Plan B
Via Tyler Cowen, Luigi Zingales offers his “plan b” proposals for digging out of the financial crisis. We’re looking at some stern measures, in particular a law making available a “re-contracting option available to all homeowners living in a zip code where house prices dropped by more than 20% since the time they bought their property” under which people would get to write down the principal of their loan by an amount equivalent to the decline in their zip code:
In exchange, however, the mortgage holder will receive some of the equity value of the house at the time it is sold. Until then, the homeowners will behave as if they own 100% of it. It is only at the time of sale that 50% of the difference between the selling price and the new value of the mortgage will be paid back to the mortgage holder.
On injecting equity into the banking system, he worried that we’re moving “too little, too late” and says we’d need to spend $600 billion. Seeing as how we recently authorized the Treasury to spend as much as $700 billion I’m not sure this is an insuperable obstacle. It’s just that Paulson will need to act boldly and decisively in this direction rather than staying invested in the “buy bad assets” model that he started out with.
27 Responses to “Plan B”
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October 11th, 2008 at 10:09 am
What Mr. Zingales seems not to consider is that a sizable number of Americans own their own homes mortgage-free. Should his plan be enacted, these home-debt-free Americans would suffer the devaluation of their home without an ensuing rebate from the original purchase price as depicted in the Zingales proposal:
Even with
the neighbor who purchased [outright ...no mortgage] his/her house at the same time as the mortgage defaultee, would be penalized at least 10% of his original purchase price vis-a-vis the subsidized neighbor.
I think it appropriate that we all pitch in to save our economy …but we must all pitch in according to our means and in compliance with our degree of responsibility for creating this mess. The prudent borrower, saver and spender should not be disproportionally penalized for thinking and acting in a caucus, careful way.
October 11th, 2008 at 10:30 am
Sheesh! Why should any mortgage holder be bailed out of anything just becasue the value of the home has dropped? They stay there, make the payments, and in a few years they’re back above water.
October 11th, 2008 at 10:41 am
Re: Should his plan be enacted, these home-debt-free Americans would suffer the devaluation of their home without an ensuing rebate from the original purchase price as depicted in the Zingales proposal:
So what? Where is it written that real estate must never decline in value? Housing prices are out of line and they need to come down to their historic norms. If that means people who confused their home with their retirement savings take a hit, that’s the way it goes. However, most people who own their home outright bought those homes many, many years ago. They will still enjoy a very large profit if/when they sell. If the house you paid 50K for in the 70s is now “only” worth 200K not 300K you’re still coming out ahead.
October 11th, 2008 at 1:00 pm
Should his plan be enacted, these home-debt-free Americans would suffer the devaluation of their home without an ensuing rebate from the original purchase price as depicted in the Zingales proposal…
This is false. Supply and demand set prices. The fact that your neighbor is getting a break on his debt does not reduce the demand for your house. If anything it might increase it, given the fact such a scheme in theory should reduce the supply of homes on the market.
I haven’t been a big fan of all of Zingale’s ideas, but this one seems quite clever. If I understand correctly it wouldn’t cost the taxpayers a dime, and it should give real help to millions of homeowners in distressed markets.
October 11th, 2008 at 1:10 pm
I have to admit that I do not understand what TheRef is talking about.
There is no mention here of the government debaluing homes, just of the government reducing the mortgage principal on already devalued homes. And the loss of 50% of any equity above the revalued principal ould only apply to those who accepted the principal reduciton. If you refused and continued to pay based on the old principal, you would still own 100% of the equity at the time of sale.
October 11th, 2008 at 2:22 pm
Am I missing something. Borrowers, when they sell their homes, would have to pay 50% of the difference between the selling price and the renegotiated mortgage to the mortgage holders. So if I have a house that was worth $300k and is now worth $200k I get to write the mortgage down to $200k. Then if I sell it in 5 years from now for $220k I split the $20 k with the bank. But if I don’t sell it for 50 years and I get $1,000,000 for it – I’d have to split $800k? THe bank would get $400k? Wouldn’t this just encourage everyone who would be eligible for this program to sell as soon as possible to get out of the obligation of splitting the equity with the mortgage holder and in the process continue to drive home prices down due to excess supply?
October 11th, 2008 at 6:24 pm
Isn’t a lot of the problem that the homes were over-valued anyway? Isn’t the dropping home values to a large degree an actual market correction? Not to be supply-side-ey, but people were paying way too much for tiny plots of land in places that were of little commercial value, and some that were prone to natural disasters. So somebody could get a big commission no matter how it panned out.
It’s not like the lion’s share of the value of a home is the actual house—it’s the surrounding economy. When the gated community becomes telegraph road, it doesn’t matter how financially responsible some homeowners have been, the value of their property is going down.
October 11th, 2008 at 7:17 pm
Wouldn’t this just encourage everyone who would be eligible for this program to sell as soon as possible to get out of the obligation of splitting the equity with the mortgage holder and in the process continue to drive home prices down due to excess supply?
I doubt this would be a major issue:
a) For one thing, a self-correcting mechanism might kick in: not everybody can dump their house at the same time or what you describe may well transpire, and then prices would dip again, obviating the ability of a seller to get the price he needs…
b) Secondly, borrowing standards are bound to get stricter. Many once-upon-a-time distressed homeowners will not be in a position to move house and buy anew the moment they’re finally above water, because they will not have accumulated enough equity (especially after the bank takes back its profit share) to come up with now more onerous downp ayment requirements. If anything, I could see Zingales’s idea making assisted homeowners “stickier” than non-assisted homeowners.
c) Thirdly, the main point of an idea like Zingales’s is to get us beyond the crisis. A bit of downward pressure on houses in, say, 2015 had better be much more of a non-event than it is in 2008 or all bets are off…
d) Finally, the situation you describe could be largely (although not entirely) mitigated by being a bit tougher on the lenders, i.e, by imposing a cap (e.g., 125% of the original write-down amount plus inflation, or whatever) on the lender’s profit.
October 11th, 2008 at 7:41 pm
I suggested something like this on this site earlier this week (no i don’t think anyone stole my idea). But in order to work, the 50% equity return must NOT arrive at either a refinance or a sale to amember of the family, as everyone will simply do that (refi, or sell to a family member at the refigured value, or when the market price is at the reconfigured level and rising). It must only be realized when the mortgage holder (and or family) physically leaves the house for another residence.
As for people who worry that they were smarter and got better mortgages that they could afford (like myself), remember that by avoiding foreclosure and keeping people in their houses until they choose (instead of being forced ) to sell, your homes value is preserved.
October 11th, 2008 at 7:53 pm
But in order to work, the 50% equity return must NOT arrive at either a refinance or a sale to amember of the family, as everyone will simply do that…
alan: are you suggesting some kind of moral hazard? I don’t follow your point about family members and “pysically” leaving “the house for another residence.” What difference would it make if an assisted borrower sold his house to a family member? The bank’s still going to get its cut, no?
October 11th, 2008 at 8:02 pm
Obviously, I didn’t make my point very clearly. Let me try again.
If my neighbor and I each bought our houses at the same time …each of us paid an equal amount [for illustration, let's say $300,000] for like houses …I paid the full price in cash …he/she paid with a mortgage for the full amount.
Again for illustration purposes, on the very next day after closing, the mortgage business tanked and the value [market value] of our respective houses dropped to $200,000 …economic circumstances and a new government program steps in to reduce the mortgage cost of the neighbors house to $200,000 …my cost remains $300,000 while his or her cost is reduced to $200,000 …the current market value …this reduces my house value to the same as my neighbor …If we should need to sell today, I will incur a $100,000 loss, while my neighbor will incur $0 loss should we both sell today. [Obviously, my neighbor is a better investor than I ...he/she invested $0 while I invested the entire $300,000.]
Since the value of both our homes is now $200,000 [again assuming we both must sell today], I loose $100K while he/she looses nothing. The mortgage holder looses the hundred thousand dollars …except this [McCain] proposal would have the government [our taxes] pay the bank the difference between the current market value and the face cost on the neighbor’s mortgage.
I am not advocating that the government send me the hundred thousand difference between what I paid and the current market value of my house. Likewise, I don’t believe that the government should send the $100,000 to the bank mortgage holder. I much prefer the path of the homeowner renegotiating his/her loan with the careless lender bank with the government acting as an honest broker if need be.
Whatever, if my neighbor now owns [with a mortgage] a $200,000 market value house [just like mine] in the same neighborhood, that forces the value of my house to $200,000 as well. Obviously, this is just paper loss until I sell but it is nonetheless a devaluation of my house …if you don’t think so, put yourself in the circumstance and try for an equity loan …I think that you will find that the real value of your house is $200,000.
October 11th, 2008 at 8:18 pm
my cost remains $300,000 while his or her cost is reduced to $200,000 …the current market value …this reduces my house value to the same as my neighbor
TheRef: Huh? just a couple lines above you write: on the very next day after closing, the mortgage business tanked and the value [market value] of our respective houses dropped to $200,000
So which is it? Has your house dropped in value because your neighbor got mortgage relief (no!) or has your house dropped in value because economic conditions “tanked” (yes!).
It is supply and demand that determine price. A program that successfully helps people avoid getting kicked out of their homes is a program that ostensibly will reduce the supply of homes available for sale. In other words, the Zingales plan as described in theory will help boost the home values of everybody — cash buyers included.
October 11th, 2008 at 8:21 pm
The federal government should look to the nonprofit sector that has been providing subprime loans for years. Certainly these nonprofits receive healthy assistance from federal, state, and even local jurisidictions (though it has not grown under Bush as it did under Clinton), but they are also successful because they leverage that funding several times over.
Look for help from Habitat for Humanity, whose equity-sharing and/or silent second mortgage provisions (both of which sunset at varying time periods depending on the affiliate) have seen great innovations over the past ten years.
There are even better models for agencies serving families who make 50-80% of the median income. These agencies excel at RESPONSIBLE subprime lending. And their default rates can be described as enviable. Homesight, in Seattle, is one of the most effective in the country.
October 12th, 2008 at 4:54 am
Jasper-
I get what TheRef is saying. He’s saying that if he bought the house without a mortgage, he doesn’t get the extra $100,000 that the guy with the mortgage gets.
October 12th, 2008 at 9:39 am
Jasper,
The point isn’t that the fall in home value would be caused by the renegotiated mortgage; it’s that whatever the cause of the fall in home value, the person who paid cash is being asked to absorb his entire loss, while the person with the mortgage is being allowed to pass his loss off to others.
Suppose, as The Ref says, the values of the two homes drop from $300 K to $200 K. Suppose, as you say, this is simply due to market forces, unrelated to the renegotiation of any mortgages. Now suppose the person with the mortgage is offered a renegotiation that resets the mortgage principle to $200 K. Let’s say the next day, both homeowners sell their home at the new $200 K market price. The person without the mortgage has lost $100 K. The person with the mortgage pays of the mortgage, and walks away with a $0.
Or if they both wait a while as prices rise, and the sell their homes at $250 K, the first person has lost $50 K. The second person pays off the mortgage, is required to split the $$50 K profit with the bank, but still walks away with a $25 K profit.
So the problem isn’t that the Zingales plan has caused the first person’s $100 K loss. It’s that the government doesn’t subsidize that loss in any way, but subsidizes the loss of the person with the mortgage.
October 13th, 2008 at 2:18 pm
The point isn’t that the fall in home value would be caused by the renegotiated mortgage; it’s that whatever the cause of the fall in home value, the person who paid cash is being asked to absorb his entire loss, while the person with the mortgage is being allowed to pass his loss off to others.
Oh, now I get it. The objection is that a plan designed to alleviate the foreclosure crisis by helping distressed mortgage payers doesn’t simultaneously provide a free pony for everybody else. Noted.
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