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Martin Feldstein lays an egg
Sunday, October 05, 2008
Well, on a positive note, at least Martin Feldstein didn't use the words "root" and "cause" right next to each other when laying this egg of an op-ed piece in yesterday's Wall Street Journal aimed at helping solve the credit crisis.
His plan?
In order to make underwater homeowners less likely to walk away from their properties, reduce their outstanding mortgage balance by 20 percent, and give them a government loan for that amount in its place.
This thinking is apparently based on the assumption that your typical American homeowner can't do simple addition.The Problem Is Still Falling House Prices
This has got to be the stupidest idea I've ever heard.
The bailout bill doesn't get at the root of the credit crunch.
By MARTIN FELDSTEIN
A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.
...
We need a firewall to break the downward spiral of house prices. Here's how it might work. The federal government would offer any homeowner with a mortgage an opportunity to replace 20% of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. This would be available to new buyers as well as those with mortgages. The interest on that loan would reflect the government's cost of funds and could be as low as 2%.
...
Consider a homeowner who has a mortgage equal to 90% of the value of his home. The 15% decline in the value of his house that may be needed to bring it back to its prebubble level would shift that homeowner into negative equity. Further price declines would make default attractive. But the 20% mortgage replacement loan would take the loan-to-value ratio to 72% from 90%, making it unlikely that prices would fall far enough to push him into negative equity. An interest saving that could be as large as $3,000 a year would provide a strong incentive to accept the mortgage-replacement loan, even if the individual thinks that he might temporarily have a moderate level of negative equity.
The argument about a low-cost loan cutting back on monthly payments has a tiny degree of merit, but the idea that the homeowner is going to think about his mortgage obligation differently because it is split into two pieces is just plain dumb - especially if the new loan is full recourse and from the U.S. government!
The whole idea of somehow propping up home prices is just sickening and the notion that renowned economists still think the root cause of the current problem is falling home prices rather than the policies that allowed home prices to rise to their previous bubble heights - well, that's even more sickening.
(Mr. Feldstein, chairman of the Council of Economic Advisers under President Reagan, is a professor at Harvard and a member of The Wall Street Journal's board of contributors)
This week's cartoon from The Economist: 
10 comments:
what an idiot.... and you wonder why we are in the mess we are in....
What are the odds that he (or his children) have a high LTV mortgage? All politics is local.
If I want man-in-the-pub economics, I'll ask the man-in-the-pub. From Harvard I'd expect a more sophisticated level of stupidity.
What's sickening about Feldstein's article is that he HAS to know his proposal wouldn't work. He's obviously grasping at straws if he's willing to attach his name to such dreck.
That's the scariest thing about this entire economic crisis. It's like the top economists aren't even trying to address the real problem. That means they're either a bunch of complete morons or else they realize the gravity of the situation and think there isn't much they can do at this point. Neither of those possibilities is particularly comforting.
It's been fun this past year or two to consistently make better predictions than famous economists, but something is clearly wrong when laymen like myself can so effortlessly defeat them. Before I go out and proclaim myself a genius compared to all these Harvard profs and Wall Street prodigies, I should at least entertain the possibility that people like Feldstein no longer believe a word of what they write. Maybe squeezing the last bit of toothpaste out of the tube of the US economy has become the modus operandi.
WHat's sickening about each and every one of you is your apparent lack of even the most basic knowledge of the financial history of this country. WHat Mr. Feldstein is proposing is a near identical re-creation of the Home Owners Loan Corporation that was started in 1933 by FDR. It's sole purpose was to refinance homes in an effort to lower the rate/extend the term/increase the borrowers equity in their homes and extended loans to over one million people facing foreclosure.
All of you should really should do a little homework before you start calling a tested plan as "dreck" or "stupid". I'm in the mortgage banking industry (since 1984) and the number one reason for foreclosures today is declining equity and the borrowers lack of commitment to remaining in their home based on their initial purchase motivator, which was to make a profit. The lack of depth in your understanding of the most basic causative reasons behind our current financial situation is appaling. Shame on you all.
az Lender,
You my friend is a moron.
The premise of the arguments is that the falling house prices are not the problem at all, but the fact prices got too high!
Does this make sense to you? Do you really believe attempting to price fix homes (at a level significantly above long term trendlines) is a good idea?
No wonder the industry is broken!
DoDo1975
He was on the board at AIG. Now you know where he's coming from.
I agree. What the hell is negative equity? When I bought my house, with the real estate commission to resell I was "under water" for over 5 years. I never once thought of not paying.
Has anyone ever bought a car? Unless you put half down you are under water the moment you walk out the door.
Negative equity is the lamest thing I have ever heard.
I hadn't thought about it until me mentioned used cars. Everybody knows cars always go down in value, so you better pay as close to cash as possible or you really lose money, because you always get next to nothing for your trade-in. It seems now we know that houses don't categorically go up in value. The only thing that does that is inflation. I guess I know know, and since I plan to buy a house someday (currently renting) I'll keep that in mind, and try not to buy a house at an inflated price.
Treating the disease, not the symptoms.
While I’m personally a staunch Obama supporter and agree absolutely that the responsibility for this mess lies squarely at the feet of the boy in the bubble, Alan Greenspan, the proposal made by John McCain last night during the debate regarding the purchase of underwater mortgages has some merit. There have been a variety of proposals for this line of attack, including recently by Martin Feldstein in the WSJ. I have also proposed a plan, outlined below. Following my plan is a précis of Feldsteins plan, followed by a comparison of both. There is great merit in a strategy of treating the disease and not the symptoms:
Some pertinent data points;
• Number of families who now hold a subprime mortgage: 7.2 million1
• Proportion of subprime mortgages in default: 14.44 percent2
• Proportion of subprime mortgages made from 2004 to 2006 that come with “exploding” adjustable interest rates: 89-93%
• Proportion of completed foreclosures attributable to adjustable rate loans out of all loans made in 2006 and bundled in subprime mortgage backed securities: 93%
• Number of subprime mortgages set for an interest-rate reset in 2007 and 2008: 1.8 million Valued at: $450 billion
There are 7.2 million subprime mortgages out there worth 1.3 trillion, of which possibly 70% of them have exploding rate mortgages, which means about 5 million have exploding rates. Exploding rate mortgages account for 93% of the bad mortgages, which means that possibly 4.5 million of these will go bad, or 63% of the total, at a value of $820 billion and an average value of $180,000. If the ARMs reset from 7% to 12%, the increase in monthly payments is about $590 per month. $590 per month times the total of 5 million is about 3 billion dollars per month. Therefore, $700 billion would pay for 233 months, or nearly 20 years of payments… and this without renegotiating the loans so that maybe they just go to… say… 9% with the government picking up the difference. The holders of all the CDO’s would then be able to value them, mark them back to market, solve their balance sheet problems… financial problems solved. From the housing markets point of view, it would relieve the pressure of the foreclosure spiral forcing down prices more than ‘normal’, and provide years for the economy to recover and housing to rebound. Furthermore, any homeowner who availed himself of the help would give up all or a part of the appreciation of the property over time, penalizing them for getting jammed up, but not penalizing the guy who is paying his mortgage and playing by the rules.
If the sub-prime ARMS were renegotiated down to 9%, the monthly payments the government would be liable for would be an average of $225 per house per month, or $1.1 billion annually. The $700 billion under those circumstances would be good for 636 months, or 53 years…
This would be a much cheaper and more effective way to solve the problem… renegotiate the exploding rate, paying the difference and profiting from the increase in asset value over time.
The following is the proposal advanced by Feldstein in the WSJ:
The Problem Is Still Falling House Prices
The bailout bill doesn't get at the root of the credit crunch.
By MARTIN FELDSTEIN
A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.
...
We need a firewall to break the downward spiral of house prices. Here's how it might work. The federal government would offer any homeowner with a mortgage an opportunity to replace 20% of the mortgage with a low-interest loan from the government, subject to a maximum of $80,000. This would be available to new buyers as well as those with mortgages. The interest on that loan would reflect the government's cost of funds and could be as low as 2%.
...
Consider a homeowner who has a mortgage equal to 90% of the value of his home. The 15% decline in the value of his house that may be needed to bring it back to its prebubble level would shift that homeowner into negative equity. Further price declines would make default attractive. But the 20% mortgage replacement loan would take the loan-to-value ratio to 72% from 90%, making it unlikely that prices would fall far enough to push him into negative equity. An interest saving that could be as large as $3,000 a year would provide a strong incentive to accept the mortgage-replacement loan, even if the individual thinks that he might temporarily have a moderate level of negative equity.
Below is a comparison of the advantages of the two plans point by point:
• No budget busting huge amounts of capital required in any one year, but rather nominal amounts in any particular year.
o Feldstein’s plan would require huge outlays of capital, a trillion dollars by his own estimate, in order to protect the 5,000,000 threatened mortgages, which is a totally unnecessary budget buster
• No need to try and ‘untangle’ all of the bundled, sold, sliced and diced mortgages… they will be paid.
o A benefit of both plans.
• Slows the fall in house values, shoring up all real estate assets both residential and commercial
o A benefit of both plans
• Doesn’t penalize those who ‘play by the rules’
o The Feldstein plan rewards those who for what ever reason can’t make their payments by making them eligible for a very cheap very long term loan. This penalizes those who are paying and is unfair on it’s face.
• Allows Mark to Market rule to continue to be used
o A benefit of both plans
• By establishing a value for all the mortgage-related assets, the markets in them will restart, liquidity problem solved.
o This is less clear under Feldstein’s plan, as there still could be defaults. Payment is left to the original mortgagee, and what if they decided to take that $80,000 and pay off some other more pressing bill. Because of that threat, the trillions of dollars in derivatives would not be as secure and thus would not be as valuable. They may be as liquid, but at a risk induced lower price… not a good thing.
• Moral hazard: companies that participated in selling the bubble take a hit for their reckless behavior through the discount in the ARM through the revaluing downwards of their assets.
o Feldstein’s plan does not recognize the need to lower the ARM (more appropriately an ERM – exploding rate mortgage) increases through a blanket one time renegotiation with all holders. This is equivalent to what happens when someone secures a better deal rescuing a company than the deal originally offered to the original stock holders… such is life.
• The program could be expanded to include anyone who was threatened with foreclosure due to ARMs… not just sub-prime, but Alt-A, etc.
o A benefit of both plans.
• No bankruptcy interventions necessary.
o A benefit of both plans.
In sum, there is merit in the strategy advanced by McCain… however, his methodology is poor and can be greatly improved upon.
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