A Note on Short Sales

Back in September, I noted that Treasury was planning to encourage short sales.

In todays New York Times, there is an interesting comment in a larger story on why the loan modification program is not working.

In late November, with scant public disclosure, the Treasury Department started
the Foreclosure Alternatives Program, through which it will encourage
arrangements that result in distressed borrowers surrendering their homes. The
program will pay incentives to mortgage companies that allow homeowners to sell
properties for less than they owe on their mortgages — short sales, in real
estate parlance. The government will also pay incentives to mortgage companies
that allow delinquent borrowers to hand over their deeds in lieu of foreclosing.

I have to wonder if the current "homeowner" could actually afford their house at the short sale price (below their current mortgage balance). I think of someone in the Valley with a $300,000 mortgage on a house currently worth $150,000. However, they can't get their principal reduced to $150,000, but it sounds like the government will encourage a bank to do a short sale so that someone else can own the house for $150,000.

I have a hard time figuring out how this is better for the economy than a serious principal reduction program. I guess it's better for real estate agents as transactions = commissions. But it also damages property, neighborhoods, and families.

I think it is much better to attack the real estate situation through supply solutions to prevent foreclosures. The need for these government programs goes away once the "underwater" problem is eventually solved. Instead, we continue to use demand side alternatves to prop up prices (tax credits, artificially low mortgage rates) which are very costly (but hidden from view) and very hard to take away once the need is over. [Note how the first time homebuyer credit was expanded to "move up" buyers when it was renewed.]