More excellent ideas from University of Chicago economist Luigi Zingales on solutions to the current financial crisis; what he calls “Plan B.”
Zingales: Time for "Plan B" to Fight the Financial Crisis
TAGS: finance, Luigi Zingales
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. You can also watch it on 
But wait … what if I invest in “Plan B” as a home-owner, and I need to sell the house and move? This plan provides relief to my monthly payments, but it does not help one of the bigger problems with this situation: Those who want to leave their house cannot afford to sell it. If I bought a place for 500K, and I’m underwater on the morgage as the home is now worth 300K, how do I move? The only option I have is to mail back the keys and rent. Banks can offer folks the ability to “roll over” mortgages into new ones, but that doesn’t make these homeowners any less trapped.
The paper glosses over the restrictions that need to be put on the homeowner to make Main Street arrangement work.
If homeowners give up 50% equity from the renegotiated price, isn’t rational behavior to sell ASAP and buy the same-priced house across the street? That way you get the forgiveness without giving up future appreciation. Is the 50% lien on appreciation going to follow you to future mortgages? Is there going to be some sort of minimum hold time? Won’t that impede people moving for legitimate reasons.
And it’s one think to enable some default forgiveness by fiat at the mortgage level, but how will the new structures’ cash flows be squeezed through the messy securitization. Do the traunching formulas and CDO contract specifications work when the underlying assets are so changed?
The mainstreet portion of the plan seems good, but the wallstreet portion scares me a bit, especially this part when talking about how to get insolvent banks to take the special form of bankruptcy he is proposing:
“If they think the institution might be insolvent, they will pull their money out as soon as they can for fear of being involved in this restructuring. In so doing, they will generate a liquidity crisis that will force these institutions into this special bankruptcy.”
That type of fear is exactly what is causing the lending crisis right now. Basically, this idea a variation of the ‘take our lumps’ idea, except it trys to make the crisis happen as fast and as painlessly as possible. That might work, or it might just drive us off a cliff at full speed.
Without knowing exactly where the bottom is, exactly how much equity is left in the world banking system after restructuring, we can’t tell if this is really a good idea or not.
Yannai, if the home owner just sells quickly, the bank is still going to get 80% of the value of the mortgage, which is much better than the proposed 40%. So, even then the plan would help, even if it wasn’t perfect.
I like the plan; improvable by scrutiny and debate perhaps, but nonetheless sensible. I wrote my representative asking him to look at it (or at least have someone whose opinion he respects look at it).
The Main Street plan is like the punchline to the old economists joke: “First, assume you have a can opener.” It seems more efficient and less costly than having the government buy out mortgages, but I do not think Congress has the power to force mortgage holders to accept less than the face value of existing mortgages.
Never mind the fact that it completely ignores the issue of moral hazard. Anybody who bought a house with a 5% down, adjustable-rate, interest-only mortgage under the assumption that housing values would only go up deserves exactly what they are getting, namely to have to pay the consequences of making an extremely poor economic decision.
Everyone seems to forget that nobody forced borrowers to sign up for all these bad mortgages. They were either greedy in trying to buy more house than they could afford, or ignorant in signing a mortgage whose terms they did not really understand, and as someone who bought a house I could actually afford, with 20% down and a fixed-rate mortgage, I really don’t have all that much sympathy for people who tried to bite off more than they could chew.
…sorry, but all I get, when I try to read the article, is the following error (Shortly reported below):
??Error while opening the file.
??The file is damaged and …etc, etc.
It might be a good planB if You only had a planC too!!
Bye
V.P.L.F.