Let the market recover please

Article source: Glenn Hubbard & Chris Mayer - online.wsj.com
Tuesday October 2, 2008

Currently we are caught up in a cruel cycle of plummeting housing prices which are in turn causing losses on mortgage securities; these in turn have a knock on affect on the amount of capital available and subsequently the amount of lending that takes place. All of these factors inevitable lead to falling house prices. Though resolving this problem has exceeded the capabilities of the housing sector the solution lies within this very sector.

There are more vacant houses than ever since the Census Bureau started tabulating such data in 1960 and completed new house builds are at the lowest levels since the dawn of the 1980s. A large number of home owners owe more on their mortgage then the value of their houses (a situation commonly referred as negative equity). There has been a steady nose-dive in the house prices that has led to deteriorating balance sheets for both private households as well as financial institutions.

This, however, can be brought to a halt. The value of a home to some extent is dependant on the mortgage rate. This is to say, a lower mortgage rate raises house prices. It has proposed that the US administration permits all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (identical to the lowest rate in the last 30 years) and place them under the control of Fannie Mae and Freddie Mac.

In order to tone down its losses, the Government could either grant owners the opportunity to divide the losses on refinancing a mortgage with the new agency (Mortgage lenders would have no option but to accept the refinancing on all or none of their mortgages), or the Government could retain the option to take a stake in the firms in return for the mortgage write-off; this will enable the US taxpayers to profit once the housing market is revived.

As much as the disposable cost is unpretentious when compared with many plans in discussion, the Government would be expected to take over trillions of dollars worth of mortgages books under its guardianship. What is more, by having guaranteed the value of the house prices, the plan would increase the value to taxpayers of existing home mortgage assets already owned or assured by the FDIC, the Fed, the Treasury, Fannie Mae and Freddie Mac.

There would be alleviation in the current downturn following a step up in household and financial institution balance sheets which in turn will increase investment and consumer spending. It is estimated that consumers would have a further $100 billion to spend annually, in the example where home prices went up by a 10% margin.

The plan would be need to be implemented immediately as a way of resolving the problems in the housing market with focus. Origination of mortgages will be facilitated more efficiently following the move by the United States Government of placing Fannie Mae and Freddie Mac under their care. As a result, the general borrowing edge would have to be moved up by Congress, while the new federal procurements of negative equity loans would also have to be carefully approved.

On the other hand, Treasury would have to seek out the participation of quite a number of additional private players since it will take a little longer for it to buy the corroded assets than Fannie Mae and Freddie Mac.

The best place to start worthwhile discussions about decrease in housing prices would be engaging in talks on the credit market corrosion.