Where do zombies come from?

So here's a new one - the problem of "zombie properties" - a name that seems to designed to obscure rather than illuminate. An entire front page article in this week in the  Journal Sentinel yielded almost no information. Why are there 400 houses in foreclosure that no one wants? The article treats this as a mystery. But that can't be.

Here's the problem. Banks lend money to people to buy houses and they do not repay the loan. The houses go into foreclosure but the process takes forever and in the meantime the properties are left to deteriorate and this causes problems in the neighborhood.

One can imagine two contending explanations. The first is that the whole lending process became too complicated. A bunch of hubristic whiz kids thought they could eliminate risk through algorithms rather than traditional tools like underwriting and requiring down payments. This involved creating a complicated ownership structure for packaged loans - so no one would be exposed to excessive risk - that is hard to unravel. For these inner city properties, where the homeowners have the least to lose by walking away and the economics of rehabilitation and resale are the toughest, this leads to homes where not only the owner but the very project of foreclosure, rehabilitation and resale is underwater. At some point, it is literally in no one's interest to reclaim the house and it is razed.

My guess is that there is some truth in this, but it is a second order explanation. How did it happen in the first place?

Here's a possible answer. We don't need concepts like the living dead to explain this. Indeed, there is a sense in which the  metaphor is exactly wrong. The problem is not that these properties refuse to die but that there are truly and completely dead, yet maintained on life support. They are victims of the fiction that they still belong to the people that bought them. Legally, they do. Economically, they don't and may never have.

On this view, the problem is that there are no real property interests in these homes. The owners don't have one because they probably paid little down and, in any event, have no equity interests in the property. In a misguided attempt to promote home ownership, people were encouraged to buy properties that they not only couldn't afford but in which they had nothing to lose. This was not home ownership in the real sense; it was speculation for those who could least afford it.

The lenders don't have a property interest because they required almost nothing down and lent to people who couldn't really afford the home.  As a result, they can't hope to get their money back through foreclosure and resale. Although you might expect the bank to move to cut its losses, the cumbersome nature of the foreclosure process - full of procedural requirements to protect the consumer - raise the transactional costs of recovering the property. It doesn't take long - foreclosed properties are notoriously abused by "owners" with no real interest to them - before many of these properties may not be worth reclaiming. While the city's Department of Neighborhood Services may not understand why the lenders don't figure out how to move faster to recover the properties, it's really not that hard to figure out.

I understand that we are supposed to chalk this all up to greed, but there are problems with that. It is not a good strategy - if you want to accumulate wealth beyond the dreams of avarice - to lend money to people who can't pay it back. While the desire to make money in a booming market can cloud one's judgment about the creditworthiness of a debtor, that's not all that was going on here.

Part of the problem is the government encouraged this type of lending. It threatened lenders with enforcement actions if they were "too strict" and imposed obligations to affirmatively further affordable housing. (Remember Barney Frank's infamous inclination to "roll the dice" on affordable housing?) Even when there was no legal requirement to provide affordable housing a lot of lenders found it expedient to accommodate organized pressure to make such loans - just as it is ofter easier today to pay tribute to activists for "sustainability" and "diversity."

To be sure, unscrupulous originators took advantage but there had to be something - a willingness to make subprime loans with insufficient collateral -  for them to take advantage of in the first place. And, while the housing collapse was limited to this segment of the market, it is in this segment of the market that a collapse in values is most likely to lead to houses that not literally no one wants. Perhaps there are zombie homes being razed in Mequon and Brookfield, but I haven't yet heard of them.

If this second hypothesis is true, we have quite the irony.

These were policies that left-wing community organizers organizations and liberal politicians supported. Like Mary Shelley's Frankenstein was a product of scientific hubris gone wrong, the zombie properties are of their own making. "Organizing" does not make what won't work viable.

My guess is that the preferred solution of the left wing organizations like Common Ground would be to try to somehow - through litigation or legislation or negotiation - get the banks to throw good money after bad. Some form of reinvestment in these properties - perhaps subsidized - may be warranted but you have to understand the cost of doing so. Making the banks responsible for neighborhood decline is likely to keep the banks out of the neighborhood from now on. Once bitten, twice shy. Selling homes to people who still can't afford them and who will still be required to put little or no money down will work no better this time than it did before. There needs to be another model - one that requires homeowners to have more of a stake in a neighborhood. That will require demanding more.

But before you get there, someone has to reacquire the properties. It seems like the city and banks are playing a game of chicken. I think I know who'll win that.

Cross posted at Purple Wisconsin.