The Senate passed a sweetened-up version of the $700 billion Wall Street bailout–sorry, Mainstreet rescue–bill. The House is supposed to take it up on Friday. In the meantime, we will continue to post about alternatives.
Yale economists Jonathan G.S. Koppell and William N. Goetzmann point out that the reason the assets are “toxic” is that certain people can’t pay their mortgages. And if government buys them, the people STILL won’t be able to pay their mortgages. So here is another way to spend that $700 billion:
The financial crisis is a liquidity crisis, yes, but it is ultimately a product of homeowner failures to pay. Unless this fundamental problem is fixed, we will continue to see — and need to treat — the symptoms. The proposed bailout ignores this. Yet the sum being demanded from taxpayers is almost certainly more than sufficient to pay off all currently delinquent mortgages.
If the government did this, all the complex derivatives based on these mortgages would be as good as U.S. Treasuries. Their fair value would jump to 100 cents on the dollar, rescuing teetering financial institutions. The credit markets would be resuscitated overnight. Foreclosures would stop. . . .
Implementation could follow the example of the Home Owners’ Loan Corp., which in the 1930s issued new mortgages to a quarter of American homeowners. The government could offer to refinance all mortgages issued in the past five years with a fixed-rate, 30-year mortgage at 6 percent. No credit scores, no questions asked; just pay off the principal of the existing mortgage with a government check. If monthly payments are still too high, homeowners could reduce their indebtedness in exchange for a share of the future price appreciation of the house. That is, the government would take an ownership interest in the house just as it would take an ownership interest in the financial institutions that would be bailed out under the Treasury’s plan.
All this could be done through the Federal Housing Administration, with the help of Fannie Mae and Freddie Mac, which have the infrastructure to implement this plan rapidly. An equity participation structure would prevent thousands of foreclosed homes from being dumped on a strained housing market and would allow prices to reach a new equilibrium that is based on realistic demand for houses rather than on easy money or impending foreclosures.