10.18.2008

First, Let's Stabilize Home Prices - WSJ.com - Sent Using Google Toolbar

First, Let's Stabilize Home Prices - WSJ.com

First, Let's Stabilize Home Prices

By R. GLENN HUBBARD and CHRIS MAYER

more in Opinion »

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.

Housing starts are at their lowest level since the early 1980s, while there are more vacant houses than at any time since the Census Bureau started keeping such data in 1960. 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.

The historical spread of the 30-year, fixed-rate conforming mortgage over 10-year Treasury bonds is about 160 basis points. So a rate of 5.25% would be close to where mortgage rates would be today with normally functioning mortgage markets. One of us (Chris Mayer) recently published a study showing that -- assuming normally functioning mortgage markets -- the cost of buying a house is now 10% to 15% below the cost of renting across most of the country. Rising mortgage spreads and down-payment requirements are what's still driving down housing prices. We need to stop this decline.

The direct cost of this plan would be modest for the 85% of mortgages where the homeowner owes less on the house than it is worth. Lower interest rates will mean higher overall house prices. The government now controls nearly 90% of the mortgage market and can (and should) act on this realization. Remove the refinancing option and you can have lower rates without substantial cost to the taxpayer. Homeowners would have to give up the right to refinance their mortgage if rates fall, although homeowners could pay off their mortgage by selling their home. For borrowers with lower credit scores, the mortgage rate would be greater than 5.25%, but it would be less than their current rate.

Now, what about mortgages on homes that are worth less than the total amount of the loan? These mortgages could be refinanced into a 30-year fixed-rate loan to be held by a new agency modeled on the 1930s-era Homeowners Loan Corporation. New mortgages would be made of up 95% of the current value of a home.

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.

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.

The decline in housing prices remains the elephant in the room in the discussion of the credit market deterioration. Let's start there.

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.

Please add your comments to the Opinion Journal forum.

Copyright 2008 Dow Jones & Company, Inc. All Rights Reserved

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit

www.djreprints.com

More In Opinion

Sponsored by

Click here to find out more!

Email Newsletters and Alerts

The latest news and analysis delivered to your in-box. Check the boxes below to sign up.

WSJ.com Email Features
More Information on WSJ Features

The email address  is already associated with another account. Please enter a different email address:

Newsletter Signup

Thank you !
You will receive in your inbox

null

Email Newsletters and Alerts

The latest news and analysis delivered to your in-box. Check the boxes below to sign up.

WSJ.com Email Features
Submit

The email address null is already associated with another account. Please enter a different email address:

  • New! To sign up for Keyword or Symbol Alerts click here.
  • To view or change all of your email settings, visit the Email Setup Center.

Thank you !
You will receive in your inbox.

People Who Viewed This Also Viewed...

NEW! Are you on Facebook?
See what content on this site is popular with your friends! Learn more »
Your Facebook Friends Are Reading
Provided by SeenThis?
What's This?

You're seeing a preview of SeenThis? — a Facebook application that helps you discover the latest news, videos and more by showing you what's popular with your friends — both on Facebook, and on sites like this one.

Have a Facebook account? Get recommendations for content popular with your friends by adding the SeenThis? app.

Once you've added it, look for the "Your Facebook Friends Are Reading" section in the sidebar.

Click to add SeenThis? now »

About SeenThis? | Privacy | Feedback

Most Popular

Journal Community

Hello

Your question to the Journal Community Your comments on articles will show your real name and not a username.Why?

Why use your real name? The Journal Community encourages thoughtful dialogue and meaningful connections between real people. We require the use of your full name to authenticate your identity. The quality of conversations can deteriorate when real identities are not provided.

Please enter your first and last name

Create a Journal Community profile to avoid this message in the future. (As a member you agree to use your real name when participating in the Journal Community)

Notice:

Your participation access with Journal Community has been disabled due to violation of Journal Community Guidelines.

If you feel you have reached this status change in error, please contact TBD@wsj.com

Copyright ©2008 Dow Jones & Company, Inc. All Rights Reserved
Posted by at