After The Fall: Saving Capitalism From Wall Street—and Washington

by Nicole Gelinas

Calling for government-subsidized loans for some “families trapped in bad mortgages,” New York mayor Michael Bloomberg told the U.S. Conference of Mayors this week that it was important to stem home foreclosures because “when neighborhoods empty out, crime and drugs and violence rush in.” Bloomberg was clearly looking back to the city’s dark history of foreclosures in the 1970s. But past isn’t necessarily prelude, and in New York, at least, government action to stall foreclosures could actually help create the abandonment and blight that it was meant to avert.

It’s true that rising crime, blight, and neighborhood abandonment accompanied mass-scale foreclosures in the 1970s and early 1980s. New York City became an owner of last resort after private landlords and their lenders abandoned properties, leaving the city to take over as payment for tax delinquency. By the mid-eighties, the city owned 200,000 apartments, including 65 percent of Central Harlem and entire blocks of Brooklyn and Bronx neighborhoods.

Starting in the 1970s, the federal government was also one of the nation’s biggest inner-city property owners. The feds took over single-family homes and apartment buildings—built with federal guarantees for lower-income Americans as part of the Model Cities project—when their owners couldn’t afford the mortgage payments. The New York Times described East New York, Brooklyn, back then as “filled with “empty, mostly two-family, houses foreclosed by the Federal Housing Administration in the past few years whose tinned-up doors and windows and rickety porches are a depressing legacy of lost hopes.”

But these foreclosures were often the result, not the cause, of urban decay—and of misguided city policies. Landlords in deteriorating neighborhoods knew that they couldn’t wring enough money from their often destructive tenants to maintain their properties, in part because of strict state and city regulations on rents and evictions. As for capital appreciation on their investments in lieu of immediate income, landlords knew that the city’s bleak future didn’t offer them much there, either. So they walked away. The Times summed it up nicely in 1971: “Landlords found themselves caught between what many housing experts agree was insufficient rent-controlled income and soaring costs for maintenance. . . . The final and perhaps most significant factor in the complex process of abandonment was a failure of confidence by the landlord not only in the building, but in the block, the neighborhood, even the city.”

The situation is different today. Foreclosures are rising as crime continues to fall. In fact, in much of the city, especially in formerly “poor” neighborhoods where middle-class residents with good credit have started to move in, it’s conceivable that enough new buyers could purchase properties at distressed sales to alleviate a downturn in property values somewhat. While prices would still drop as the property market deflates, they would drop less than they would without any interested buyers—which was the case in the seventies, when potential buyers abandoned the city in droves.

Even in today’s healthier city, investor uncertainty is a real risk. In a falling real-estate market, prices in the most vulnerable neighborhoods could crater as buyers looked for affordable apartments in better sections of the city. If that happened, it might be a long time before homeowners and investors felt that prices had fallen enough to start bidding on properties in places like East New York, where, despite progress, bad credit and spotty work histories are still the norm. This potential market stand-off poses a corresponding risk: investors who don’t want to sell their vacant properties at low prices could simply leave those properties to deteriorate.

But aggressive government policy—already proposed by some presidential candidates, in addition to potential candidate Bloomberg, and sure to be proposed in the coming months by the city’s 2009 mayoral candidates—may only worsen the problem. If the government halts or slows market sales, including foreclosures, as Senator Hillary Clinton and others have suggested, it will take longer for the market to find the right price for houses, discouraging potential buyers. Further, such delays may themselves create deterioration. A foreclosure “moratorium” would hurt a neighborhood if it kept families in homes that they couldn’t afford to maintain. Families might not see the point in maintaining their homes anyway, since they’d know that they didn’t have much, if any, equity—actual investment—in them and that foreclosure remained a distinct possibility.

Nor should the city or state, encouraged by the feds, issue its own mortgages to help homeowners refinance. Remember that the federal government became a big landlord 35 years ago in part because it tried to subsidize homes and new apartments for people who couldn’t afford them, particularly at the inflated prices that such subsidies encouraged.

That’s not to say that elected officials should do nothing. In fact, it’s not too early for cities and state governments to act, and Bloomberg should consider some real solutions. For example, New York and other cities could create a database of recently foreclosed properties to ensure that each precinct knows where extra police patrols are warranted, and make clear that it won’t tolerate disorder—from squatting in vacant buildings to stealing materials like copper wiring—as New York did decades ago. (Unfortunately, aggressive theft of basic materials is an even greater risk than it was in the seventies, thanks to sky-high prices on the international market for any recyclable metal.) New York has an advantage here over cities like Atlanta as well as suburbs hit by foreclosures: its housing density, even in its comparatively low-rise neighborhoods, makes it easier for the cops to know what’s going on, and its excellent policing strategies and tactics enable New York to respond to any increase in a particular type of crime. Increased police presence in a shaky neighborhood could, for example, be the factor that persuades a working-class immigrant family to take a chance with its savings on a newly affordable home.

The city can act creatively as well when it comes to discouraging owners—including speculators who buy foreclosed properties at auction—from keeping foreclosed property vacant and thus more vulnerable to deterioration. Perhaps through tax policy, the city and state could also encourage owners to rent out such properties at market rates through a private property-management agency, rather than leave them vacant in the hope that prices quickly rise again.

One thing the city shouldn’t do is encourage landlords, through subsidy or decree, to convert properties into homeless hotels or rent them to people who can’t afford market rates. And where larger properties are concerned, the city and state should revisit New York’s strict rent regulation and anti-eviction rules, which may make such properties unattractive to investors facing a post-bubble world. Navigating that world won’t be easy. But a rise in foreclosures doesn’t necessarily portend a return to the past.

Nicole Gelinas is a Chartered Financial Analyst and a contributing editor to City Journal.