Alan Blinder gives details on how to structure a modern version of the depression-era HOLC program. The program is an attempt to reduce the number of foreclosures and stabilize financial markets:
How to Cast a Mortgage Lifeline?, by Alan S. Blinder, NY Times: The financial markets are downright scary. And it seems unlikely that we can extricate ourselves from the current series of rolling financial crises without improving the situation in three related markets: those for houses, mortgages and securities based on mortgages.
In a previous column for Sunday Business, I advocated one possible approach: creating a modern version of the Home Owners’ Loan Corporation, or HOLC, the Depression-era entity that bought up old mortgages and issued new, more affordable ones in their stead. ...
But this is one of those cases where the devil truly is in the details. How would it work in practice? Let’s concentrate on six major design issues:
STRUCTURE The original HOLC bought mortgages outright. But Representative Barney Frank, the Massachusetts Democrat, and Senator Christopher J. Dodd, Democrat of Connecticut, ... are now cooperating on a different ... approach [that] would use a beefed-up Federal Housing Administration to guarantee new mortgages ... instead of buying up old ones. The effects would be much the same: old, unaffordable mortgages would be replaced by new, affordable ones; and the government would then assume the risk of default. But in the Frank-Dodd proposal, the federal government would be a big insurer rather than a big bank. Because the approach actually has a chance of becoming law, let’s adopt its structure.
BAILOUTS The Frank-Dodd plan for a Super F.H.A. ... must not be too generous in shielding people and businesses from the consequences of their own bad decisions — both for economic reasons (to minimize moral hazard) and for political reasons (to gain voter support). So, what to do?
In the Frank-Dodd approach, existing mortgages would be bought below face value, forcing investors to ... “take a haircut.” But homeowners who get nice, new mortgages to replace their nasty old ones should also be made to pay for the privilege. If not, the Super F.H.A. would be flooded with applicants. So the proposal would make homeowners relinquish part of any price appreciation on their houses for as long as their Super F.H.A. mortgages remain in effect.
Good idea. But I’d go further, by also making beneficiaries of the plan forfeit the right to take out second mortgages or home equity loans.
LEGAL SAFE HARBOR ...[M]ost mortgages these days are bundled into pools, turned into marketable securities, and then sold to investors all over the world. ... To buy selected mortgages out of these pools, the Super F.H.A. must clear a legal hurdle. Servicers are petrified of lawsuits if they sell individual mortgages — which are, after all, owned by other people — “at a loss.” So, to unfreeze the market, Congress must pass legislation shielding servicers from legal liability when (as now) market conditions depress prices. ...
SETTING PRICES The HOLC bought pre-existing mortgages at a discount. The Super F.H.A. would use government guarantees to induce private businesses to do so. In either case, we need prices for the old mortgages.
Conceptually, the answer is simple: Haircuts should reflect current market values... But there is a problem: With the resale market for mortgages virtually shut down, there are hardly any market prices.
The draft legislation is vague on this point, perhaps necessarily so. My suggestion is that the Super F.H.A. categorize the mortgages ... into, say, “high,” “medium” and “low” qualities and, based on its best guesses of fair market value, post initial buying prices for each type.
Then it should adjust those prices according to whether mortgage owners rush in to sell (meaning that the prices were set too high) or stay away (meaning that the prices were set too low). Thus can the government synthesize a market until a real one re-emerges.
SUNSET Emergency measures must not outlast emergencies. ... The legislation will ... end the granting of Super F.H.A. mortgages after a few years.
ELIGIBILITY AND SCALE How large should the mop-up operation be? Mr. Frank and Mr. Dodd are thinking about one million to two million mortgages, but they understand that a larger number might be necessary to stem the downward spiral.
Clearly, we would limit Super F.H.A. to refinancing primary residences — no second homes or houses bought “on spec,” please. There should also be upper limits on both family income and house value — no McMansions. Beyond that, the Super F.H.A. would have to develop sensible criteria to screen out applicants who can afford their current mortgages without any help and those who cannot afford even new, less onerous mortgages.
The urgency of creating something like the HOLC or a Super F.H.A. has grown ... since I wrote my previous column. Credit markets remain traumatized despite [an] aggressive ... Federal Reserve. ...
Now we have the Frank-Dodd proposal, which, while not a panacea, offers a smart approach to a knotty set of problems — an approach that should breathe some life into the housing market, the mortgage market and the related securities markets. Their design is not flawless. But do you know of any perfect solutions? It deserves our support.