Writing in The Wall Street Journal, highly respected economist Martin Feldstein proposes that the government provide low-interest loans to consumers in return for mortgage debt.
These government loans would not be secured by the borrower’s home. The loan would need to be paid back even if the home goes into foreclosure and would not be eligible for relief in bankruptcy.
The idea behind Feldstein’s plan is that falling housing prices are at the root of the financial crisis. As home prices fall, homeowners end up with mortgages that are larger than the values of their homes, making it financially beneficial for the homeowner to simply walk away.
These foreclosures put even more downward pressure on housing prices, exacerbating the problem. Feldstein’s plan would help to reduce the loan-to-value ratio of existing mortgages, and thus lessen the incentive to default.
Feldstein’s proposal is interesting and very original. I have to say, though, that there is one thing about it which really troubles me.
The goal of the Feldstein plan is to keep housing prices high. In general, economists are strongly against government interventions in markets designed to affect prices — whether it’s central banks trying to defend currencies, or wage and price controls like those Nixon instituted.
An important question to ask is: if there was a house-price bubble (which it sure seems like there was), would it just be better to quickly get house prices back into equilibrium and take our lumps, or should we try to forestall prices getting back to where they should be?
My instinct is that it is best to take our lumps as quickly as possible.
People who own houses are a lot poorer than they thought they were at the peak of the housing bubble. My gut feeling is that the sooner folks accept this and make decisions going forward that recognize this, the better.
If the mortgage-backed securities are worthless, then they are worthless. The people who hold them have lost a lot of money; the people who sold them to the people who now own them made a lot of money. We sort out who is bankrupt and who isn’t, deal with those who are bankrupt, and then get on with things.
Feldstein’s response, no doubt, would be that we are going to get caught in a reverse price bubble — where buyers stay out of the market in anticipation of future house-price depreciation — which would make falling housing prices a self-fulfilling prophecy. That would be a mess.
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I was contriving a similar approach this weekend over multiple beers.
idea being, the govt loan adjusts the price of the home to market. The “underwater” amount is financed by the govt. The current Market amount is brought into a 30 year fixed. This allows the consumer to do what ever is necessary with the property in question. And the govt loan goes with the individual. No tax incentives for opting into the program. But the owner is able to enjoy appreciation on the home, (based on new market value) any appreciation goes to the got loan first.
it doesn’t add money to the economy, but it stabilizes those with ludicrous amounts of home debt. and the Govt, if administered correctly) could turn a nice profit as well.
I am sure there need to be some type of capital gain/loss, amendment too..
I doubt Congress is at all inclined to consider a new plan to spend $1 trillion – even if the money would, in theory, be recovered. I also find it difficult to believe that an extra $250 a month – at most, according to Feldstein – would be the difference defaulting and not defaulting, except at the margins. (It would be interesting to know what the figure would be for a “typical” loan.)
This has similiarities to what I proposed last week: the government should refinance existing first mortgages on currently owned primary residents if the owner declares bankruptcy (and thus eliminate second mortgages and home equity loans).
That will help stabalize the bottom at 20% decline from the peak, allow people to stay in their houses, and spread the “hurt” around to the primary players in this mess.
Since this would be a refinance, the currently “bad” first mortgage would be made “good” as the bank would get all of their money back to spread out among the MBS owners.
The core problem with Feldstein’s analysis is that people need some place live. Even if the house is worth less than they owe on it, the owner will keep the house. The key metric for walking away is not how much you owe on the house, but whether or not you can afford the payments. Most people routinely owe more on their car loan than the vehicle is worth.
Aren’t houses already in a reverse price bubble? In my conversations with homeowners, they’re reluctant to even list their homes, because they’re afraid they won’t get much for them… while on the other side, myself and many of my friends who rent, refuse to buy, because we feel the price of homes are still too high, and thus, stay on the sidelines.
They say never to try and catch a falling knife. Well I’m especially opposed to trying to do so in the largest purchase of my life.
His fear of a reverse bubble is totally unfounded because most prospective home buyers aren’t motivated by profit. I’m 24 and if I could buy a house in eastern MA for $100,000 I would but things aren’t going to fall far enough for me to get in the market. I know a fair number of people with somewhat higher incomes who will get into the market once things fall to historic norms because that is actually how much people can afford to pay. So please let house prices keep falling, my generation is waiting!
It’s interesting to see the number of intelligent people who are trying to place a ban on prices from going down. If price controls are ever a good idea, they have to be implemented in relation to the asset’s intrinsic value. Maybe in the future we can have a commission that roughly assesses the “real” value of homes, and tries to remove some of the punch when things start to race above that level.
This would be easier in the stock market, where real values are easier to calculate. We know businesses are worth what we can reasonably estimate their future cash flows to be, so if the broad indices trade for 150% that amount, we can make margin trading more expensive.
Maybe I’m missing something, but if the government can force mortgage companies to accept reduced payments, why does the government need to be involved at all?