There was a New York Times editorial today calling for providing relief to the housing market through aggressive policy:
Tens of millions of Americans are being crushed by the overhang of mortgage debt. And Congress and the White House have yet to figure out that the economy will not recover until housing recovers — and that won’t happen without a robust effort to curb foreclosures by modifying troubled mortgage loans….
The administration needs better ideas. It can start by working with Fannie Mae and Freddie Mac, the government-run mortgage companies, to aggressively reduce the principal balances on underwater loans and to make refinancing easier for underwater borrowers. If the president championed aggressive action, and Fannie and Freddie, which back most new mortgages, also made it clear to banks that they expect principal reductions, the banks would feel considerable pressure to go along….
Reducing principal is a better solution than lowering interest rates, because it reduces payments and restores equity. Bankers resist, because it could force them to recognize losses they would prefer to delay. The administration has resisted, in part because principal reductions are seen as rewarding reckless borrowers….
Housing advocates and bankruptcy experts are calling for the administration to try new approaches. One would have Fannie and Freddie urge banks to let underwater borrowers who file for bankruptcy apply their monthly mortgage payments to principal for five years — in effect, reducing the loan’s interest rate to zero.
Another solution would be for Fannie and Freddie to ease the rule for refinancing underwater mortgages for borrowers who are current in their payments. The lower payments on refinanced loans would help to prevent defaults and free up money for borrowers to use for paying down principal or consumer spending.
President Obama is reportedly planning to include housing relief measures in his new jobs plan. Unless the plan includes strong support for principal reductions and easier refinancings, it will not get at the root of the problem: too much mortgage debt and too little relief.
This reflects a lot of other analysis, including New Bottom Line’s recent report “Win-Win Solution” that calls for principle writedowns to create a million jobs.
Jonathan Cohn wrote about how any new stimulus that is proposed needs to be focused on three things: size, speed and smarts. Jared Bernstein’s FAST stimulus program is an example of this. I think getting the housing and foreclosure markets under control is a good idea in and of itself; an added benefit is that it’ll help with the recovery. Stimulus provided through allowing underwater homeowners to refinance into record-low interest rates and sharing the losses fairly between homeowners and creditors with reduced principal payments hits all three of Cohn’s remarks. Plus it is possible, because it can potentially be done by sidestepping Congress.
Let’s stick with the simpler one of mass refinancing of underwater mortgages; we’ll come back to principal write-downs in future posts, but they apply even more to all three categories. For size, Columbia Stern NYU economics professor Chris Mayer argues that getting homeowners who are underwater to refinance into record-low rates “Fannie Mae and Freddie Mac could face a one-time loss of $40 billion to $60 billion because the new HARP loans would pay lower interest rates, Mayer said. The cost would be offset by fewer defaults and it would put $50 billion to $70 billion a year in homeowners’ pockets, he said.” (Here’s an FAQ he wrote on this.) That’s a fair amount of money for stimulus – not enough to get us where we need to go, but definitely something.
Even better, once the can is kicked speed is going to be relatively quick. There’s no environmental review to conduct or long-delay in actually getting this into motion; underwater consumers who want to knock a few hundred dollars off their mortgages are well-incentivized to initiate, carry out and make sure this gets completed themselves. It outsources much of the bureaucratic requirements to those consumers who stand to benefit.
Also it is well targeted to help the economy where it is hurting the most. There is a direct correlation between the amount of underwater mortgages and unemployment (and the relationship holds for states with deeply underwater mortgages and unemployment):
(Data source.) This stimulus will go to those places most impacted by the housing collapse, places with high unemployment that could use additional demand.
For those of you who worry about propensity to consume and/or the inter-temporal consequences of government debt, stimulus driven through the housing market will act just like a permanent tax cut. The locked-in reduction in rates will be a permanent increase in income from the point of view of the household, giving us an absolutely great bang-for-the-buck in terms of stimulus. For those of you who worry about deleveraging and possible cascading effects of foreclosures, lower rates will mean lower-payments which will reduce the risks of foreclosures. Consumers can delever in a quicker and less risky, or in high-foreclosure areas deeply uncertain, way.
All in all, a great approach to helping the economy. I hope it is a major part of the jobs package being put together for next month.