There has been much impassioned public agonizing over the crisis in
the housing market, much of it strongly expressed but not deeply
thought. It is clear that something must be done to reverse the
declines in housing. No domestic sector is as crucial to US economic
health. But there is a hue and cry over "moral hazard" - the apparent
aim being to paralyze public action so as to leave outcomes to the
private markets that have (in the view of objectors, it seems) managed
economic affairs so masterfully in the last months. We must let nature
take its course, it is affirmed.
There are two problems with this
approach. First, it renders policy moot. There is little point in
electing or appointing a President or Fed chief if their main role is
simply to stand aside and let things happen. Second, the damage to the
economy is too dire. In any emergency, remediative action is the moral
responsibility of all involved, even if there is a good chance of
disaster remaining unaverted. And in this case, there is a good chance
corrective action can be effective - if it is correct.
Objectors
decry the rescue of the guilty at the expense of the innocent. They
declare there is no way to halt the collapse of the housing market
except to reward the bad behavior of irresponsible borrowers. But must
we punish every property holder to ensure that the market punishes the
guilty? Because that is the effect of the "let nature take its course"
option. Leaving aside questions of culpability on the part of lenders
who invented such ingenious instrumentalities as the "option ARM" and
the CDO, perhaps we should investigate the issue of saving the economy
instead of chastising the wicked. The matter is simple: how do we
intervene to halt the freefall of housing at least cost to the body
politic?
I think the matter is fairly straightforward. Create a government lending facility that buys up troubled loans. The Treasury owns these debts and thus allows the banking sector to rectify its balance sheets. Next, all bad loans are reevaluated and restructured in such a way as to render them viable and performing. As a condition of receiving writedowns on principal and reduced payments, the borrowers agree to forgo an appreciation or realized net gain on the future sale of the home, until and unless the proceeds of a future sale exceed the government's costs in guaranteeing the loan at the reduced principal and payment. That is, a home originally mortgaged at $300,000 written down to $200,000 would yield the borrower no net gain at a sales amount less than $300,001. A further condition would require that the government mortgage holder sign off on any transfer of the property. This would ensure against collusion and abusive sales below prevailing market prices.
How would this fix the problem? First, it would provide the much needed "floor" to the housing market. Affordability would again be a significant factor in house-buying activity. Those who could afford the reduced principal and payment would stay in the houses to maintain them and service the debt. Those who cannot would provide an opportunity of an affordable entry point for buyers otherwise unwilling to venture to purchase in an unstable market. Second, it would indemnify the body politic against the predations of unscrupulous opportunists (as distinct from scrupulous opportunists, such as hedge fund managers) willing to profit from the government funds expended to shore up failing mortgages. In short, it would prevent "losers" becoming "winners" at public expense. And in the process, it would prevent whole neighborhoods, towns, cities, even the nation, from falling down the endless black hole of a continuing housing market collapse.
The key is to create a bracket, a "zone of no gain," in which mortgage debtors can keep their homes without cashing in unwarrantedly on the largesse of a government rescue plan. I doubt that any such plan could be put into action, however. There are too many injured parties for that. Injuries on this order of magnitude always seem to require the spectacle of public blood-letting -on a large scale, and repeatedly.
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