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Sunday, December 21, 2008

"Effective Nationalization of the Mortgage Finance Sector"

James Kwak says it's likely that the new administration will get behind the Hubbard and Mayer plan to have Fannie and Freddie buy mortgages and refinance them at 4.5%:

We Have a Winner?, by James Kwak: After seeing dozens of mortgage proposals emerge over the past several months, there are news stories that Larry Summers and the Obama economic team are converging on an unlikely candidate: the proposal by Glenn Hubbard and Christopher Mayer... Hubbard and Mayer published a summary of the plan in the WSJ last week; a longer version of the op-ed is available from their web site; and you can also download the full paper, with all the models.

I say “unlikely” not only because Hubbard was the chairman of President Bush’s Council of Economic Advisors, but because it doesn’t look like a Democratic plan; then again, it doesn’t look much like a Republican plan, either. ... Before getting to the policy specifics, though, I want to outline two of the premises...

First, Hubbard and Mayer, like many others, have the goal of preventing an overcorrection on the downside (housing prices falling further than where they need to go to be reasonable). But unlike many others, they have calculated where prices need to go, and one of their central arguments is that we are already there, and therefore housing prices should be propped up right now. This was surprising to me, since I am familiar with Case-Shiller charts like this one from Calculated Risk..., which seem to show prices still more than 50% above their 2000 levels (nominal prices, but in a low inflation environment). ...

Second, Hubbard and Mayer argue that housing prices are mainly a function of real mortgage rates. While they acknowledge that other factors took over at the peak of the boom, their model shows that most housing price appreciation through 2005 was due to fundamentals, primarily low mortgage rates. ... Right now, they argue, mortgage rates are historically high relative to Treasury bond yields, and those high mortgage rates are pushing housing prices below their long-term levels. (Mortgage rates are only historically high because Treasury yields are world-historically low, but we’ll come back to that.)

Given those premises, the policy proposal is simple: force mortgage rates down to 4.5% (by reducing the cost of Fannie/Freddie debt relative to Treasuries), thereby propping up housing prices at a level that Hubbard and Mayer think is sustainable. ...

Now here’s the surprising part. In order for these mortgages to rejuvenate the housing market, they have to be available to everyone. This isn’t a program for reducing mortgage foreclosures; this is a program for boosting housing sales and refinancings across the board. ...

The goals of the program are to stop the slide in housing prices, stimulate the economy by unfreezing home sales and through the wealth effect of increased housing prices, and stabilize the value of mortgage-backed securities, thereby aiding the financial sector. ...

One question is whether the loans will be sustainable. ... Fannie and Freddie could face the problem of getting stuck with riskier mortgages while the private sector keeps the better ones. But in any case there are signs that some version of this plan will be brought to the floor.

Brad DeLong:

Glenn Hubbard and Charlie Mayer call for the effective nationalization of the mortgage finance sector. ... All in all, I approve of the plan: having Fannie and Freddie buy up mortgages at market prices and refinance them at 4.5% could do a lot of good for the country and make a fortune for the government.

I am, however, gobsmacked to see Glenn Hubbard proposing it.

    Posted by on Sunday, December 21, 2008 at 10:17 AM in Economics, Housing, Policy | Permalink  TrackBack (0)  Comments (57)

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