We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify.
The direct cost of this plan would be modest for the 85% of mortgages where the homeowner owes less on the house than it is worth. Lower interest rates will mean higher overall house prices. The government now controls nearly 90% of the mortgage market and can (and should) act on this realization. Remove the refinancing option and you can have lower rates without substantial cost to the taxpayer. Homeowners would have to give up the right to refinance their mortgage if rates fall, although homeowners could pay off their mortgage by selling their home. For borrowers with lower credit scores, the mortgage rate would be greater than 5.25%, but it would be less than their current rate.
Now, what about mortgages on homes that are worth less than the total amount of the loan? These mortgages could be refinanced into a 30-year fixed-rate loan to be held by a new agency modeled on the 1930s-era Homeowners Loan Corporation. New mortgages would be made of up 95% of the current value of a home.
The government might use two approaches to mitigate its losses. It could offer owners and servicers the opportunity to split the losses on refinancing a mortgage with the new agency. Servicers would have to agree to accept these refinancings on all or none of their mortgages, to avoid cherry-picking. Or the government should take an equity position in return for the mortgage write-down so that the taxpayers profit when the housing market turns around.
Our calculations based on deeds and Census data suggest that the total amount of negative equity for all owner-occupied houses is $593 billion. However, capping an individual's write-down to $75,000 would reduce the government's total liability to $338 billion and cover 68% of individuals with negative equity. Even this loss will be reduced as the proposal spelled out here raises housing values and economic activity, and contemplates loss sharing with lenders, hopefully matching the experience of the old Homeowners Loan Corporation.
While the net cost is modest compared with many plans on the table, it would require that the government could assume trillions of dollars of additional mortgages on its balance sheet. But we have already crossed this bridge with the explicit "conservatorship" of Fannie Mae and Freddie Mac. In any event, these mortgages would be backed by houses and the verified ability to repay the debt by millions of Americans. In addition, by putting a floor under house prices, this proposal would raise the value to taxpayers of trillions of existing home mortgage assets already owned or guaranteed by the FDIC, the Fed, the Treasury, Fannie Mae and Freddie Mac, among others.
Improvements in household and financial institution balance sheets will increase investment and consumer spending, which will mitigate the extent of the current downturn. Americans, on average, spend about 5% of the equity of their homes on consumer goods and services. So if home prices increased 10% above where they would have been without government intervention, we estimate consumers will have an additional $100 billion annually to spend.
Thursday, October 02, 2008
Glenn Hubbard's $340 billion rescue alternative
Hubbard is my choice for Bernanke's backup:
Posted by Caveat Bettor at 1:18 PM