On one of many flights this week I was asked the question, “what would you do with the $700 billion of bailout money?” Not an easy question to answer and there has been lots of arm chair quarterbacking on the topic. I’m hardly an expert on financial policy, but in short this was my layover induced answer.

There seem to be two fundamental problems, of many, worsening our current economic quagmire. 1) The housing bubble pushed home prices to levels most working Americans could not afford and to keep the bubble going the financial community became very creative with mortgages and how the risk associated with them was calculated. The end result was lots of people in houses they could not really afford and very little transparency in the risk this created in the financial markets. There is a lot more to the story but for the sake of brevity we’ll leave it at that. 2) Credit liquidity in the current market has almost ossified causing our collective economic gears to come to a rattling halt. Wall Street freaks…the media freaks…the consumer freaks (no spending)…sales of goods plummet…Wall Street freaks again…media fuels more freaking…rinse and repeat.

To break the cycle it would seem logical that liquidity needs to be injected into the market. A lot of pundits have looked at this being solved by the government buying up the bad assets, giving capital to the banks in return for equity stakes, and several other derivative plans. While all these ideas have their merits and risks the idea I exposed on the plane was slightly different. Back to the core issues - I saw the biggest failing being lack of market transparency and a fundamental mismatch between supply and demand in the housing market. So how could we restore transparency to the market while getting people in homes they can actually afford thus freeing capital for consumer spending and financial investment.

My answer was a foreclosure clearing house. This may be Polly Anna and not feasible, but it made for a fun intellectual exercise. There has been lots of talk around providing bail outs to people whose homes are foreclosing, but even this will be short term and will not solve the fundamental problem that they are in a home they cannot afford. The only real solution is to put these individuals and families into homes they can afford. The easy credit and risk shell game that banks ran has created a basic mismatch of people buying supply with demand they did not really have.

The clearing house is a simple idea of providing a transparent market place where people can trade down to houses they can afford and have new loans guaranteed to do so. The loans could be guaranteed by the government but competed for by the banks. Banks that already have the mortgages on existing properties could have the choice of refinancing the house so the owner could afford the payments (that would be their own risk calculation) or entering the home into the clearing house. Also the home owner could have the choice to enter their home into the clearing house if they would like to trade down voluntarily.

The clearing house itself could run like many of the existing home real estate market places matching buyers and sellers (Zillow, Trullia. RedFin etc.). In fact the government could probably contract with one of the sites to run the technology side of the clearing house at a reasonable cost. Once a person’s home was identified for purchase they would then be free to look for a new home in the clearinghouse they could afford. The government backing would allow loans to be made so the individual, now free of the foreclosed home, could buy a new home they could afford. Banks would still compete to provide the best rate and terms to new owner, but the risk would all be transparent to the government since they would be providing financial backing and to the owners so they were not mislead into buying more house than they could afford (again).

In theory this should introduce liquidity back into the market and with a little time put liquidity back into the consumer market since the majority of a person’s paycheck would no longer be going to a mortgage. The market would be transparent again but not run or partially owned by the government. I would argue that it was not capitalism or the market economy that broke during this financial crisis, but a loss of transparency and a resulting hiding of risk. In fixing the crisis the government’s role should be ensuring transparency in the market place so that it can function effectively. My idea is most likely off the deep end, but I do hope government action is centered around restoring transparency and restoring liquidity to the market. If you were Sec. Paulson for a day what would you do with $700 billion? There are no shortage of smart people around the globe. Can we crowdsource an answer?

Popularity: 18% [?]

What’s so special about Cumberland, MD-WV? This energetic, small town is one of a select number of cities around the country that appears to be weathering the housing storm. While in many metropolitan areas housing prices are either stabilizing or are on a downward spiral, Cumberland’s market continues to climb. One indicator of prices, the OFHEO Housing Price Index, shows a growth rate of nearly 11% for the last year. The market is also still quite affordable. Over 80% of the households in that area with the city’s median income can afford homes that are currently up for sale.

Hot housing markets can also be found in large parts of Texas, North Carolina, Pennsylvania and other more localized areas of the country. Below is a heat map showing those hot spots. The cities used to generate the map include those whose OFHEO’s Housing Price index has risen over the last year and Wells Fargo/NAHB Housing Opportunity Index is currently above the national average of 40%. A normalized index was created to weight cities based on their relative ranking on both criteria. Cumberland comes out at the top of the pack.

Hot Housing Markets

Other notable cities on the list include:

The Gazelle: Housing prices in Midland, TX are surging. Over the last year, that city’s OFHEO HPI rose by 12.5%, which is the the higest growth rate out of all cities on the list. On the downside, the market appears to be out of reach for many who live in that city. It’s HOI is only 41.2 and declining.

Best on a Budget: The most affordable market on the list with an HOI of 87.5 is Indianapolis, IN. Prices in this market though, have risen at only a modest rate in the past year. The city’s HPI grew by just .7%.

Big City Sizzler: Austin, TX is one of the larger metro areas on the list whose housing prices are growing at a relatively high rate and it’s housing remains more affordable than the national average. This 16th most populated city’s HPI increased 7.2% and it’s HOI is currently around 53.1.

Housing Price Indices, Housing Opportunity Indices and other market attributes for all 76 cities on the list are available for interactive mapping at geocommons.

Popularity: 14% [?]

The Realtytrac 3d Quarter foreclosure numbers released this week paint a grim picture for the nation’s housing market. Unprecedented foreclosure rates were reported for numerous cities. In Stockton, CA, the leader of the pack, an astounding 1 in 31 households filed for foreclosure last quarter.

What is also unsettling is the geographic pervasiveness of the problem. As James Saccacio, the CEO of the Realtytrac noted this week: “…increasing foreclosure activity was not limited to just a few hot spots.”

The maps below show foreclosure rates and trends in filings for the top 98 largest metropolitan areas (lower 48 states), based on Realtytrac’s numbers. Pan across the maps to identify hotspots by city or zoom out to get a more general spatial perspective. Top rankings are provided beneath each map.

Foreclosure Rates

Stockton, CA ~ 1 in 31

Detroit/Livonia/Dearborn, MI ~ 1 in 33

Riverside/San Bernadino, CA ~ 1 in 43

Sacramento, CA ~ 1 in 48

Las Vegas/Paradise, NV ~ 1 in 48

Percent Change in Property Foreclosure Files (2nd to 3d Quarter 2007)

Richmond, VA ~ 224%

Wilmington, DE-NJ ~ 202%

Springfield, MA ~ 151%

Boston/Quincy, MA ~ 146%

Cambridge/Newton/Framington, MA ~ 132%

Percent Change in Property Foreclosure Files (3d Quarter 2006 to 3d Quarter 2007)

Bethesda/Frederick/Gaithersburg, MD ~ 1640%

Cambridge/Newton/Framington, MA ~ 1552%

Boston/Quincy, MA ~ 1274%

Springfield, MA ~ 1169%

Essex, MA ~ 994%

Popularity: 13% [?]

Making the News

Here’s an eye-catching statistic: “Foreclosures cost neighbors 223 billion dollars.” This statistic comes from a study just released by the Center for Responsible Lending and its drawing a lot of attention. In their study, they take an unprecedented look at the spillover effects of the recent explosion in foreclosures (2005-2006). They look specifically at the devaluation in property values that the neighbors of those properties are likely to incur and the losses to communities as a result of depreciating property tax bases.

The numbers coming out of the study are ominous. They cite that over 44 million homes in the United States will experience property devaluation as a result of foreclosures in their neighorhoods. Fourty-two counties in the United States can expect to see their property tax base erode by more than $1 billion. And households located in proximity to lost properties could see the value of their property decrease by $5,000, on average.

What parts of the country will get hardest hit?

To examine this, the county level statistics statistics in the Center for Responsible Lending study were geocoded and the hotspots mapped. It should be noted that while their analysis is based on census tract data, the numbers presented in their report are at the county and state level. Further, they provide statistics for only those counties contained in Metropolitan Statistical Areas (MSAs). A full description of the data and the methodology they employ can be found here on their website.

The map below shows which parts of the country could see large property devaluations and tax base erosion as a result of foreclosure spillovers. The top ten counties ranked in order are: Los Angeles, Ca; Cook County, Il; Kings, NY; Miami-Dade, FL; Queens, NY; Orange, CA; Bronx, NY; Broward, FL; Maricopa, AZ; and New York, NY. Los Angeles county clearly dominates: It’s total devaluation is nearly double that of the second ranked Cook county.

Pan around the map to see the other hotspots, in the Chicago area, the northeast and Florida.

Total Property Devaluation from Foreclosure Spillover Effects

If you are a homeowner, you don’t want to live in the following counties: Kings; NY, Hudson, NY; Queens, NY; Miami-Dade, FL; Bronx, NY; Los Angeles, CA; Manassas Park, VA; Passaic, NJ; New York, NY; and Prince Georges, MD. Those are are the top ten counties ranked by average property value loss per household affected by the spillovers. The map below shows a richer illustration of the geographic aspects of the problem.

Average Decrease in Property Value Per Household Affected

A Slightly Different Look At Things

Where can a single foreclosure be expected to result in the largest impact on property values? To get at this, the study’s numbers on total property devaluation and houses lost due to foreclosures were used to create an index: property tax erosion per foreclosure.

The answer: New York, NY. On average, every foreclosure in this area can be expected to result in a 18.8 million dollar decline in the county’s tax base, due to spillover effects alone! The top ten counties, according to the index, are:

New York, NY ~ $18,824,604

Kings, NY ~ 3,189,975

San Francisco, CA ~ 2,806,025

Bronx, NY ~ 2,744,213

Queens, NY ~ 1,801,715

Hudson, NY ~ 1,459,685

Alexandria, VA ~ 1,362,766

District of Columbia, DC ~ 1,127,907

Arlington, VA ~ 1,106,435

Suffolk, MA ~ 1,040,268

Popularity: 15% [?]