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The fact that an asset's value is at or below the debt used to finance it does not and should not require the debt to be arbitrarily and systematically reduced.
December 23
The period of severe economic turmoil that has convulsed the U.S. economy is far from over. Thus far, the doctors' treatments have kept the patient out of the morgue, but a serious chance remains that the worst is ahead. Why is this and what should we do?
A key reason for our continuing woes is that the U.S. economy has for decades been heavily reliant on the housing industry for jobs and wealth creation. As we all now know, excessive liquidity, predatory subprime lending practices, weak regulation and an excessively efficient securitization model let Americans overleverage themselves in housing. Once the financial industry finally recognized that excessive borrowings and inflated home prices were unsustainable, the foreclosure machine got rolling.
Foreclosures are one of the real tragedies of this financial crisis — made more tragic by the fact that they were predictable and to a great extent preventable. In December 2007 and again in April 2008, I wrote on these pages about the havoc that would be unleashed if we allowed a massive number of foreclosures to take place in the subprime area. My views have not changed, but the last three years of financial catastrophe have borne out my worries for America.
A high level of foreclosures weakens housing prices, depresses new-home building by throwing more inventory on the market and stimulates more foreclosures. Foreclosures disrupt lives and damage neighborhoods.
And there is no cheer in the news that foreclosure filings fell 21% nationally in November compared to a month earlier. RealtyTrac, which published the statistics last week, noted that the decline amounts to a "false positive" because it largely reflects the fact that mortgage companies were under the microscope for paperwork processing errors that led to a temporary slowdown in defaults, auctions and bank repossessions.
Today, we are on the brink of further calamity. The vicious foreclosure cycle appears likely to continue unabated. The cycle has undercut confidence, fed the forces of financial panic and robbed the country of jobs. Municipal governments are likely to be the next to feel the pain.
We need to put a stronger floor under housing prices and greatly slow down the foreclosure machine. To do this, I strongly support my friend and colleague Alan Blinder's call to recreate a version of the Home Owners Loan Corporation of the 1930s. A version of this approach has been advocated as well by my friend John Allison, the retired chairman and CEO of BB&T Corp.
More specifically, the government needs to use an existing federal entity — possibly Fannie Mae or Freddie Mac — or create a new one that would pay off and then refinance existing mortgages for a large class of homeowners whose properties have declined in value. This entity would then lend or guarantee a loan at today's lower interest rates for a new mortgage at current appraised value. The government would recover the difference between the payoff amount and the new, smaller mortgage, with interest, through any appreciation in the home's value when sold.
Of course, speculators and housing investors, as opposed to homeowners who live in the home, would be excluded. Only homes under a certain dollar value would be eligible.
America has historically stood out as a global leader in acting boldly to solve its problems and move ahead. It has also shown to its citizens a level of support that has mixed empathy, community values and common sense. The program I am proposing today fits within this historical frame and underscores the traditional American commitment to home-ownership.
Now is the time to act before we reap a further whirlwind.
