October 5, 2008
The success or failure of the governments newly enacted bailout plan may rest on stabilizing the housing market. Two Columbia Business School economists have offered a plan to do just that, by shoring up the mortgage market and stabilizing home prices.
Writing in The Wall Street Journal, economists R. Glenn Hubbard and Chris Mayer call on the government to push down residential mortgage rates to 5.25%, close to where mortgage rates would be in a normally functioning mortgage market and matching the lowest mortgage rate in the past 30 years.
The authors point out that falling housing values have caused the credit market to seize up, perpetuating further declines in house prices and contributing significantly to the current financial mess. They propose lowering the mortgage rate to stop this decline, with the following terms:
• Homeowners would have to give up the right to refinance their mortgage if rates fall, although they would have the option of paying off their mortgages if they sell their homes.
• For borrowers with lower credit scores, the mortgage rate would be greater than 5.25% but likely less than their current rate.
Negative equity
Mortgages on homes that are worth less than the total amount of the loan (homes with "negative equity") could be refinanced into 30-year fixed-rate loans to be held by a new agency modeled after the 1930s-era Home Owners' Loan Corporation.
The new agency would split the losses on refinancing a mortgage with servicers and owners and take an equity position in return for the write-down (which could be capped to limit liability), allowing taxpayers to profit once the market recovers.
Expected outcomes include:
• Raising the value to taxpayers of trillions of dollars worth of existing home mortgage assets already owned or guaranteed by the FDIC, the Fed, the Treasury, Fannie Mae and Freddie Mac, by putting a floor under house prices.
• Recapitalizing the banking industry by moving an appreciable amount of mortgages off bank balance sheets to the government's balance sheet.
• Increased investment and consumer spending (an estimated additional $100 billion annually) in response to improvements in household and financial institution balance sheets.
• Restoring the confidence of potential new homebuyers and reducing housing inventory by making owner-occupied housing more affordable. (In a recent study, Chris Mayer has shown that the cost of buying a house is now 10 to 15% lower than the cost of renting in most parts of the country.
The authors conclude that this plan could be enacted quickly, as the government now controls nearly 90 percent of the mortgage market. They predict the cost to taxpayers would be modest: while the government could end up assuming trillions of dollars of additional mortgages on its balance sheet, these would be backed by houses and the verified ability of millions of Americans to pay back the debt.
Finally, they suggest that this plan would help the economy independent of the Emergency Economic Stabilization Act of 2008 passed by Congress. Stabilizing house prices increases the value of the securities that the government would buy, thereby minimizing the net cost to taxpayers if the plan currently before Congress were to be implemented, they say.
