The Obama administration promises action on dealing with the nation’s housing and foreclosure crisis. Most recently, Obama has assured Americans that the relief will go only to honest borrowers who have fallen into financial difficulty rather than those who took out “liar’s loans” — i.e., loans in which the borrowers provided false information about their financial situation, with the tacit blessing of the lender. But there are few details, and even the head of the FDIC admits that it’s hard to separate the good borrowers from the bad. Now’s the perfect time to look at a better approach to dealing with the mortgage crisis.
In financial terms, “liquidity” refers to the amount of capital available for lending. During the housing-bubble years, the economy suffered an excess of liquidity, with too much money chasing too few good deals. Now, the system has far too little liquidity; lending needs to start again.
But the government is bailing out the wrong entities — the banks, plus a large insurance company (AIG). This does little to fight illiquidity, because there’s no incentive for the banks to lend out the money.
What to do? Here’s a plan that will restore liquidity to credit markets, raise housing prices for sellers, and help struggling borrowers pay their mortgages, all at the same time. I propose that the government lend money to banks for the sole purpose of allowing the banks to issue new 30-year mortgages to people whose income streams are truly sufficient to make payments. The interest rates would be fixed between 3.5 and 4.5 percent. People buying homes would be eligible, as would those with existing mortgages who wish to refinance. The banks would bear the risk of default — but at these lower interest rates, far fewer borrowers would face foreclosure.
The government would fund its lending by selling 30-year Treasury notes — which it can offer, in the current market, at rates significantly lower than those the banks would charge on the new loans. For the purpose of this plan only, the banks would be able to borrow from the government at the cost of funds to the government (the rate on 30-year Treasuries plus any additional costs). The difference between the banks’ rate of borrowing and the rate that they offer to their own borrowers should cover any defaults and still create a small profit for the banks.
At the lower interest rates, more people will be able to make their mortgage payments and avoid foreclosure, and more people will be able to secure mortgages to buy homes. This will stabilize the real-estate market and start the process of reviving it.
This plan will also help restore the market in mortgage-backed securities. Because it allows refinancing of the mortgages underlying “bad” securities, it will add liquidity and value to the securities themselves. This will help the balance sheets of the troubled banks by decreasing “bad” assets held by these banks. In addition, markets hate uncertainty; this plan restores certainty.
What’s more, unlike the bailouts we have seen so far, this plan costs the government nothing. If the government lends the money to the banks at a spread over its cost of funds, the plan could even bring revenue to the government — revenue that we need to pay for the ambitious spending plans of the Obama administration (or, better, for tax cuts).
Would banks participate voluntarily, given the choice between this plan and the current bailout? The plan has one big advantage (a lower cost of capital) and one big disadvantage (the interest banks are currently receiving on mortgage loans would be sharply reduced). The idea of receiving low-cost funding from the government for lending activities should appeal to many banks. Once one major bank agrees, others will follow simply to compete. And the plan would be particularly helpful to smaller banks, which are eager to resume large-scale lending.
Sens. Mitch McConnell and Lamar Alexander have proposed legislation along these lines in the form of their “Fix Housing First Act,” which covers both new and refinanced mortgages. We should enact this type of plan now. It won’t bring back the big investment banks or solve the problems of AIG. It won’t end risk. But it’s a bailout for Main Street and Elm Street and Seventh Street, not Wall Street — in short, the right kind of bailout. The credit crunch — which has now become the most severe downturn in a quarter century — began with housing. It can end with housing, too.
– Mallory Factor is a merchant banker and the co-chairman and co-founder of the Monday Meeting, an influential gathering of economic conservatives, journalists, and corporate leaders in New York City.