Monday, March 8, 2010

A Fix For the Economy: Buy Mortgages Down by 33%

OK.  I have an idea. 
Here’s the problem.  25% of homeowners are underwater on their mortgages right now.  That’s unbelievable.  It’s horrible.  I’m surprised things aren’t much, much worse in the general economy. 
From 1996-2006, home values skyrocketed.  In California they approximately tripled.  In Washington they more than doubled.  A lot of people received the magical gift of massive new equity in their homes.  Let’s look at an imaginary couple, Bob and Sue, who bought a house in 1997 for $500,000, putting down $50,000 and borrowing $450,000.  By 2002, that home could easily have been worth $800,000.  Bob and Sue were worth $50,000 when they bought the house, plus their cash on hand, investments if any and, let’s say, an IRA.  Suddenly, they had $350,000 in their house (plus their cash on hand, investments if any and their IRA).  We’re rich!  We’re rich! 
Bob and Sue could borrow against their new equity, refinancing their $450,000 mortgage into a new $750,000 mortgage, giving them $300,000 in cash after they pay off the old mortgage.  Times a million couples in the US, that bought a lot of vacations, remodels, cars, evenings out, feel good contributions to the Sierra Club, espresso machines and snazzy new outfits.  Good times.
Now the market has changed.  Bob and Sue’s home is worth let’s say $550,000.  Oops.  They’re way underwater.  Not only is there no more money available in the refinancing well, but their “net worth” is negative (and plus -- their jobs are less secure in the new economy).  Yikes.  It’s a financial nightmare.  People living financial nightmares usually aren’t in the mood to spend. 
Bob and Sue’s situation is common.  It’s easy to see why consumer spending, which is 70% of the economy, declined.
It’s also easy to see why banks aren’t lending very much, despite the TARP money.  Firstly, Bob and Sue are not going to be inclined to borrow any time soon and their credit rating is horrible anyway (even if they haven’t missed payments, they’re overleveraged).    Beyond that, the value of real estate is now perceived, rightly, as insecure. Lending now against real estate is like catching a falling knife.  Banks can hope we’re at the bottom, but what if we’re not?  What happens to the bank’s money then?  Will there be TARP money to save them again if the market goes down another 30%?  Maybe yes, maybe no, right?  So banks are reluctant to lend and if they do, they want 33% down, not 5-10% down.  The only entity doing any mortgage lending these days is the federal government.  Banks won’t lend until the economy is looking good. 
OK so we’re basically hosed, right?  Bob and Sue feel poor.  They are either going to walk away from their house and destroy their credit rating, in which case they won’t spend, or they will continue under the burden of their inflated mortgage, in which case they also won’t spend.  If real estate appreciates at 3.5% per year going forward, Bob and Sue will have $50,000 of equity in their house again in 9 years.  They will feel poor that whole time. 
That is bad because despite their foibles, Bob and Sue drive the economy.  Bob and Sue are us.  If they don’t spend, we get the Great Depression II.  Whether you like Bob and Sue or not, it’s in your interest to have them be happy and to have them feeling kind of affluent.  This is the key to our economy.
Today we’re basically like a teenager who had a large drunken party while his parents were away and woke up with his house trashed, his Dad’s car crashed and “IDIOT” written on his forehead in Magic Marker. 
It’s like Barney Frank slipped us a roofie. 
Is there any way to uncrash Dad’s new car?  My idea has its risks, but I think would be better than 9 years of a zombie economy. 
What we need is for Bob and Sue’s mortgage to be $500,000, 33% below its current level of $750,000.  This would restore their $50,000 in equity.  We need Mr. Wolf from Pulp Fiction.  We need to make it like last night’s party never happened. 
Like the solution to so many problems, it can be done but it’s not cheap.  What I propose is that we buy down all residential mortgages in the US by 33%.  Yup, you heard me.  The total value of US residential mortgages is $11.3 trillion.  So this would require $3.8 trillion.  It would not be easy but it would be possible.
At the same time we would have to change the rules around mortgage lending to make sure we never did that again.  We would have to establish minimum credit standards that make it much more likely that if someone borrows against a house, they’re good for it.  This is what most countries do.  Is it harder to buy a house in Italy than in the US?  Yes.  Did they have a crazy mortgage real estate bubble?  No.   (I can’t believe we’re taking economic lessons from freakin’ Italy.  Ugggh.)
Some of this money would be a windfall to Bob and Sue.  Real estate prices might decline as the market became more liquid (more people would sell because they wouldn’t fear a short sale on their house like they do now) but Bob and Sue would definitely benefit.  Is that fair?  Do they deserve it?  Not really, I guess, but at least we get our economy back. 

No comments:

Post a Comment