers -- They Can't Fix This Problem
Remember that home buying credit? Yeah, it didn't work out so well. Home sales rose for about a year, then they plummeted and prices began to fall again. The problem is that consumers aren't in any position to fix the problem, so you just pulled forward a little bit of future demand. Most people who can qualify for and afford to own a home already have one at this point. To clear out housing inventory, you'll need to rely on people who have cash to spend. Most Americans don't.
Lesson #4: Stop Pretending You Control Fannie and Freddie -- You Don't
What about the idea that maybe Fannie and Freddie could take these foreclosures and rent them out? First of all, Fannie and Freddie's very job -- what they developed decades of "expertise" doing -- was to manage mortgage risk. We all know how that turned out. Do we really want them to take on something as foreign as the role of landlord?
And you've got another problem: you can't tell those guys what to do. I mean, you can try, since you kind of own them. But your coercive powers aren't working out so well. After all, they refuse to participate in your principal reduction program. If you had any real control over them, then you would have forced them do so. So even if they go along with this whole foreclosure rental idea, do you really trust them to look out for their new tenants without your oversight?
Help the Private Market to Work
But you were actually on the right track there with the whole foreclosure-rental idea. We know two things about the housing market. First, the distressed inventory is huge and growing. Second, we're going to see lots of rental demand as more Americans leave homeownership behind, which will push up prices and make renting less affordable. This is the solution to both of those problems.
You've got to get more investors into the game. They see these distressed properties and have a few reactions. Initially, they're probably disgusted by the condition of some of these homes and don't want to invest more money in their renovation. But even if a property is in good condition, investors worry about the market's downside risk. Until home prices hit a firm bottom, many will avoid buying.
So give these investors big, tangible reasons to take on that risk. Here are a few ways to encourage them to purchase short sales and foreclosed homes and convert them into rentals:
Idea #1: No Taxes on Rental Income for Five Years
Is there anything better than making money tax free? Make investors a deal: if you guys buy distressed properties from now through 2015, you do not have to pay income taxes on your rental profits in the five years that follow.
Sure, that might cost the Treasury some tax revenue. But many of these properties are going to remain unproductive over this period anyway. If they aren't purchased and converted into rentals, then you wouldn't have received any income taxes from their potential rental income.
Idea #2: Allow Crazy Flexibility with Rental Property Improvement Tax Deduction
Obviously, you want these investors to put money into renovating these properties to get them up to code and make them more livable for their tenants. And home improvement projects also have a delightful side benefit: they'll create some desperately needed construction jobs.
But here's the problem: if you follow Idea #1, then these investors already won't be paying income taxes on their property, so any upfront home improvement expense deductions won't have much of an impact. Instead, allow these investors to claim home improvement depreciation expenses in whatever way they like -- all at once or gradually -- over the next decade. That way they could lower their future taxes as well by a little. Again, this would apply to properties purchased between now and through 2015.
Idea #3: Exempt These Investors from Real Estate Taxes through 2015
Those first two ideas might be enough to encourage investors to buy, rehabilitate, and rent lots of distressed properties. But just in case they need an extra nudge, exempt them from real estate taxes.
Yes, it's true: real estate taxes are levied on a state-by-state basis. But here's where the Treasury comes in: you reimburse the investors for the real estate taxes paid on properties purchased and used as rentals through 2015. Yes, this one would cost some money, and I know Uncle Sam is broke. But I think there's some possibility that you can get Republicans to go along here. Most of them have never met a tax break they didn't like. And its cost would be limited.
These are just a few ideas I thought of as ways to encourage investors to buy up the millions of distressed properties and convert them into rental properties. I'd bet you can think of some more. The key here is that the government would keep its distance from the housing market by merely encouraging the market to do what it's fated to do anyway -- just a little more quickly. We know that we're in for a future where more investors rent out once-distressed properties. Why not get there faster so that the economy can begin to recover that much sooner?
Thank you for your time, and I'll see you at the next blogger roundtable.
Daniel Indiviglio is an associate editor at The Atlantic, where he writes about the intersection of business, finance, economics, and politics. Prior to joining The Atlantic, he wrote for Forbes. He also worked as an investment banker and a consultant.