Stabilize House Prices, Part 1

October 5, 2008
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“We are in a vicious cycle: falling housing values cause losses on securities, which reduce bank capital, thereby tightening lending and causing house prices to fall further. The cycle has spread beyond housing, but housing is the place to fix it.” – R. Glenn Hubbard and Chris Mayer.

I find it very interesting that conservative economists, who have been and are, in general, against government regulation and interference, and who believe that government should allow a free market system to be free, are coming up with ideas to save us from the financial crisis. That these plans include and revolve around the U.S. government, and ultimately the tax payer, in a very big way can be construed as an indication of the economists’ new-found flexibility or an indication of how bad the financial crisis really is.  Or it may be the recognition that the U.S. government is already so heavily involved in the financial system that these economists are seeking to do the least amount of harm.

First, Let’s Stabilize Home Prices by R. Glenn Hubbard and Chris Mayer, which appeared in the October 2nd issue of The Wall Street Journal, is a good example.

Millions of homeowners owe more on their mortgage than their house is worth. Foreclosures are accelerating. House prices continue to fall, weakening household balance sheets and the balance sheets of financial institutions.

But this can stop. The price of a home is partially dependent on the mortgage rate — a lower mortgage rate raises house prices.

We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify.

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.

In addition to focusing on the very real problem in the housing market, the plan could be implemented immediately. As a result of the U.S. government’s conservatorship of Fannie Mae and Freddie Mac, origination of new mortgages can be financed quickly. Congress would have to raise the overall borrowing limit and approve the new federal purchases of negative equity loans. But it will likely take the Treasury much longer to buy troubled assets than Fannie and Freddie, and it would have to seek the involvement of many additional private actors, as opposed to using vehicles already in place.

To be continued

“Mr. Hubbard, dean of Columbia Business School, was chairman of the Council of Economic Advisers under President George W. Bush. Mr. Mayer is a professor of finance and economics and senior vice dean of Columbia Business School.”

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