Will the Government Bailout Plan Work? Financial Markets Are Still Nervous, Should We Be?
Interesting article from Yahoo and the Associated Press around the challenges still ahead, in spite of the $700 billion dollar banking bailout plan signed into law by the President today:
Bailout signed, now it’s wait and see its effects
From the article:
The immediate response to the 263-171 vote was not promising. Wall Street, which plunged a record 778 points after the House initially rejected the bill last Monday, fell 157 points. More economic bad news — a jump in job losses — outweighed the good news from Capitol Hill.
The Bush administration gained broad authority to buy up toxic mortgage-related investments and other distressed assets from shaky financial institutions. The hope is it will restore confidence in markets and thaw a near-freeze in credit availability that has begun to affect the ability of banks to lend, businesses to obtain money for payrolls and investments, and individuals to gain credit to buy a home or a car.
Again, the best way to restore confidence in markets (especially the mortgage market) and alleviate the credit crunch is to deal with the issue of foreclosures head-on. Until we do that, we’ll still face people walking away from their homes, declining property values and low consumer confidence.
One Comment
It is great to see someone talking about real solutions to the underlying problems that started this financial mess. I too have been trying to “spread the word” on related ideas for addressing the underlying problems. Below are my two top suggestions for your consideration. Please feel free to forward at will, adapt, rewrite, rethink, or establish that your current ideas will be more cost-effective!
Cheers,
Julius
Two Ideas for Reducing Mortgage Defaults
Idea 1: Principal Residence Home-Equity Guarantee
The government could guarantee that the value of a principal residence will be at least equal to the purchase price, plus modest interest, when the mortgage reaches full term.
In other words, the government would implicitly issue an option to sell one’s home to the government at the original purchase price plus interest X. This option would be exercisable at the mortgage expiration date (or, for greater simplicity and uniformity, 30 years after the start of the mortgage, irrespective of its duration).
What should interest X be? One can argue zero (or less), because why should real estate investments have a floor? In my opinion, for principal residences (not speculation plays), it would be good for America to give home-owners such a floor on the biggest financial investment (and risk) of their lives (in most cases). I personally believe X should correspond to at least the TIPS rate. I think people deserve more security in the equity they build up in their homes through hard work year after year.
What should the “charge” be against the U.S. Treasury for these options? I would argue zero. The options cannot be exercised before mortgage maturity, and that means long-term averages must be used for projecting housing value. I cannot imagine any reasonable way to project a loss over a 30-year time period in the housing market.
Note that an equity protection of this nature would enable principal-residence mortgage rates to be lower, because of the reduced risk. This would also be good for the country because it would mean more home owners.
If the government-purchase option is exercised by the home owner, the government would have the property inspected, and any deferred maintenance costs would be deducted from the proceeds. The home-owner can also, of course, hire an independent home inspector, and an arbitration procedure could be spelled out to ensure efficient, fair resolution in cases of disagreement.
Idea 2: Automatic Mortgage Refinancing
When people can’t make their full mortgage payment, they would simply pay as much as they can afford, and this would result in an automatic extension of their mortgage term. The minimum payment should generally be “interest only”. Paying only the interest for a particular monthly payment would automatically extend the mortgage term by approximately one month.
I say “approximately” because a truly fair formula will calculate a new mortgage duration that holds the “present value” of the mortgage (to the lender) constant in real terms. Such a formula should be based on current and historical market data.
Similarly, one’s interest rate may be adjusted slightly so that future “interest only” payments will keep the expected return constant, in real terms, on the overall mortgage loan.
For homes with more than some minimum accumulated equity (say 10%), payments could be allowed to fall below the “interest only” level, because the owner’s equity could be tapped to make up the difference. Foreclosure proceedings would not be an option until accumulated equity fell below the minimum level. The minimum equity level could be set, for example, to equal the average cost of home resale.
Given the stability of homeowner equity provided by Idea 1, the quantities needed for the above calculations would be relatively reliable, on average. Computers are very good at carrying out such calculations, so there is nothing complicated about this proposal beyond its initial set-up.
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