Saturday, September 27, 2008

A "Bail Out" Proposal that the Median Voter Will Support

Congress cares about what the voters want. The median voter is a home owner. Home owners want their key asset to go up in price. Chris Mayer proposes a solution to reduce defaults and prop up home prices. He wants to lower interest rates down to their historical spread. If people could borrow at these interest rates (financed with "bail out" $), then demand for housing would rise, home prices would rise and defaults would slow down.

His proposal would redistribute income to the middle class at the expense of the poor and the rich. Why? The poor are renters so they would now face higher prices for housing and they are tax payers and part of their taxes would go to subsidizing the interest rates of home buyers. The rich would face higher taxes due to the progressive nature of the tax code and the rich will want "Jumbo" loans (greater than $700,000) and thus won't qualify for these subsidies that Mayer proposes.

I must admit that there is a key detail in all of this that I don't get. Suppose that the Treasury took the set of homes where the owners have defaulted on their mortgages and auctioned them off to new buyers at lower prices. Yes, Wall Street would take a loss but how much capital has been destroyed?

So, suppose that 3 million homes are in foreclosure. That sounds quite large.
Suppose that they were worth $400,000 each and now are worth $200,000 each. That's a whopping 50% decline in average prices.

that is "destruction" of 600 billion dollars. Where does 700 billion come from? That's the bailout number.

I'm not a macro economist. What "multiplier effect" am I ignoring?

Here is Chris Mayer's plan.

New York Times
September 27, 2008
Op-Ed Contributor
Help Housing

A T the heart of the financial crisis is an unprecedented decline in house prices. Yet the government response so far has been to try to prop up insolvent financial institutions while doing nothing about the underlying housing problem. The proposed Wall Street bailout would not stop the next wave of defaults, which are coming from the rapidly rising delinquencies in near-prime mortgages.

The government needs to directly stabilize the housing market. This is equivalent to treating the infection with antibiotics, instead of applying a cold compress for the fever. Both the fever and the infection need treating.

The first step should be to reduce mortgage interest rates. In a normal mortgage market, rates are about 1.6 percentage points above the interest rate for 10-year Treasury notes. Recently, the difference has been closer to 2.5 percentage points.

The government is in a great position to cut rates by about a point: Through Fannie Mae, Freddie Mac and the Federal Housing Administration, it now controls nearly 90 percent of all mortgage originations. These lower rates would apply to most home buyers who take out a loan under $729,750 for a house that they will live in.

Along with lower rates, the government should provide temporary down-payment assistance for buyers. The government could, for example, match the amount of money that buyers use for a down payment, up to $15,000. Because the government now controls the bulk of all mortgage financing, this money could be provided directly at closing. Homeowners who refinance their current mortgages could also receive assistance, allowing them to avoid foreclosure.

Programs like these would draw buyers into the housing market and reduce the backlog of unsold and vacant homes. Investors and speculators would be ineligible and would face the full cost of their mistakes.

By stabilizing house prices, these programs would benefit the bulk of Americans, who own a home but did not get involved in the subprime mortgage market. Price stability would more directly achieve the goals of the Wall Street bailout: increase the value of mortgage-backed securities (by increasing the value of the underlying houses) while injecting government capital into the financial system.

Some in Congress have suggested allowing homeowners to go to bankruptcy court to lower their mortgage payments. But this would only make credit more expensive by reducing the willingness of companies to lend money. It would also worsen the current problems by letting bankruptcy judges reduce mortgage balances — imposing even greater losses on the owners of the mortgages, whose problems are at the heart of the financial crisis. Such a program would also be limited to only the most indebted and, in some cases, financially irresponsible homeowners.

Some might argue that propping up house prices is what got us into this mess. But with the recent decline in house prices, my calculations suggest that the cost of owning a home today, relative to renting, is about 10 percent lower than its average over the past 20 years.

The credit crisis will not be over until house prices stop falling. Direct assistance for home buyers and homeowners is the best, and the fairest, way to make that happen.

Chris Mayer is a professor of real estate and the senior vice dean of Columbia Business School.


ylDave said...

The bailout plan is a bad idea. We're better sending out a financial swat team to help the unsophisticated sub-prime borrower get his finances in order and help him downsize if he is overextended.


Anonymous said...

I like your ideas. It addresses the longer term stability of the under lying assets. This bailout plan isn't really about mortgages though. It's about the availability of overnight, unsecured debt to keep the machinery running.

Whether investors revalue the properties, or the Feds revalue the properties, the values must fall. As an investor, that is the cost of doing business, we’ll take credits on our taxes for years to come for these loses. As a Taxpayer though, I’m offended at the notion that I am the unwilling holder of these assets at the end of the day.
Even the insurance program proposed promises to shift the burden to the government, which ultimately are us.

The recent move to support FANN / FRED / AIG is a sufficient burden to place upon the taxpayer with long term effects. To increase that burden further would be an insult, and a resignation of the trust we place in our representatives.

There are systems in place that will resolve this in time. Do not jeopardize our future by rushing to support assets of little worth.

On Monday morning, like the balance of last week, banks and money market account managers will be less likely to lend overnight nearly as much of the billions and billions of dollars they normally lend because some will be needed at the home office for normal business reserves.

The fact that in the previous several years they borrowed and re tendered the money daily to squeeze out a couple fractions of a percent before moving it on to the next guy ultimately had them moving 20-30 times more debt than they really had deposits to cover. Shame on them; and this is the overvalued system my reps are rushing to use my future to shore up.

As a taxpayer, I have no intention to own anymore of this, or insure it's presumed value for that matter.

Either way, my dollars are going to be worth less by the end of next week. Whether the shops on Wall street have to write down their assets, or whether my trusted representatives borrow me into oblivion from China, or our rich oil producing friends to perpetuate this mess.

Anonymous said...

The problem with this well written article, is that it is based on a false assumption. That at the heart of this "crisis" is and unprecented decline in housing prices. This just isn't factual. We have seen several declines similar to this, since and including the great depression. The last occured in 1980. The heart of any devaluation crisis almost always is excess valuation. Caused by the Fed's lame policy of oversupplying money, artificially depressing interest rates below sane standards, record budget deficits, which have the same effect of causing monetary oversupply, record trade deficits that promote foreign purchase of US securities, which supply debt. Inflation needed to occur somewhere and housing was the spot. Add to that, banks loaning in near criminal ways, traders and brokers bundling risky paper to make it look desirable, and profits everywhere and you have a recipe for disaster. All these activities increase asset valuation which in turn, increases the wealth and portfolios of the already priviledged, which lends questions about why their was no oversight? Why stop something that is making you and your rich friends even richer, even if your job is to "regulate" this? The answer certainly is not the "bailout", which tries to again artificially inflate values and get us back to the same cliff we fell from. Values are returning to where they should be, according to whatever is left of our "free market" and to fight this is just to cause further danger and weakness in the economy. Nothing really needs to be done, except to get out financial house in better order[deficits, credit, etc.] and help those who truly need help, the hungry and those without any homes, and wait for natural forces to right the ship and continue our sail.