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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I wrote to my Senator, Chris Dodd. Asked him to get to work on legislation that would allow me as a homeowner to put aside a protion of my pre-tax income (see 401k) to pay down my mortgage principal.
Have not through through all the details of how it would work, or the reasons it is a good idea, or a bad idea… Just that it might be better than loosing over 40% indexing the S&P 500.
He hasn’t gotten back to me yet.
The next move is to reach out to Howard Pitkin, Connecticut’s Banking Commissioner. Dodd, I think, respects him.
Having both the ability to repossess your house _and_ to make a claim against future income or other assets creates a conflict of interest for mortgage lenders. When a house is repossessed, the lender has a duty to get the highest possible price for it. If they know they can go after other assets or income, that incentive is lessened.
I agree with Thomas above — if the bank takes collateral (i.e. a lien against your house) — then that’s their protection. It’s true that a lot of borrowers made stupid choices, but so did banks. Before the latest bubble lenders used to insist that borrowers finance no more than 80% of the purchase price. That gave them pretty good coverage in the event of a default.
Banks really hung themselves. Nobody forced them to write stupid loans.
Does anyone see this the way I do? That this was the swindle of all swindles? Let’s take a bird’s eye view of this, as if we are aliens studying this from afar:
If I can convince a group of people that the ‘widget’ I’m selling is worth 5 times its actual value, so much the better, right? I make money, everyone is happy, because they paid a price they considered fair.
Houses were sold the same way, as ‘widgets’. People bought the homes at prices way above the historical median, drawn in by the hysteria of the moment, and being told that “prices are only going up”.
All of this would have been fine if not for mortgages: a promise made by the holder to pay over 30 years (30 years!!) each month, with the punishment of losing a down-payment and a home if the payments could not be made. Folks have to pay this loan for their entire working ife, and in exchange they can own property when I retire, and pass this to their children when they die. The strength of this promise (read: contract) is based on the buyer’s integrity, and perceived ability to pay.
Now, when this idea was conceived, this seemed like a pretty good bargain for both sides: the mortgage holder was able to “own” property, thus being in greater control of their lives, and the mortgage company was guarenteed of a steady return on the loan for many years.
But look at how things have changed: is this now a fair deal, or a devil’s bargain? Is it any wonder folks want to walk away from something now perceived as a raw deal? By loosening the restrictions on mortgages, and allowing more folks to have one, all we have done is increased demand for this item and started a bidding war for homes. Do we then try to artificially prop up the market at unsustainable prices? With taxpayer money???
Unfortunately, there is no “fix” for this problem aside from lettting the folks who were swindled either decide to make good on their promises or leaving the deal behind, and suffering the consequences. We should not protect the “swindled” or the “swindlers” from the consequences of their actions. We do, however, have to make sure it does not happen again, and to protect the innocent.
@DavidG, actually, I think the banks were required to make loans they wouldn’t otherwise have made by the Community Reinvestment Act of 1977. At least, if they wanted to receive FDIC insurance, they were.
The Community Reinvestment Act applies to depository banks. But many of the institutions that spurred the massive growth of the subprime market weren’t regulated banks. They were outfits such as Argent and American Home Mortgage, which were generally not regulated by the Federal Reserve or other entities that monitored compliance with CRA. These institutions worked hand in glove with Bear Stearns and Lehman Brothers, entities to which the CRA likewise didn’t apply. There’s much more. As Barry Ritholtz notes in this fine rant, the CRA didn’t force mortgage companies to offer loans for no money down, or to throw underwriting standards out the window, or to encourage mortgage brokers to aggressively seek out new markets. Nor did the CRA force the credit-rating agencies to slap high-grade ratings on packages of subprime debt.
- from Slate columnist Daniel Gross
As someone who worked in a bank for a decade and a half (in the technology department, but still), I always thought there were good reasons why there were limitations on who the bank would give a mortgage to. Those criteria were based on income, current debt, and credit history. And the banks also determined what they considered to be a “safe” (i.e. likely to be repaid) amount to authorize you for, rather than letting you walk in and demand a $500,000 mortgage on your $80,000/yr income. Certainly that meant that some people who desperately WANTED to own a house couldn’t, but I don’t think it ever stopped anyone who COULD AFFORD to own a house from getting it.
It’s really too bad that that all changed in recent years. I know everyone may feel like they’re entitled to home-ownership, but the reality is that you really have to be able to afford it, first.
As for the person (# 1, above) who feels that someone else should be held accountable for the fact that his house is currently worth less than he paid for it, would he also have been eager to give away the profit if instead the house’s value had gone up by 50%? If not, then he really needs to re-think his position. I sold my first house for a 30% loss (the market changed for the worse in the 8 yrs between when I bought and when I sold) but understood that that was simply how things can go. My current house is valued at 50% more than what we paid for it 10 yrs ago, but since we’re not planning to move anytime soon, it’s not really all that relevant.
@ you know who you are:
Why do we as tax-payers have to be responsible for the bad choices that mortgage companies made to loan to subprime borrowers? It amazes me how entitled mortgage companies feel that the public sector should incur losses because they made bad choices to lend to people they knew would default.
-your friendly neighborhood Antithetical
In America, mortgages are non-recourse loans for two reasons. First, our legal system (with the exception of Louisiana, which derives its laws from France’s Code Napoléon) is derived from the English system; a hallmark of English, and thus American real property law is the difference between “in personam” and “in rem” jurisdiction. “In personam” refers to laws and causes of action against individual persons–be it criminal, contractual, tort-based, etc. “In rem” refers to laws and causes of actions derived against things or objects, chief among these objects being buildings and land, as well as the collateral for “purchase money” loans (e.g., home mortgages and cars) and secured secondary loans on real property (i.e., refinancing of mortgages). When someone incurs mortgage debt, the debt in legal reality is that of the object being financed, i.e., the home. (This is so even when a person signs for or assumes a mortgage). The evidence of the secured loan is the promissory note–which states that the recourse for failure to meet the obligation is repossession of the object securing it, according to a lien created by a separate instrument: the mortgage. A lien, since it attaches to an object, is by its very nature in rem and limited to the object, not the debtor.
In normal times (most of modern history until now), a mortgage was a relatively low-risk loan. People defaulted on mortgages because they were unable to meet the payments, regardless of the property’s underlying fair market value; because of their financial track record and deficient assets they could not meet requirements lenders imposed for refinancing on easier-to-comply terms. When a home was repossessed by foreclosure, the lender always came out at least even–it could sell at a foreclosure sale for the amount still owed, or decide to sell it for fair market value and take a profit since most real property appreciates over time. The debtor homeowners, if they were lucky and their state law permitted, were able to recoup the equity they had at the time of purchase–the down payment they made. As to car loans, recourse is usually limited to repossession (though more and more new-car loans provide for additional recourse despite being secured by the vehicle; the debtor’s equity diminishes and usually disappears because nearly all personal property–except for rare collectibles and precious substances–depreciates).
That being said, it is an exaggeration to say that people who can afford their mortgages are “walking away” in a snit over declining equity. The vast majority of foreclosures today occur on properties for which the homeowners cannot afford to meet their payments and cannot qualify to refinance to an affordable interest rate and monthly payment. It is a very recent nationwide phenomenon for lenders to be stuck with properties that are “underwater,” i.e., worth less than the mortgage balance. Until the past year or two, this was such a rare occurrence that it never occurred to lenders to seek an additional loan (with recourse) over and above the one secured by their lien (the mortgage) on the property itself. We may well start to see a break from the English legal tradition in the U.S. and see home sales involving personal-recourse loans in addition to mortgages.
In that case, today’s foreclosure tragedy will be dwarfed by the widespread poverty, despair and chaos that is sure to come and which will make 2008 referred to as “the good old days.” Be careful what you wish for!