It has been the elephant in the living room of our national debate since the housing bubble burst five years ago: Why not simply bail out homeowners who are upside down in their homes and facing foreclosure?
As Harvard economist Martin S. Feldstein points out in a recent op-ed in The New York Times, nearly 15 million homeowners currently owe more than their homes are worth. In half of these situations, the mortgage exceeds the home value by more than 30 percent.
The domino effect from the housing collapse continues to plague our economy. Consumers save more and spend less, nobody's borrowing, so businesses cut back production and lay off workers. Unemployment creates even more "underwater" properties to further feed the downward spiral of home values.
Understandably, the banks holding these troubled mortgages don't relish the thought of taking it full in the boxers, so they begrudgingly extend a few loan mods and wait for better days. Our current zero-sum political environment has thus far offered little more than tea and sympathy.
Feldstein dares to suggest the elephantine solution: a mortgage bailout.
"To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are 'underwater' are in this category. If everyone eligible participated, the one-time cost would be under $350 billion. Here's how such a policy might work:
If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. For the millions of underwater mortgages that are held by Fannie Mae and Freddy Mac, the government would just be paying itself. And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse – in other words, the government could go after the borrower's other assets if he defaulted on the home."
Feldstein says his solution is fair because it would require sacrifice from lenders and borrowers alike. Lenders would accept the cost of the principal write-down because the resulting loan, with its lower loan-to-value ratio and full recourse feature, would make default much less likely. Borrowers would accept the full-recourse risk to receive the mortgage reduction and thus avoid foreclosure.
Feldstein admits chances are slim that any politician from the White House on down will acknowledge the elephant, especially in this election year.
"But failure to act means that further declines in home prices will continue, preventing the rise in consumer spending needed for recovery. As costly as it will be to permanently write down mortgages, it will be even costlier to do nothing and run the risk of another recession," he writes.
What's your assessment of the elephant? Do you see a mortgage bailout as an obvious solution? Or just another government bailout for the banks?
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