A Solution to the Mortgage Crisis
By Mike BookeyThere 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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