One of the great things that we have seen from President Obama is his ability to get everyone “onto his agenda”. During the campaign, he convinced us (not that it was that hard) that we needed change. He defined this change very loosely. Some would argue that he did not define it at all. Now that skill is being applied to the stimulus plan and bailout of the financial sector.
Nobody can deny the scope of the problem. This is easily the most challenging economy since the recession of 1981-1982. The most interesting thing about this as opposed to other economic crises of the past is that people have pulled back dramatically. Consumers want to see what happens before they make their next move. Oddly, the rhetoric in Washington by both the White House and Congress is causing people to adopt this wait and see attitude.
What are they waiting for though? Those with mortgages in trouble seem to be waiting for the bailout. Often the borrowers are hoping that they can forestall foreclosure until Uncle Sam rides to the rescue. Banks have been horrible at modifiying the existing troubled loans because they don’t want to reduce principal balances, cut rates, or forgive arrearages. Finally people who are in no trouble at all have bought into this rhetoric and are sitting on the sidelines, slowing the economy further.
So I have a proposal. Often the government manages to set “quotas”. How many people in a group have been given school lunches, scholarships or government contracts? What if we put that to use on the housing situation? I would propose that every person that was “upside down” on their house but current on their payments be allowed to refinance to 4.0% on a 30 year fixed rate loan. This rate would not be subsidized by the government. With the cost of funds down under 1.0% each loan would make 3.0% on the spread for the lender as well as provide the opportunity to pick up about $1000 in fees. However, it would be below market financing. Why would the bank do this? Because each loan that a “current” borrower refinances they get a credit in the program.
This credit can be traded for insurance to cover the losses on loans that get modified that are behind. Those loans would be modified to 4.5% but must qualify at a 31% debt to income ration. Again, the banks make money if the loans perform on the spread. The credit goes to cover the losses currently being experienced by the bank or the end investor. The bank would now have more incentive to modify the loan because they could pass on the past losses.
The rest of the loans would have to go to foreclosure. It stinks but at some point there are three pools of loans. The good borrowers resent the help that those in foreclosure are benefiting but they are not. The challenged borrowers can pay their mortgage and are motivated to pay, but not with the existing terms of their mortgage. Finally, there are the bad borrowers. Some people will say it’s callous but there are people that have stepped into the market over the last few years that are not qualified to have a mortgage. They don’t pay their bills, they don’t have a history of consistent income and they are horribly upside down in most cases. They need to go back into the rental pool.
The framework of this proposal would have the following impact. First, all those who were to refinance to lower rates would have more safety and security than they have today. Additionally, those who feel that they are being taken advantage of by this bailout and not benefiting would benefit. The savings would find its way into the economy via spending and would allow people to increase spending without giving up the increased savings rate adopted over the last six months. The banks would have loans that perform back on the books. The non performing loans would qualify for bailout funds. Finally, not every loan currently on the path to foreclosure would end up there. This would have the effect of reducing the inventory of homes for sale, stabilize the prices of the homes on the market and get us the path to economic recovery.
I am sure the details are more complex, but in spirit it seems workable on the surface.
