Wednesday, October 08, 2008

All In?

About the only thing that happened in last night's debate that attracted any real attention was McCain's proposal to have the government step in to help people who are upside down on their mortgages:

As president of the United States, Alan, I would order the secretary of the treasury to immediately buy up the bad home loan mortgages in America and renegotiate at the new value of those homes -- at the diminished value of those homes and let people be able to make those -- be able to make those payments and stay in their homes.

The immediate reaction from many conservative pundits was far from positive. Part of the problem may have been with McCain's presentation of the plan itself. I assume that what he's proposing is similar to the plan put forward by R. Glenn Hubbard and Chris Mayer in last Thursday's WSJ:

The government might use two approaches to mitigate its losses. It could offer owners and servicers the opportunity to split the losses on refinancing a mortgage with the new agency. Servicers would have to agree to accept these refinancings on all or none of their mortgages, to avoid cherry-picking. Or the government should take an equity position in return for the mortgage write-down so that the taxpayers profit when the housing market turns around.

Our calculations based on deeds and Census data suggest that the total amount of negative equity for all owner-occupied houses is $593 billion. However, capping an individual's write-down to $75,000 would reduce the government's total liability to $338 billion and cover 68% of individuals with negative equity. Even this loss will be reduced as the proposal spelled out here raises housing values and economic activity, and contemplates loss sharing with lenders, hopefully matching the experience of the old Homeowners Loan Corporation.

While the net cost is modest compared with many plans on the table, it would require that the government could assume trillions of dollars of additional mortgages on its balance sheet. But we have already crossed this bridge with the explicit "conservatorship" of Fannie Mae and Freddie Mac. In any event, these mortgages would be backed by houses and the verified ability to repay the debt by millions of Americans. In addition, by putting a floor under house prices, this proposal would raise the value to taxpayers of trillions of existing home mortgage assets already owned or guaranteed by the FDIC, the Fed, the Treasury, Fannie Mae and Freddie Mac, among others.

Improvements in household and financial institution balance sheets will increase investment and consumer spending, which will mitigate the extent of the current downturn. Americans, on average, spend about 5% of the equity of their homes on consumer goods and services. So if home prices increased 10% above where they would have been without government intervention, we estimate consumers will have an additional $100 billion annually to spend.

Like the $700 billion bailout, no one is crazy about the government having to intervene in this manner. However, as this story in today's WSJ (sub req) makes clear, the problem of homeowners being "under water" is a very real one:

About 75.5 million U.S. households own the homes they live in. After a housing slump that has pushed values down 30% in some areas, roughly 12 million households, or 16%, owe more than their homes are worth, according to Moody's

The comparable figures were roughly 4% under water in 2006 and 6% last year, says the firm's chief economist, Mark Zandi, who adds that "it is very possible that there will ultimately be more homeowners under water in this period than any time in our history."

Among people who bought within the past five years, it's worse: 29% are under water on their mortgages, according to an estimate by real-estate Web site

With the government already so thoroughly ingratiated in the mortgage market, this might be the most prudent way to guarantee our current investments and help keep the economy from sinking further. In for a dime, in for a dollar.

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