Propping Up Home Prices Will Not Solve the Crisis

Well, on a positive note, at least Martin Feldstein didn't use the words "root" and "cause" right next to each other when laying this egg of an op-ed piece in Saturday's Wall Street Journal aimed at helping solve the credit crisis.

His plan?

In order to make underwater homeowners less likely to walk away from their properties, reduce their outstanding mortgage balance by 20 percent, and give them a government loan for that amount in its place.

This thinking is apparently based on the assumption that your typical American homeowner can't do simple addition.

The Problem Is Still Falling House Prices
The bailout bill doesn't get at the root of the credit crunch.
By MARTIN FELDSTEIN

A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.

...

We need a firewall to break the downward spiral of house prices. Here's how it might work. The federal government would offer any homeowner with a mortgage an opportunity to replace 20% of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. This would be available to new buyers as well as those with mortgages. The interest on that loan would reflect the government's cost of funds and could be as low as 2%. ...

Consider a homeowner who has a mortgage equal to 90% of the value of his home. The 15% decline in the value of his house that may be needed to bring it back to its prebubble level would shift that homeowner into negative equity. Further price declines would make default attractive. But the 20% mortgage replacement loan would take the loan-to-value ratio to 72% from 90%, making it unlikely that prices would fall far enough to push him into negative equity. An interest saving that could be as large as $3,000 a year would provide a strong incentive to accept the mortgage-replacement loan, even if the individual thinks that he might temporarily have a moderate level of negative equity.

This has got to be the stupidest idea I've ever heard.

The argument about a low-cost loan cutting back on monthly payments has a tiny degree of merit, but the idea that the homeowner is going to think about his mortgage obligation differently because it is split into two pieces is just plain dumb - especially if the new loan is full recourse and from the U.S. government!

The whole idea of somehow propping up home prices is just sickening and the notion that renowned economists still think the root cause of the current problem is falling home prices rather than the policies that allowed home prices to rise to their previous bubble heights - well, that's even more sickening.

(Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors)

Comments

[norespect:]

i believe FELDSTEIN, is talking about the solution not how we got here

2008 Oct 06 07:53 AM

[Dr. Jackpot:]

It's not affordability. It's disicipline. No spanking in school, etc. People walk away from loans because it's the trend and seems to work. It's like sex with your neighbor. You do it if everybody else is doing it. We need PENALTIES-----not cuddleing ! Walkaway's should be required to pay 5 years interest collected by the IRS over a lifetime if necessary. Realtors should be required to refund all commissions on a house they sold in foreclosure. And banks the same. You would see foreclosures drop to near zero. Plain old fashioned disicipline has disappeared into some vague notion of motherhood for all.

2008 Oct 06 08:46 AM

[Jim98:]

I'm not sure why everyone thinks it was only the banks and wall street that caused this crisis. What about realtors, and what about homeowners themselves? How many of them knowingly abused the system by taking out excessively large mortages and equity loans? How many of them are still in denial about the value of their property? House prices still need to go down 25-30% to be approaching fair value. Probably, a good solution would be have houses reappraised, adjust the value of mortgage accordingly, and figure out who will pay the difference. jd.

2008 Oct 06 08:52 AM

[Mr.G:]

Norespect I believe Tim is pointing out it is a lousy solution -the current solution to the crisis which is bailout ( I believe the sum is well over a trillion w/fnm AIG- bailout lehman) and print money will in no way resolve this crisis either but create another -not only that at this point , you have every asset on the planet (food -oil- metals- stocks-muni bonds corporate bonds residential /commercial real estate -gas) being liquidated or taking loses and going into cash - now what happens when all of that money being hoarded plus all the new money jumps back in the game -and releveraging of all the assets occurs -you are going to see inflation skyrocket at such a level that 30% interest rates will probabaly be below the norm - and you will also see the American consumer being wiped off the map .Already, some measures of money supply, the ultimate source of devaluation of a currency and inflation in the economy, show money growth running at an annual rate of more than 14%.

And in the last two weeks, that rate has exploded even higher, to an annualized growth rate of over 200%! Now it seems europe is jumping into the fold - so expect to see the same there .

There is no way that kind of monetary growth can be anything but inflationary and I doubt with the economy tanking it will result in wages keeping pace for the American consumer

2008 Oct 06 08:54 AM

[SeniorMoment:]

NORESPECT has it right. I like Feldstein's idea; this provides liquidity to lenders and improves their capital ratios, while relieving pressure on homeowners. Risk to taxpayers is low, especially compared to the wide open, poorly defined TARP. I can actually understand how this initiative would be implemented and most homeowners would understand it as well. The market's underwhelming reaction to TARP implies we'll be seeing more intervention to come from the government...this looks like a more transparent "investment" on their (our!) part than any other I've seen.

2008 Oct 06 08:58 AM

[techzone12:]

Dr. Jackpot! While you are at it, why not send homeowners to jail too!. It starting to sound like communism. You can not force people to stay in their homes. If they don't have enough of an incentive to stay then they will just continue to walk away. The 20% at 2% rate, is too little. In some markets the decline is a lot more than that.

2008 Oct 06 09:10 AM

[Smarty_Pants:]

I agree with the author. Dumb idea. Only someone with a degree in Keynesian economics would think splitting a mortgage into two parts is somehow "helping" the upside-down borrower.

Plus, anyone who is foolish enough to borrow from the government with full recourse would be asking for trouble. Ask anyone who is behind on their student loan payments. Miss a payment or two and the penalties and interest will multiply the balance due beyond the point where you will ever catch up, and the IRS will garnish your wages to get the money back.

As with any government "deal", the likely downside far outweighs the possible upside.

2008 Oct 06 09:14 AM

[No Free Cake:]

Ignoring the merits, if the federal govt wanted to make mortgages cheaper and hence encourage home retention, wouldn't it be quicker and cheaper to use tax policy? For example, allow everyone to deduct 100% of their mortgage payment even if they don't use Schedule A?

2008 Oct 06 09:22 AM

[svkoho:]

Tim, your last paragraph says it all. It seems likely that nothing anybody will do will stop the toilet from being flushed. Kissinger talking about the Balkans had a great comment: "Everything we do will be wrong, including doing nothing." Ditto.

2008 Oct 06 10:23 AM

[Shiv Kapoor:]

In fact home prices need to fall for the crisis to end. Home inventories are at record highs despite significant price correction. I reckon prices need to fall considerably before the market can absorb the inventory and allow normalcy to return. My reckoning is that a 30% to 40% peak to trough fall in values should return normalcy. This is why I think the bail out works - provided the government picks up the illiquid debt at reasonable values (50c to 60c on the $ max). This may well be more than mark to market value - but as far as I am concerned mark to market is a complete joke - here is why maxkapital.blogspot.co....

2008 Oct 06 10:46 AM

[Danny Newton:]

How much of this problem is demographic? We are in a situation where two generations can be retired at the same time. Many people are leaving their home state and looking for cheaper housing in less aggressive, taxwise, states.

2008 Oct 06 11:27 AM

[carey_jim:]

I'm propping up the price of my home by not selling it for less than a million dollars but I have no proper takers.

I'll never sell it to anyone who would pay less for it than I did. And you can take that to the bank.

2008 Oct 06 11:46 AM

[User 208341:]

Why not consider converting the troubled mortgages to 50 yr fixed rate
instruments. The exact rate I'm not exactly sure of, the key is to decide on a rate which will leave the homeowners more able to pay while preserving some kind of real value for the lenders.

2008 Oct 06 12:00 PM

[henarl:]

The trouble with the government changing the terms of existing mortgages is that they will have to totally destroy contract law. Any advantage given to one party in a contract will be a disadvantage to the other party. We will no longer be a country of laws but a country of arbitrary government edicts. Sound like Russia?

2008 Oct 06 02:09 PM