Martin Feldstein: How to Stop the Mortgage Crisis

Martin Feldstein has a plan to reduce mortgage loan defaults:

How to Stop the Mortgage Crisis, by Martin Feldstein, Commentary, WSJ: The potential collapse of house prices, accompanied by widespread mortgage defaults, is a major threat to the American economy. A voluntary loan-substitution program could reduce the number of defaults and dampen the decline in house prices -- without violating contracts, bailing out lenders or borrowers, or increasing government spending. ...

Limiting the number of ... defaults ... requires a public policy to reduce the ... value of mortgages. None of the current mortgage-reduction proposals are satisfactory. ... If the government is to reduce significantly the number of future defaults, something fundamentally different is needed. Although there is no perfect plan, a program of federal mortgage-paydown loans to individuals, secured by future income..., could ... cut future defaults.

Here's one way that such a program might work:

The federal government would lend each participant 20% of that individual's current mortgage, with a 15-year payback period and an adjustable interest rate based on what the government pays on two-year Treasury debt (now just 1.6%). The loan proceeds would immediately reduce the borrower's primary mortgage, cutting interest and principal payments by 20%. Participation in the program would be voluntary...

Although individuals who accept the loan would not be lowering their total debt, they would pay less in total interest. In exchange for that reduction in interest, they would decrease the amount of the debt that they can escape by defaulting on their mortgage. The debt to the government would still have to be paid, even if they default on their mortgage.

Participation will therefore not be attractive to those whose mortgages that already exceed the value of their homes. But for the vast majority of other homeowners, the loan-substitution program would provide an attractive opportunity. ... They will participate if they prefer the certainty of an immediate and permanent reduction in their interest cost to the possible option of defaulting later if the price of their own home falls substantially. ...

The current possibility of widespread defaults is a cloud over all mortgage-backed securities, and over credit markets generally...

To lower the risk of a downward spiral of house prices and to revive the frozen credit markets, the government must move quickly to reduce the potential number of mortgage defaults. A loan substitution program may be the best way to achieve that.

Another solution that has been proposed is for lenders take "haircuts" on loans.... Richard Green says:

Should lenders take haircuts to stave off default?, by Richard Green: It is a tempting solution to the current problem: for those whose mortgage balance is greater than their house value, cram down the loan owed to the value of the house. This will presumably reduce the probability of default substantially, and losses will (largely) be borne by those who took on the lending risk. Ben Bernanke likes the idea, and he knows a lot more about financial crises than I.

But two serious problems stand out. First, future investors could respond by requiring higher spreads for mortgages. If these spreads get capitalized into values, the borrowers whose loans got crammed down could find themselves under water again, and the problem will remain.

Second, there is an issue of fairness. Consider two borrowers, one of whom has a 20 percent down payment, and the second of whom has a 5 percent down payment. If house prices decline by 10 percent, the second borrower gets debt forgiveness, while the first one doesn't. Perhaps the first casualty of financial crises is fairness, but as a policy matter, it is hard to ignore the problem.

I like Feldstein's idea better than the haircut proposal, though I can't imagine it actually happening and if it did I have no idea how many people would participate so it's hard to say if it would make a substantial difference. There is one aspect he doesn't mention. I'm not quite sure how the government avoids default risk without substantial loan collection costs, and even with aggressive and costly collection not all default can be avoided. I suppose the government could take future tax returns, Social Security payments, etc. in the case of default, but each additional restriction the government puts in place to protect itself will make the loans less popular and limit the program's effectiveness. The government could also avoid any losses from defaults by setting the interest rate high enough (spreading the losses among borrowers), but the higher interest rate would also limit participation. In the end, it's hard to imagine the government not taking some losses from this program, especially if participation is widespread, and the since the losses the government absorbs would be seen as some sort of bailout to lenders, the proposal would likely face political opposition. Or am I missing something here?

Comments

[Spectator]

We are all socialists now. Why trickle it out? May as well nationalize the entire housing market, the whole enchilada.

Let's move onto the next market where we can privatize the profits and socialize the losses.

[Reducing]

Reducing the mortgage interest rate to 1.6% would probably do it. Home values will probably sky rocket, increasing the property tax intake (paid for with a 2nd home loan). Might have to reduce everyone's mortgage interest rates to make it politically popular though. Future mortgage will all have to be gov guaranteed though, as no one in their right mind would buy a 1.6% mortgage without an iron clad gov guarantee. As a matter of fact, once the flight to safety ends, no one at all will want to buy them.

This is a very effective way to convince foreign savers to stop lending to us. Maybe they will buy our exports instead, instead of free loading by not consuming. We can create more money to make all future domestic loans. Changing the CPI calculation methodology again, and telling the public prices are stable, will keep inflationary expectations under control. Don't worry about where the purchasing power will come from. The hapless workers/retired workers/extinct monetary unit savers will never know what hit them.

It will keep things going for awhile yet (maybe decades). The system is not stable in the long run, but can be patched up with creative effort in the intermediate run.

[johnchx]

Note to Professor Feldstein: over my dead body!

First of all, this is simply a five-hundred basis point gift to everyone with a mortgage (letting them borrow at 1.6% to pay down debt at, say, 6.6%). And the size of the gift is proportionate to the size of the mortgage balance...so if I owe $600,000 on my downtown condo, I get six times the gift that goes to someone with a $100,000 farmhouse in rural Ohio. Notice also that LTV doesn't seem to be a factor, so most of the gift will go to people who are nowhere near defaulting.

I think this is probably the worst quasi-bailout I've seen yet. What the heck has happened to Martin Feldstein?

[Reducing]

When the system finally does collapse, simply issue a new currency the way Germany did after their hyper inflation. Keep it stable long enough to inspire confidence in it as a monetary store of value, then the above process can slowly be repeated. I am starting to see the pattern emerging. Its just a matter of figuring out where we are in the cycle, and monitoring whether policy is sufficient to avert collapse in the near future.

A system that is inherently stable long term is not needed. Just a system that can adapt to emerging threats to short term stability, along with a willingness to periodically reset the system (issue a new currency). Monitoring how purchasing power is transferred between groups at various stages in the cycle will show the most likely winners and losers from current short term adaptations.

[peterbob]

The Feldstein plan would probably not affect the majority of foreclosures. A major reason for foreclosures is not high interest rate but rather dropping prices. And since prices will likely fall another 10% or more, this plan will not change anyone's mind about sending "jingle mail."

But on a much more fundamental level, why in the world are so many people trying to stop foreclosures? Letting bubble prices fall to fundamental levels is a good thing. It makes housing affordable. It gives future generations a chance to buy. Only when prices come down will sales start to come up.

This is an important point that almost everyone is missing. There are gains from trade. If prices are stuck at bubble levels, then there will be fewer sales. From an economic standpoint, society is worse off if people are willing to pay the the marginal cost of housing but they are unable to do so. This is the trouble with monopolies, since they restrict sales.

The only reason to worry about housing (unless you are going to admit that you want to help specific groups, like current homeowners, which to me is NOT the reason for intervention) is to prevent a financial collapse. But then the most direct solution is for the government to keep credit flowing. So keep lowering interest rates, or heck, start making direct loans to businesses for new investment (I think that the Fed has the power to do this, but I could be wrong).

[Lafayette]

Article: The federal government would lend each participant 20% of that individual's current mortgage, with a 15-year payback period and an adjustable interest rate based on what the government pays on two-year Treasury debt (now just 1.6%). The loan proceeds would immediately reduce the borrower's primary mortgage, cutting interest and principal payments by 20%. Participation in the program would be voluntary...

This is ostensibly a solution, but it does bail out the Mortgage Industry for causing a problem of its own making. That is a dangerous precedent and will only invite similar laxity from the industry in the future ... as it goes off the deep end whenever it craves profits at all costs.

For securing the loan, I'd ask the lender to accept lower rates AND THEN the above measure could kick-in -- but at lower, more palatable long-term interest rate payments on the bulk of the loan. I'd also make sure that no monies are given to owners, but the entire process be managed by a government-created intermediary agency positioning itself between the lender and the borrower.

If the government starts handing out money to people foolish enough to get into this mess, they are quite likely to take the money and walk.

[ndd]

What Johnchx says.

Why on earth should any American from here on evermore not get into debt up to their eyeballs? You get really cool upscale stuff, and then you get bailed out too!

(I say that as someone who has taken heat elsewhere just for saying nice things about the OTS proposal, which is entirely voluntary!)

[zinc]

I don't like Martin's plan. The shift in risk is too the speculator, er, homeowner while the risk shifters (mortgage writers) get a walk.

A better approach might be that the morgage writers take a tax deductible, capital loss for up to 20+ % of the original price and then agree to underwrite a 30 year fixed, 5 pct, fully assumable loan on the residual. They can participipate in any gain on sale for the life of the loan up to the original principle.

For this privelege, the USGov will insure the loan but retain rights to the assumable loan if they end up owning the damn thing.

The loans will be available only for existing homes and for anyone the bank wants to take the capital loss and underwrite. Maybe the below market financing will stabilize the bloated prices while new homes adjust downward to the equilibrium price level which is probably 25 % below where they are now.

[chris]

While the doctors argue about which treatment is best, the patient will languish and die, and that of course will solve the problem. LOL.

[groucho]

"What the heck has happened to Martin Feldstein?"

Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.
- John Maynard Keynes

It IS a telling sign of the desperation of "the Scribblers".

As one of the "scribblers", his main goal is to try and keep "a John Law legacy" out of the history books.

At this point I'm following Meltzer for what is prudent and ethical. The scribblers that got us into this mess will try just about anything(remember Greenspan endorsing Iraq war for "oil economics"?)to keep their failed policies going.

Let's kick the can down the road another mile or two and hope we're long gone before the can "blows up".

[freemarket]

"downward spiral of house prices"

The MUST go down because they are to high to be affordable to the majority of people. Martin Feldstein the crisis will pass once prices drop enough for people to qualify for loans. In other words let markets allocate capital efficiently. At current valuations allocating capital to buy a house is not efficient

[paine]

its not fun
(at least not for most of us )
playing mortgage ogre

mark i suspect
has a certain uneasy feeling
as he combs the lice out
of both
the hair brain schemes
and the uncle sap scams

i say relief is relief
only if its timely sufficient
and generous to a fault
give it now
and
thru uncle's free mint

but
penalty penalty

find the loose credit high hock rate
intentional pushers and wack em

try to be civil of course
but
i'd say fraud was the key
to plutonic paradise's here
so fraud oughta yank em back to dirty reality too

go after the fraudsters

[groucho]

Ironic, after the fall of communism you would have thought that private market free enterprise would be the winning strategy.

Instead we end up with market socialism through nationalization of asset losses.

Nationalism usually leads to war. Maybe we should vote for McCain as an insurance plan in case WW3 is just around the corner?

[paine]

free market

" let markets allocate capital efficiently"

lot backed 30 year mortgages ??

where's the efficiency found ??

a second best guess at lot "optimal values" ??

in the real world
efficiency improving conjectural cases
could be made (given actually incomplete markets)
for almost
any rate change

at some time or other
we'll be righter then wrong
or wronger then right ...

get me ???

if not
you may be
like my pet song bird ...

sweet to the ear
but without a deep clue

ps
letting lots of
weeble hi fi wanna bes
play capitalist
efficiency master mind
on the open areas
of the internet
has its life enriching
howlerations

[paine]

"At this point I'm following Meltzer for what is prudent and ethical"

better i guess then following ...oral roberts
but not much

since in the long run you'll be dead
and might meet oral's lord

speaking of the rock of ages
any chance
the almighty one's son
is a gold bug
or even a monetarist

i know he can't be a fiat prankster
like goethe's mephisto

well at least surely
the holy ghost's not a fiatist

he has infinite velocity ...

[save_the_rustbelt]

There is no way to prevent an ugly result.

The only hope is to control the ugliness.

Economists are very skilled at looking at the big picture, they are not, in general good at understanding individual transactions.

It is the castor oil theory, better to gulp than to sip. Take our medicine and move on (and yes there will be a human toll either way).

[baileyman]

Dean Baker's cramdown idea has attractive attributes. Force lenders to become landlords (the cramdown), then they reap capitalist pain, former owners lose their investment, but people still have houses to live in.

[paine]

ndd
"..I say that as someone who has taken heat elsewhere "

apparently not enough heat

to borrow up to the eye balls
some one has to lend to you

if foreclosure is a voluntary act
then these collection agents
of the beknighted bag holders
must see it as their very own personal
prefered
least lost/most profit option

too many
potential
stray agency /principal
interest contradictions
flying around here

[paine]

Force lenders to become landlords (the cramdown), then they reap capitalist pain

not necessarily so
"collectors"
might gain more by processing the sour deals
then the sound ones

the name names
jail terms for everyone
and wealth rake backs too of course
will require a jouvet mind set
a wrath directed at
the lender demonics
not
the borrower heels

ultimately
the flame thrower
needs to be
turned on the whole
private profit
home value shylocking system

but not till the ass hole
venal borrowing public
is safely if humbly
sheltered by uncle

says...

"speaking of the rock of ages
any chance
the almighty one's son
is a gold bug
or even a monetarist"

paine, the only "oral roberts" I'm familiar with is Tawney "oral" Roberts. I believe Bill Clinton use to get "advice" from her. (says she gave "good phone")

[paine]

rusty
"It is the castor oil theory, better to gulp than to sip. Take our medicine and move on (and yes there will be a human toll either way)."
castor oil ??
shades of aunt ironsides
and the black shirts

i can hardly agree less

yes swift massive action
but generous and relief bringing
at least
for the debtful householders

such "human "
polonian transgressions
hardly "deserve "
the squadristi treatment

and as to the other side of these squalid "deals "

patience
is the motto

relentless patience

in the official and posse type
civil court headed track down
of all the lender culprits

[ken melvin]

http://calculatedrisk.blogspot.com/2008/03/jumbo-conforming-loan-guidelines.html

1. Fixed rates can be sold to Fannie on or after April 1; ARMs on or after May 1. The loan has to be closed on or after March 1 to be subject to the following rules; inventory loans (closed from last July to March) have to be subject to a "negotiated commitment."

[paine]

"why in the world are so many people trying to stop foreclosures? Letting bubble prices fall to fundamental levels is a good thing. It makes housing affordable. It gives future generations a chance to buy. Only when prices come down will sales start to come up.

This is an important point that almost everyone is missing"

maybe we're not missing the point
but only trying
to put the mostest part of the total loss
as lot values drop
where that loss belongs
on the bubble makers
not the bubble victims

[paine]

reducing

flash points
a few good uns

but
to know all
by itself
is not to change anything

what action is called for
go to
"do xyz now "
not sit tight with
" i got it all figured "

[wimpie]

wiki on John Law:

"The system however encouraged speculation in shares in 'The Company of the Indies' (the shares becoming a sort of paper currency) and inflation. In 1720 the bank and company were united and Law was appointed Controller General of Finances to attract capital. Law's pioneering note-issuing bank was extremely successful until it collapsed and caused an economic crisis in France and across Europe.

Law exaggerated the wealth of Louisiana with an effective marketing scheme, which led to wild speculation on the shares of the company in 1719. In February 1720 it was valued for a very high future cash flow at 10,000 livres. Shares rose from 500 livres in 1719 to as much as 15,000 livres in the first half of 1720, but by the summer of 1720, there was a sudden decline in confidence, leading to a 97 per cent decline in market capitalization by 1721. Predictably, the 'bubble' burst at the end of 1720, when opponents of the financier attempted en masse to convert their notes into specie. By the end of 1720 Philippe II dismissed Law, who then fled from France.

Law initially moved to Brussels in impoverished circumstances. He spent the next few years gambling in Rome, Copenhagen and Venice but never regained his former prosperity. Law realised he would never return to France when Phillipe II died suddenly in 1723 and was granted permission to return to London having received a pardon in 1719. He lived in London for four years and then moved to Venice where he contracted pneumonia and died a poor man in 1729."

some things never change........let's hope the current instigators meet the same fate as Law.

[paine]

"We are all socialists now. Why trickle it out? May as well nationalize the entire housing market, the whole enchilada.

Let's move onto the next market where we can privatize the profits and socialize the losses."

who's the real man
behind the irony mask

of course
a lot of us
might try to privatize gain
and socialize loss... if we could

this after all
after the s and l
is round two of such
credit institutional looting

the agenda calls for
not just some exemplary hangings
like hanoi johnny's friend keating got
for the last big raid
but massive shylock crucifixions

[paine]

jouvet ???

javert

[paine]

insight for my friends

i think
i despise
fatty delong
out of pure grain
180 proof envy

the mirrorgazzzin
nar-lad in me
sez

"how come
his hot air gets
sniffed in
by thousands of eee gerr nostrils
while MY ME ME I's
no more pale gas
gets ........comment cage consignment

is there no injustice
amerika won't sleep thru ???

[paine]

John Law:

now there's a guy
i'd like to be like

bubble pioneer ???
far more

the very doctor faustus
of modern credit
driven paper towers

[bakho]

What is the downside of letting housing prices collapse? What is the downside of a lot of people walking away from mortgages?
Why should the taxpayers be interested in a bailout?

Conversely, what are the downsides of propping up bubble prices for houses? What are the effects on future home buyers (who will see no gain from home purchases)? Is there less downside from allowing the air to come out of housing price bubbles all at once?

[bullbust]

Why the panic?

There never was a bubble. People were buying houses because they could afford it. Prices went up because.. er..because ..incomes were going up. Jim Hamilton explained it. The Fed researchers explained it. The NAR explained it.

If people are not paying their mortgages, its not because they cant afford it. They are just not honoring their debt. Make them pay.

/sarcasm (for the irony impaired)

To lower the risk of a downward spiral of house prices and to revive the frozen credit markets,

Where were these maestros when prices went up? ONE fool decides to pay 250,000 more for a ONE house, and suddenly EVERY house is up 250,000. No wage increase, no increase in any income(rent, dividends), no productivity increase, nothing. The price of all houses went up. Wealth out of thin air.

And this FOOL's equity is considered as savings and wealth. Now people are panicking because this FOOL's equity has disappeared. There are no more fools to buy at reckless prices.

Maybe we should handout money to fools, so that they can buy and keep comps higher.

[robertdfeinman]

Why does no one look at the Japanese experience. When real estate prices got out of whack and firms (instead of homeowners) could no longer pay, the loans were just marked "non-performing".

The government allowed them to remain on the books at full value and everyone pretended things were fine. It took about a decade for things to work themselves out, but there was no panic.

I think the problem this time is that there are still those in the US who are anxious to get back into the game and a stand down that lasts years isn't to their liking.

What would happen if foreclosures were just suspended and owners were required to work out new payment schedules?

Any plan which lowers the monthly cost of borrowing (say by government intervention) is just going to translate into higher home prices. Is this the idea, allow prices to re-inflate so that people can start flipping again?

[bullbust]

http://seattletimes.nwsource.com/html/businesstechnology/2004263699_wamu06.html

WaMu rewrites execs' bonus plan to dodge subprime damage

WaMu has revised its bonus plan for nearly 3,000 top executives so continuing damage from the subprime-lending collapse won't crimp their annual awards.

The struggling Seattle-based lender said in a regulatory filing Monday it will exclude the cost of soured real-estate loans and foreclosure expenses when it calculates net operating profit, the biggest component of executives' 2008 bonuses.

Other changes to the bonus plan also appear to reduce the impact of troubled parts of its business, while giving a bigger role to factors that are less problematic.

[paine]

house lot value = " FOOL's equity "

yup

[ken melvin]

Bankers prosper as banks suffer
Report shows execs did well; now panel in Congress will probe compensation

Top banking industry executives earned hundreds of millions of dollars through their salary, retirement and stock sales last year while their companies got scorched by the mortgage market meltdown, a congressional report said Thursday.

The report comes a day before Rep. Henry Waxman is expected to grill Angelo Mozilo, chief executive officer of Countrywide Financial Corp., former Citigroup Chief Executive Officer Charles Prince and Stanley O'Neal, former CEO of Merrill Lynch & Co. In calling the hearing of his Oversight and Government Reform Committee, Waxman, D-Los Angeles, said he'll look into whether their "level of compensation is justified."

With the three companies losing a combined $20 billion in the second half of 2007, Waxman wants to know how much the top executives are taking home - and had his staff review internal documents and Securities and Exchange Commission filings to find out.

The report said Mozilo received more than $120 million in compensation and stock sales last year. O'Neal left Merrill Lynch in October with $161.5 million in stock, options and retirement benefits, after leaving the brokerage with its biggest-ever quarterly loss. Prince left with a $10 million bonus, $28 million in stock and options, and $1.5 million in other perks when he left Citigroup in autumn, according to the report.

Spokesmen for Citigroup and Merrill Lynch declined to comment, while a Countrywide spokesman could not be reached for comment.

Republicans blasted Waxman's inquiry, with Rep. Tom Davis of Virginia, the House oversight committee's top Republican, calling it "a sanctimonious search for scapegoats."

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/03/07/BU5HVF438.DTL&hw=bankers&sn=001&sc=1000

[Julio]

I see nothing in this whole mess that a good bout of inflation will not cure.

Even the meortgage-holders win this time, if the mortgages get reevaluated upwards because more houses are over-water and fewer default.

Where's the downside? It's not a rhetorical question -- I keep hoping one of you more knowledgeable folks will explain it...

[save_the_rustbelt]

Paine:

Had castor oil once - hope you avoid the experience.

At this moment there is a house hearing on CEO compensation that includes the CEO of Countrywide (such a sun tan - life is good for the wealthy). Check CNBC is you are close to a television.

[Fred]

Yet another complicated scheme when what is needed is something very simple. Namely, a massive tax cut (starting with the poor and working upwards) so that the budget deficit balloons to $2 trillion or thereabouts. Accompany this with a RISE in interest rates so as to push the dollar back up and eliminate the price inflation caused by the weak dollar. Finally, slap on an across the board tariff to avoid letting the budget deficit stimulus leak away into a trade deficit. Then stand back and watch while a wildfire of bankrupcties burns the system clean of all the bad debt while the huge budget deficit and tariff prevents a collapse in aggregate demand.

The Fed needs fine-tuning control over all forms of economic policy (monetary policy via the overnight rate, fiscal policy via a threshold for payroll and income taxes, trade policy via the tariff rate) so they aren't forced to resort strictly to monetary policy.

[paine]

fred on the money as usual

" a massive tax cut starting with the poor and working upwards "

exactly

make it a payroll tax
job bonus rebate of massive scope and size
sure make it temporary
but tie its phase out
to a wage rate index
that only zeros out when
we have a return
to robust wage rate increases

given our job ethic
who could quibble with that

[paine]

ahh but like the red sox of old
he blows it in the late innings

"Accompany this with a RISE in interest rates so as to push the dollar back up and eliminate the price inflation caused by the weak dollar. "

pure lunacy

beat the asians to death with targeted tariffs
calibrated to neutralize their fiddled forex
and ready to abate automatically as their cureency rises to ppp levels

we need to close the trade gap
before we can close the wage gap

as to inflation

lets take head on any
price tsunami
bound our way
from a lower dollar forex rate

i suspect it will be far less then
wally world capital export oriented
agitprop
would leads us to expect

[Fred]

price tsunami
bound our way
from a lower dollar forex rate

Yes, I didn't explain correctly why it is low interest rates are bad right now. To the extent that low interest rates push the dollar down, that is equivalent to imposing an across-the-board tariff and not a problem. But low interest rates also facilitate hedge fund speculation, which IS is a problem. Higher interest rates, at least temporarily, will crush all this speculation for once and for all. After enough hedge fund blowups and bank failures to put the fear of God back into Wall Street, then sure, loose monetary policy is again a viable option for the Fed.

[billy]

Higher interest rates, at least temporarily, will crush all this speculation for once and for all.

That can always be done via margin requirements. But that is in the power of the Fed to set, and they have vehemently opposed any suggestions to use it.

In fact, almost all of the current turmoil can be boiled down to this very issue. For eg: Carlyle had ~3% and leveraged it 32 times. A 3% change in valuation and its creditors started making margin calls.

How did Carlyle get the money? Borrowed from the banks, made possible since the repeal of Glass-Stegall.

Current foreclosure crisis? Same. Not enough skin in the game as down payments.

Everything has been said before, but since nobody listens we have to keep going back and beginning all over again. - Andre Gide

[paine]

"low interest rates also facilitate hedge fund speculation"

not if their credit inflow is regulated
by strict reserve moves
to strengthen their balance sheets

of course the hedge funds will need to be reg able
and this will require imposing on their freedoms

but as u suggest
let tight credit
blow one or two of em up
and the rest will bow to uncle

he who must be obeyed

low policy rates and tight credit channels
are not mutually exclusive
just as we can drop mortgage rates but up income qualifications to counter the borrowing capacity effect

[John V]

And George McGovern gets shafted?

He also had an Op Ed in the WSJ today.

[Peter Schaeffer]

The folks over at Calculated Risk (http://calculatedrisk.blogspot.com/search/label/You%20Must%20Be%20Kidding) have a few comments on this plan. They are not positive.

"The Feldman Plan: Just Get Yourself a Latte
Via Housing Wire, I just read Teh Dumbest mortgage-related proposal I think I have yet seen."

"OK, so we are going to ignore piggybacks (people do have more than one mortgage, you know), so we don't have to ask whether the second lien lender gets all the repayment, or what. We are going to ignore prepayment penalties that apply to substantial partial prepayments. We are going to ignore those sacred contractual rights lenders have to require you to continue to make the payment specified in your loan documents even if you make a partial prepayment (it takes a modification agreement to change the contractual payment). We are going to ignore the lack of a credit risk premium.

We are not going to ignore the elementary math of amortization. Not today.

Let's just pretend we have a single lien mortgage loan. The original loan amount was $200,000 at 8.5% for 30 years, and just for entertainment purposes we'll say the loan has been amortizing and it is now two years old. It's either a fixed rate or a "frozen teaser," so the rate is still 8.5% going forward. The original P&I was $1,537.83 and the current loan balance is $196,842.51.

We turn that into a 28-year 8.5% loan for $157,474.01, plus a 15-year 1.6% loan for $39,368.50. That gives us a first mortgage payment of $1,230.26 and a second mortgage payment of $246.15. Firing up my trusty 10-key, I see that totals to $1,476.42, or a 4% reduction in the total monthly payment.

A monthly savings of $61.41! Oh Lord, they'll flock to this!"

The CR post goes on further. I recommend it.

[Jas Jain]

--
US is full of rogue economists involved in promoting public policies to punish 80%+ of the working people to help crooks and imbeciles.

Federal Reserve is full of rogue economists who can’t identify bubbles or don’t think that bubbles can be prevented at all. Fed couldn’t prevent the housing bubble? It is like saying that Hitler and Himmler couldn’t stop the murder of innocent Jews. Sorry for the analogy but the point must be made about these liars.

Under the guidance of these rogue economists the whole financial system has been turned into a legally sanctioned criminal enterprise with full support of the Fed and the USG when needed.

The future of such an economy is not in doubt.

Jas

[William Anderson]

Please make sure that this idea gets to someone who can seriously consider it!

How to Fix the Housing Dilema:

The problem is way beyond sub prime. As prices go down further, people who have put $150k down are starting to walk away too.

As buyers keep waiting to buy, due to dropping prices, the problem continues to grow. If we can help put a floor under values we can stop this costly spiral meltdown. Benanke's idea to forgive principal is good, but the following idea is an easier and less costly way for the government to make people want to stay in their homes.

Lets create an FDIC sticker for a home like the one on the window at the bank. It basically insures that if you put money in youll get money back later. Lenders currently protect themselves with PMI (Private mortgage insurance). We should make this available to home buyers, that if they agree to hold the home for a least X number of years that the value will be insured if they have to sell after that time. The owners could make a small payment per month to pay for the insurance. Buyers would not wait any longer to start buying again and this would put a floor of confidence under the market.

At some point in the future a smart insurance company who is already recognizing a bottom in the market anyway could step and make a lot of money at low risk. Government could encourage the insurance industry to create an FDIC like insurance that would stop this spiral down dead in its tracks.

[RobertV]

This is not a principal problem but an Amortization and OAS problem. Lowering principal will only exacerbate the current issue as lenders/banks will have a moving/falling goal post of appraised values. Presented with that dynamic, banks which are already undercapitalized, will become even more restrictive on loan terms as they will not be able to tell who will opt for "putable" principal in their current portfolios. Not to mention the legal issue of who would take the principal hit in homes that consist of first and second position mortgages. Is the Prof. suggesting that second position (heloc) home equity with no rights should now be senior to first mortgage position as customers voluntarily ask for a reduction on principal? A better solution needs to lower payments through a classic supply side stimulus and prepayment combination. Banks should be allowed to pass through a government paid subsidy of 3% (300 Basis Points) on two types of mortgages (only) a 15 year fix and a 20 year fix upto 110% of the value of primary and secondary homes only (no investment property or commercial) with no dollar cap. This product would create faster prepayment speeds off a 3% 15 Year and a 3%20 Year bank product. Thus the note rate is 6% but the borrowers effective interest rate for tax purposes is 3% (coupon of 6% minus the government subsidy of 3%). By switching the entire mortgage system to amortizing payments all previously securitized products begin to prepay lifting current depressed CDO values.

While the mortgage market tends to be symetrical, interms of cash flow, around 5.50%. Duration and prepayment are not symetrical and skew heavily. By offering a government subsidy in conjunction with shorter amortization and 110% leverage, housing will stabalize, tax receipts at the treasury will go up over time (as tax deductible interest is caped at 3%) and a much needed stimulus will hit the economy now. Prof. Feldstein misses the mark that current Fed Policy is handcuffed by Prime Floating Rate Arms with no term out duration product available on an OAS basis. Why if I have a 4.5% floating rate ARM (current reset rate on Treasury Based ARM) would I opt for a 7% 30 Fix or 6.% 5/1 ARM? A principal reduction does nothing to correct this OAS problem and will distort home values block by block as consumers opt in or opt out. To de-lever the system in an orderly fashion mortgages need to become callable bonds again and not putable equity as it is now. Adding optionality is not an answer. As the stimulus suggested takes effect leverage could be withdrawn from the system first on an LTV basis 110% down to 100% then on a subsidy basis 3% to 2.5% etc. This action would collectively stabalize households at the micro level, stimulate the economy on a tax swap basis (up front subsidy now/ higher pay roll taxes later), true up home prices by offering temporary leverage which amortizes quickly and most important frees the Federal reserves hand. Kep in mind a future rate hike has no effect on an Amortizing loan but is devestating to ARM products. Lastly homeowners who amortize are less likely to abandon their property even if the original leverage was high.

[Chidambaram]

Date: Wed, 15 Oct 2008 11:17:10 -0700 (PDT)
From: Chidambaram P
Subject: Getting Creative around the US Mortgage Crisis...
To: bsetser@cfr. org

The Sixty-Year Mortgage: (Mortgage Banker gets around 20% stake in the home equity)

Hello Dr. Setser,

Please go through this interesting proposed solution to the current global economic crisis!


This solution requires very little regulatory intervention and involves absolutely no cost to the tax payer. Yet it will ensure a rapid recovery of mortgage markets, solve the liquidity crisis and avoid a global recession.


Hopefully the product described here will actually enter the market and solve the current crisis.

Also, please post this on your very interesting blog if possible.


There are four policy objectives with respect to the U.S. mortgage crisis:
1) Ordinary people living in their own home need to be empowered to stay in their home without having to default their mortgage payment and have the bank foreclose on them.
2) The housing market needs to receive a stimulus to arrest the downward trend in home prices and avert further decline in economic growth.
3) Mortgage bankers who have either already booked losses or are likely to book more losses need to be recapitalized so that liquidity in the financial system can be ensured.
4) All of the above objectives need to be met without much of an impact on the U.S. taxpayer.


All of the above objectives can be easily met with the introduction of a new commerical financial product, largely within the bounds of the existing regulatory system; but with a couple of small innovations to the current structure of a typical mortgage product.

The new mortgage product required to solve the problem is a simple mortgage loan from any private mortgage banker or other relevant private financial institution.

Though the mortgage loan will be like any other existing mortgage loan product, there will be two modifications to the product:

1) Both the mortgage banker and the borrower will have the right to foreclose the mortgage with due notice. (While I believe this is currently the case from a legal perspective it is very rare for the mortgage banker to actually exercise their right to foreclose unless there is a default by the borrower. The new product will specifically stipulate that the mortgage banker can foreclose the loan at their option with due notice, irrespective of the borrower's payment history)

2) In case the borrower should choose to foreclose their loan, or transfer it to another party, 20% of the proceeds of the sale will accrue to the mortgage banker and only 80% of the proceeds of the sale will be received by the borrower. The same would apply in case the mortgage banker should choose to foreclose from their side.

3) The term of the mortgage loan will be 60 years instead of 30 years.
a) In the event the borrower is deceased prior to the expiry of 60 years, the home will revert to the ownership of the mortgage banker.
b) The only exception to b) above would be that the borrower will have the right to bequeath the home, provided the person receiving the home continues to make the mortgage payments as usual.
c) The borrower will not be compelled by the mortgage banker to take out life & disability insurance to the extent of the mortgage principal and assign it to the bank only as a result of this increased term. The current practice on this will be followed.

4) One important change in the product will be that the mortgage banker will have norms enabling them to lend out the higher of the following two amounts:
a) The current market value of the home (as determined by a valuation, as happends right now)
b) The pay off amount on an existing mortgage loan on the home.


I request you to carefully evaluate the impact that the introduction of this new product or a similar product will have on the U.S. mortgage market and it's beneficiary impact on the current global financial situation.

Expected Impact:

Consider a typical problem right now:

The borrower has an outstanding pay off amount of say $300,000/= on their mortgage. They are unable to afford the monthly mortgage payment and they have less equity in their home than the outstanding pay off amount. The market value of the home is only $220,000/=.

A new lender might be willing to re-finance but the existing banker has to agree to book a loss for this to happen.

In either case, the borrower is not in a good situation to afford the payment.

A new lender can now come in and offer a Sixty Years' mortgage product to this borrower. The lender is very motivated to do this because the lender will be able to
1) Charge a high interest for this product(say around 20% ... 20% is becoming a favorite number here for me :-) )

2) Benefit from a future sale of the home at a higher price. It's important to remember that according to the terms proposed here the lender has a 20% equity stake in the home.

For the borrower the benefit is that they will be able to stay in their home while making a much reduced monthly mortgage payment. In the longer term appreciation in the price of land will ensure that they will more than make up any losses from having to pay 20% of their home equity to the bank.

For the existing lender, there is absolutely no problem because they will realize the pay off amount from the new mortgage in case the market value is lower than the outstanding loan.

Questions and Answers:
1) If the mortgage term is extended to 60 years, will everybody want to move to this structure?
The answer is no, because taking this loan means that the borrower loses 20% of the value of the home to the mortgage banker.
Only somebody who is very serious about staying in their own home for a long term, and who is also currently distressed, will avail of this loan.

2) How long will the 60 year mortgage actually carry on?
Probably within a period of less than 2 years from now, all the 60 year mortgages will disappear from the market. This is because both the banker and the borrower are motivated to foreclose this mortgage as soon as the home values appreciate around 20%. The banker will want to book a high profit. The borrower will want to keep all of the home price appreciation as their own profit.

Please note that some changes to the 20% equity proposed for the mortgage banker might be needed. In any case the market will ensure an appropriate percentage is arrived at.

3) Will a renter want to take this mortgage?
A renter who plans to stay for a short while will not want to go for this. This is because they will be liable to go bankrupt or pay 20% of the home sale proceeds to the bank.
A long term renter will want to go for this, and afterwards they will have the motivations as any other borrower above.

4) Will owners of 2nd and 3rd homes, or speculative real estate investors go for this?
Some of them will, depending on their intention to wait for a sufficient time till the home values appreciate much beyond 20%. But somebody with a short term outlook will not go for this, again because the bank holds a 20% equity stake in the home, which reduces the speculative profits.

5) Will this product solve the global crisis?
Yes, because many lenders will be motivated to come into the market again, borrowers are a plenty and the value of the homes will increase in the short terms since the payments on a 60 year term will be around twice as affordable.

6) Should there be any regulatory or systemic changes related to the introduction of this product?
The only change might be that in future whenever the home underneath a Sixty Year mortgage is sold, it would have to be through an open auction where both the banker and the borrower are present; or to have some other mechanism to ensure mutual agreement that the home is being sold at it's correct value.



Please add to this reasoning any further insights you may have. Also, please propose any modifications you might like to.

Best regards,
Chidambaram