Three cheers for Jonathan Laing for his proposal in Barron’s this weekend for how to solve the mortgage crisis. Laing’s entire article is definitely worth reading. In a nutshell, though, his plan boils down to four basic actions. Laing says the federal government should:
- Offer to refinance every U.S. homeowner’s mortgage at a 4.5% fixed rate.
- Make similar mortgages available to home buyers (just as the Treasury is said to have considered this week).
- Use Fannie Mae (FNM) and Freddie Mac (FRE) to repackage all new loans as safe securities for investors.
- Modify the $500 billion of subprime and Alt-A loans in arrears. Extend their maturities to 40 years; in certain cases, pay down principal, as well.
Laing’s plan would provide three huge benefits. First, it would help delinquent borrowers who want to stay in their homes by substantially reducing their monthly payments. Second, risk of moral hazard would be reduced since all borrowers, not just delinquent ones, would be eligible for rate relief. Lastly, the entire economy would get a needed jolt, as borrowers’ reduced monthly payments would cause disposable income to soar.
And here’s a fourth, bonus benefit: lower fixed mortgage rates would go a long way toward stemming the decline in home prices.
I like Laing’s proposal a lot, but would make one important change, and offer an addition, too. First, I wouldn’t set the 4.5% mortgage rate by fiat, but instead would have the Treasury issue debt for Fannie and Freddie or would explicitly guarantee their debt. That would cause the agencies’ borrowing costs to plummet, which in turn would likely lead to 4.5% mortgage rates. Thus mortgage rates would still be tied to some market.
And I’d make one addition: I’d have Fannie and Freddie temporarily ease their underwriting standards regarding maximum loan-to-value, and let any borrower who’s stayed current on his mortgage for the past twelve months refinance at the new lower rate. However, I would suggest that the size of any new mortgage can’t be larger than the mortgage being refinanced.
I also believe Fannie and Freddie should also be willing to purchase subprime mortgage loans created in such a refinancing, priced at a rate set at some meaningful premium (say 250 basis points) over the conforming conventional loan rate.
Jon Laing’s proposal, along with my suggestions, would do a lot of good things to help end the mortgage crisis. The plan would help struggling homeowners stay in their homes, and would ease the downward pressure on home prices. It would reduce the moral hazard that arises from helping only delinquent borrowers. And it would help consumer spending by boosting borrowers’ confidence and putting more discretionary cash in their pockets.
I don’t see a lot of downside. So let’s get going, first by lowering Fannie’s and Freddie’s funding costs, and then putting that funding advantage to work!