Thursday, October 21, 2010

Solving the Housing Mess

There actually is a solution to the foreclosure mess which would go a long way to solving the underlying mortgage mess, increase consumer spending, cut tens of billions from the deficit and in all probability be the ultimate October Surprise that retains Democratic control of Congress and probably would reelect the President in 2012. It could be done with the combined power and authority of the Executive Branch in conjunction with the Federal Reserve.

It is the automatic refinancing of all outstanding mortgages to the currently available interest rates. The Fed has pushed down interest rates as low as they can – to almost zero between banks and to 4.25% for 30 year loans as of today. That should be resulting in a vast wave of refinancing – people bringing their 6%, 7% or 8% loans down to 4.25% -- unleashing a large effective increase in consumer spending. But the banks will not refinance because they require adequate collateral – house has to be well above water – and great credit history and employment prospects – which has become increasing rate in this economy. Those requirements would make perfect sense if we were talking about new customers coming in for new loans. But the bank is already on the hook for that borrower’s negative equity and ability to pay.
Decreasing the interest rates actually decreases the likelihood of default because the homeowner has a lower monthly “nut” to come up with.

At this point through the various existing loan guarantees and the government bail outs of Fannie Mae and Fredie Mac, the Treasury is already backstopping a vast number of these loans already. I wonder if part a driver of the foreclosure is that the banks need to foreclose to collect on the Federal guarantees. The Federal Reserve is practically giving the banks money by providing it at zero percent interest, so requiring some of those savings to trickle down to the consumers is perfectly fair.

Extending this lower interest rate to all homeowners overcomes the gut level moral objections to the helping those in trouble – “why should the deadbeats who can’t pay their mortgages and the people who bought houses beyond their means be bailed out?” But with this program, the evil “They” are only be helped to the exact same extent as the hardworking homeowners who have struggled to make every mortgage payment on time.

Doing this automatic mortgage interest rate reset would actually be a great help to the Federal Budget. The Mortgage Home Interest Deduction is by far the largest itemized deduction on personal income taxes. The Urban Institute calculates it as $131 billion in forgone revenue a year. So if home interest was suddenly 40% less overall, the Treasury would take in additional $40 billion per year.

The foreclosure document crisis could be used as the carrot and stick to get the banks to reduce these interest charges. Refinancing everyone would produce a set of good clean documents, that hopefully the financial institutions could keep track of going forward. The President could also use his Pardon Power to free those who agree to these terms from the threat of civil or criminal prosecution. Finally for those who don’t agree, in addition to the threat of criminal prosecution, they could be cut off from future sale of their mortgages to Fannie and Freddie, which puts them effectively out of the mortgage business. And if that isn’t enough, the Fed can shut their access to the zero percent money window.

All of this can be done without Congressional action. It simply requires the act of will on the part of the Administration and to a lesser extent the Bernanke and the Federal Reserve (which is looking for new ways to help the economy now that interest rates can’t decline any further.)

Although, of course, the jolt it would give the economy and the help on the deficit are the most important things. But consider the political impact – after a day of high level meetings with Bernanke and various agency heads and perhaps bank heads – Obama announces this program from the Oval Office in a prime time address. And with those words, every homeowner would know that this President had significantly reduced their mortgage payments. (Someone owing $400K with a 7.25% mortgage would save a thousand dollars a month). Let the Republicans rail against it and call it an Election stunt. This would be the change that we could believe in.