Excerpt from the Hussman Funds' Weekly Market Comment (11/24/08):
Fundamentally, the current mortgage crisis is about present value. We could ease the crisis in the mortgage market tomorrow if distressed homeowners were allowed to get a reduction of current mortgage principal in return for giving away an equal claim to future price appreciation of the home. The cash flows required to service the mortgage would be greatly reduced, but the present value of the payment obligations would be about the same. As a result, the value of the mortgage securities on the books of financial institutions would also stabilize.
The two most important actions that government can take to address this crisis are: 1) continue to provide capital directly to the banks, rather than purchasing troubled assets, and 2) reduce the mortgage principal of distressed homeowners in return for a claim on future price appreciation.
The best use of the TARP is to do exactly that. It would be a dangerous mistake for the Treasury to arbitrarily pay down various distressed mortgages receiving without an equivalent property appreciation right (what might be called a "PAR") from the homeowner. To do so would create an immediate incentive for every homeowner in the nation to go delinquent in hopes of receiving free money, and would provoke a rash of additional foreclosures.
Beyond following through with policy changes discussed in the Presidential campaign, I don't believe that the U.S. economy needs any massive “stimulus” targeted toward consumers. The force of this economic downturn is coming from mortgage losses, and the interventions we require must be targeted at 1) bank capital and 2) mortgage principal reductions in return for property appreciation rights. Mortgage related losses have impaired the asset side of bank balance sheets because of the requirement for those assets to be “marked to market” at their going liquidation value (which is heavily affected by short-term sentiment). The decline on the asset side is reflected in a lower total of “Tier 1” capital on the liability side, which frightens customers and depositors into withdrawing funds, and causes available credit to shrink. Boost bank capital and restructure the payment obligations of distressed mortgages, and credit, confidence and consumption will quickly be restored.