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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It would seem the proposal suggests that while a return to equilibrium is necessary, the government can and should create a parachute to slow the descent. The alternative is letting the market crash, leaving a massive crater and causing collateral damage along the way.
Is it possible to have our cake and eat it too?
But it doesn’t bother you the role Feldstein had in helping this crisis along to begin with? He has provided much of the academic underpinnings of this crisis and also served as a board member of AIG through accounting restatements and its eventual failure, even serving as Chairman of AIG Financial Products, the division that brought down the company. So why should we take his advice on anything now? He hasn’t proven himself especially prescient.
“If there was a house-price bubble…My instinct is that it is best to take our lumps as quickly as possible.”
THANK YOU!!! It is amazing how many people are arguing the opposite and want the powers that be to do everything to keep those home prices high. What this economy needs is a housing correction – and fast!
I hope Feldman’s plan includes low-rate loans for the middle class – the group of people who are stuck in the middle of all this.
This doesn’t make sense to me. Why would a homeowner who’s underwater on his non-recourse mortgage want to make part of that mortgage collectible after the fact?
If, as the article claims, there is a financial incentive to just walk away and let the bank foreclose, providing cheap money from the government (that *has* to be repaid) shouldn’t change that incentive much. I guess the ones who are dumb enough to agree to it in the first place will have an incentive to stay in their homes afterward, but that doesn’t seem like a great economic strategy to me.
In reply to Adam, it is fairly straightforward to arrive at an intrinsic value for a home – as long as there is a rental market, the home is worth some multiple of the yearly rent. When I bought my first home in the UK in the 1990s, the annual rental return for a similar property was about 12%. When I left Australia last year, it was impossible to buy a home in any state capital there with a rental yield in excess of the cost of borrowing money – in some cases the rental return net of property taxes, maintenance costs etc. was close to zero, not even considering the cost of finance.
Addressing the broader point & agreeing with the author, clearly the price of property throughout the western world is vastly above any intrinsic value – why should governments intervene to prop up an over-inflated market (in anything)? Anybody who didn’t use their house as an ATM for the last few years, or didn’t buy a whole bunch of houses to flip based on the “greater fool” theory, shouldn’t be too badly affected by reducing house prices (apart from the few who had to buy at the top of the market, including myself).
History suggests that government intervention to prop up over-inflated prices is unlikely to succeed.
I vote for taking our lumps now as they have a strange way of getting bigger over time.
Housing prices should be market driven and if the capital isn’t there to purchase a home on credit home owners will have to lower their prices to attract buyers.
There should be some way to determine what the “ideal” amount of residential capital should be in the market place on a per capita basis.
The fed can then add or subtract to keep this number at its expected level, which may stabilize price fluctuations over the long run.
Now why would in negative equity situation or expects to be in a negative equity situation take this deal?
They will be swapping part of their mortgage for the same level debt – which contains full recourse and exclusion from bankruptcy. Someone that still ends up in foreclosure could be in debt to the government for decades afterwards.
This plan would probably be most appealing to homeowners who would still have postive equity after another 15% – 20% price drop. They would use it as an interest rate buy down.
if he truly wants to prevent negative equity foreclosures, the excess principal will need bought down and/or written off before the borrower stops making payments.
Right wingers are always whining about “high taxes” hurting the economy. One thing that is seldom recognized is that high home prices are in effect a “tax” on productive businesses. To attract employees, they must pay them an income sufficient to afford housing. As housing prices have escalated into the stratosphere over the past 4 decades, am I the only one who sees the parallel decline in real economic activity?
Here in Calgary, we are seing this limitation. House prices have gone up by more than 4 fold in less than 15 years and now, nobody can afford to come here to take the many jobs that go unfilled. Over the long term, this has a corrosive effect on job creation in all places.
We need to let them crash to an affordable level.