Martin Feldstein has written another Wall Street Journal op-ed (here’s an NBER version) extending his idea for stabilizing home prices. Steven Levitt has written about Feldstein’s basic idea before. The basic idea is for the government to provide low-interest loans to mortgage holders in return for mortgage debt:
The federal government would offer any homeowner with a mortgage an opportunity to replace 20 percent of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. This would be available to new buyers as well as those with mortgages. The interest on that loan would reflect the government’s cost of funds and could be as low as 2 percent.
The Feldstein proposal has a real advantage relative to Luigi Zingales‘s ingenious “Plan B.”
Zingales proposes that Congress pass a law to give a recontracting option to all homeowners living in a zip code where housing prices have dropped by more than 20 percent. If exercised, the Plan B option will write down the face value of the mortgage by the same percentage that the area housing price has dropped and, in return, the homeowner will give the mortgage holder 50 percent of any appreciation at time of sale. (Zingales points out that mortgage holders will do much better under this program than with foreclosures, where transaction costs eat up a hefty proportion of the market value.)
Feldstein, like Zingales, reduces the incentives for homeowners to default on their mortgages. But Feldstein avoids the sticky question of bank approval. Zingales’s plan tries to do this by legislative fiat. But a law that forces mortgage holders to accept a write-down of principle might violate the Constitution’s Takings Clause. Indeed, another parallel between 1932 and 2008 may be how the court responds to legislative innovation. (Here, Chief Justice Roberts plays the role of Charles Evans Hughes.)
But the Feldstein proposal has a couple of real disadvantages as well. Feldstein emphasizes that the government loan would be a “recourse” loan, giving the government the right to look to homeowners’ wages and other assets. Feldstein is critical of American exceptionalism with regard to making mortgages non-recourse:
The “no recourse” mortgage is virtually unique to the United States. That’s why falling house prices in Europe do not trigger defaults, since the creditors’ potential to go beyond the house to other assets or to a portion of payroll earnings is enough to deter defaults. Officials and investors in other countries are amazed to learn that U.S. mortgages are no recourse loans. It is indeed surprising that this rule in the U.S. applies to home mortgages but not to any other type of loan.
Feldstein’s proposal, however, goes beyond merely making the government loan “recourse.” Feldstein would not make the loan eligible for relief in bankruptcy.
To me, it’s an open question whether many homeowners would accept the bribe of a subsidized write-down in third-party mortgages in exchange for taking on a recourse, no-bankruptcy loan. In scary economic times, many homeowners might be reluctant to take the Feldstein option.
The big concern is that we still may be on the brink of an even larger foreclosure disaster — with wave upon wave of foreclosures feeding back to reduce housing prices, thereby inducing more homeowners to walk away from their mortgages.
To stabilize things, we need to solve what economists call a “participation constraint” problem. We need to either 1) meet homeowners’ participation constraint (offer them a deal that is worth taking), 2) meet mortgage holders’ participation constraint (hard to do because ownership is so fractionated), or 3) take on the hard question of cramming down a legislative solution that roughly makes the different participants better off.
(Hat tip: Roberta Romano)
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what will that do? Make us more indebted! Why not start a mortgage company and re-organize the debt. to meet the reality- my house is worth less than I paid for it and possibly less than what I would get if I sold it after the debt was paid.. Unless I add a few rooms with the money I would be supposedly lent and then raise the value of my house, increase my taxes etc.,etc.But what a risk to take.
Seems like a devaluation process is in order. Frankly, the mortgage companies ought to incur the loss to me of the value of my house and refinance at the real value, with a 30 year mortgage. That would take the stress away from me.the owner, the mortgage company could incur the loss as a tax break. Part of the loan deal could be, payable by the fifth of the month (with a 75$-100 fee thereaftter) not the 16th- giving the mortgage company an extra 11 days to fool around with my money- Everyone would benefit. Do quote me on this- our government seems to need a bit of help in solving the mortgage problem. Here is one solution and my guess is, it is probably the fairest around to all concerned.
It is a collateralized loan, why does there need to be recourse. If you default, then the bank gets the house and your credit score is ruined.
I’m not sure this would address the true problem, which is that median home prices are not in line with median incomes across the country based on historical data. Until home prices get reasonably in line, home prices will decline in value. Lowering the interest rate on a portion of the loan would certainly lower the payment, but I’m not so sure it’d lower it enough to bring the market back to equilibrium.
While a low interest recourse loan would decrease the cost (in dollars) of purchasing a home, there is a cost implied in moving fron a non-recourse loan to a recourse loan… especially when the lender has the power of the federal government. Ask those that defaulted on federally subsidized student loans how this has worked out for them. Now, in my opinion, the student loan defaulters are a bunch of whiners who should have paid their taxpayer backed debts, but its not as if the lower interest rate was a free lunch. Those that defaulted significantly impacted their lives by doing so, ruined credit (which can close some doors for employment), never get a tax refund, garnished wages… Their situation would be far less dire if they defaulted on a higher interest private loan.
@1…why in the world should the mortgage company be responsible for YOUR bad choices in purchasing a house you couldn’t afford that dropped in value? If you had made wise borrowing choices in the first place, it wouldn’t matter that house prices had dropped…you’d be able to pay it off now as you were able to when you took out the loan. it amazes me how entitled people feel for private companies to incur losses because they CHOSE to make a bad deal!
I prefer the Zingales plan, but both are preferable to most ideas that have been proposed by our “leaders” in Washington. What is the chance that one of these tough-but-fair type plans actually gets adopted?
You know what, as a renter who has been waiting the housing market, I’m getting more and more indignant by the day. I’m sorry to you people whose houses are worth less than you payed for them, but that’s what happens to things we buy. My car is worth a lot less than when I bought it new, but I’ve derived a lot of utility from it in the mean time. Yes, a house is an investment, but it’s also a purchase. Please don’t forget that.
If you live in a nice home, can meet your mortgage payments, and then walk away because you don’t like the value of your home anymore, you should be ashamed of yourself. How about sucking it up, and continuing to enjoy the nice home you have.
@thomas, the point is that the Government would not get a piece of the house if you default, so they go after your other assets now and into the future (wage garnishment for example).
@science minded, just writing off some chunk of the mortgage would be a big gift to you and would likely expose the mortgage holders to more grief than now (since not everyone underwater will default, for obvious reasons). The Zingales solution was to forgive your excess over FMV, but only if you agree to share any proceeds when you do sell – that is, it recognizes that once prices stabilize, your house will in fact be worth more than the mortgage again. So, it is only a gift to you if the FMV never gets above the mortgage. That makes it like a short sale (where the mortgage holder takes whatever you get and eats the loss), but only if there is no gain in the future.
I don’t understand how so many people talk as if all U.S. mortgage loans are non-recourse. Aren’t most U.S. mortgage loans recourse? I think only in California are they mostly non-recourse.
Nevertheless, as a practical matter banks rarely go after the shortfall. What would happen if the government was the lender and defaults were commonplace? Millions of civil suits brought by the government against the ex-homeowners?