The Bailout We Should Have

Includes: FMCC, FNMA
by: Bo Peng

Imagine a 10% principle reduction on all main home mortgages below, say, $1M. Or some regressive scale with diminishing percentage as principle increases.

1. Boosts home equity and spending.

Officialspeak so far have all blamed slow job recovery for the slow consumer spending recovery. But they intentionally ignore the other main factor: depressed housing price and increasing delinquency/repossession/foreclosure that will surely continue for a long time. This is a huge overhang both psychologically and materially. Renters would also benefit from rent/buy parity.

2. It's not all bad for banks and GSEs.

Lenders may get some special, one-time accounting write-off from this. And it would definitely improve the future outlook of their loan books and expand their consumer credit market. Since this would be a huge (both immediate and long-lasting) boost to the economy, this should significantly improve the outlook for commercial real estate, which is projected to be an even greater risk than housing in the coming years.

3. This bailout has moral benefit.

It actually encourages and rewards honest people who try to pay their debt.

4. Reduces deflation risk.

All the bailout and QE have not brought about the much feared inflation. Why?

  • Velocity of money has decreased and will remain so until home equity improves. Both borrowers and lenders are depressed by low home equity ratios.

  • Printed USD spills out to the rest of the world.

On the other hand, the U.S. faces real risk of prolonged deflation, not unlike Japan but for somewhat different reasons:

  • Aging demographics, similar to Japan.

  • Continuing increase in economic disparity, dwindling and more frugal middle class.

  • Cross-contagion among all developed world. Japan was lucky to have entered the lost decade first and alone.

  • Low home equity depresses spending, borrowing, and lending.

It's not too late. Just wait for next dip.

Disclosure: None