Bailing Out Underwater Mortgages
Ronald Reagan's chief economist has a radical plan for solving the housing crisis.
Martin Feldstein, a Harvard ecoomics professor who chaired Ronald Reagan’s Council of Economic Advisors, calls for a radical write-down of underwater mortgages.
HOMES are the primary form of wealth for most Americans. Since the housing bubble burst in 2006, the wealth of American homeowners has fallen by some $9 trillion, or nearly 40 percent. In the 12 months ending in June, house values fell by more than $1 trillion, or 8 percent. That sharp fall in wealth means less consumer spending, leading to less business production and fewer jobs.
But for political reasons, both the Obama administration and Republican leaders in Congress have resisted the only real solution: permanently reducing the mortgage debt hanging over America. The resistance is understandable. Voters don’t want their tax dollars used to help some homeowners who could afford to pay their mortgages but choose not to because they can default instead, and simply walk away. And voters don’t want to provide any more help to the banks that made loans that have gone sour.
Most residential mortgages are effectively nonrecourse loans, meaning creditors can eventually take the house if the homeowner defaults, but cannot take other assets or earnings. Individuals with substantial excess mortgage debt therefore have a strong incentive to stop paying; they can often stay in their homes for a year or more before the property is foreclosed and they are forced to move.
The overhang of mortgage debt prevents homeowners from moving to areas where there are better job prospects and from using home equity to finance small business start-ups and expansions. And because their current mortgages exceed the value of their homes, they cannot free up cash by refinancing at low interest rates.
To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. If everyone eligible participated, the one-time cost would be under $350 billion. Here’s how such a policy might work:
If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. For the millions of underwater mortgages that are held by Fannie Mae and Freddie Mac, the government would just be paying itself. And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home. This would all be voluntary.
The notion of write-downs has been out there for some time but this is the first time I’ve seen the “full recourse” twist. Then again, I don’t read the economics literature all that closely.
This proposal makes a lot of sense, in that being trapped in an underwater mortgage has all manner of cascading effects, as Feldstein alludes to. Politically, though, it’s a non-starter because it once again rewards those who made bad choices at the expense of those who didn’t.
The DC area housing market, like our economy generally, was hit less severely than most of the country. Still, our house is worth less than it was when we bought it five years ago. But we’d also benefited from the previous bubble, having sold my house before we got married and then hers a few months later. We rolled that money into the financing of this one, putting down a much larger than necessary down payment. The net result is that, while we no longer have the 20 percent equity needed to refinance, we’re not underwater either.
So, we’re talking about 11 million homes where either values have gone down way more than the national average, the owners put down little or no down payment, or both. It’s going to be really hard to convince their neighbors, who deferred gratification until they could put down substantial down payments, to pony up the money to bail them out.
Fairness aside, it may well be the right thing to do to get us out from under this mess. And this is yet another data point in the story of the changing definition of conservative in America. Again, Feldstein was Ronald Reagan’s chief economist. Can you imagine a Tea Party conservative coming out with this plan?