As the presidential inauguration draws near, it is increasingly clear that bailouts and government guarantees are unlikely to be successful unless government assistance is focused on the 10 million or more American homeowners who are in trouble and the millions of jobs than can be created directly and indirectly through homeownership.
Many believe that President Bush was right in promoting homeownership, but we have learned that this cannot be achieved without careful government scrutiny, guidance, and regulation of all industries in the homeownership chain, from mortgage brokers to investor pools and home builders.
Glenn Hubbard, President Bush's former chief economic adviser, may have the best idea yet for how to create a stable homeownership society that does not depend on subprime lending. His idea of offering current and new homeowners a 30-year mortgage guaranteed by the government, with a below-market fixed rate, has much merit. This could create 3 million to 5 million jobs over the next three years in construction and other industries related to homeownership, such as appliances and furniture.
The problem is that this proposal, in its presently conceived form, would primarily benefit the affluent and could have little or no impact on declining home prices and the preservation of low- and moderate-income neighborhoods.
"Stealing" from the Bush playbook, we would propose that the Obama administration devise the following plan for the next three years.
- Make a 30- to 50-year, government-guaranteed mortgage available for all families at 120% or below the median income, with a maximum fixed rate of 4.5% or 200 basis points above the rate of return for 10-year Treasury notes, whichever is lower. These loans should be available only for up to the median regional home price.
- To partially equalize the disparity in tax benefits for homeownership between the 70% of Americans who live from paycheck to paycheck and America's most affluent, give all homeowners at 120% or below median income the option of taking a $5,000 annual tax credit, rather than itemizing their home deductions.
- To ensure that homeowners have equity in their homes while having sufficient funds to meet down-payment requirements, allow lenders to take a lien on the $5,000 annual tax credit, up to the amount that satisfies the down-payment requirement.
You may ask, "What about the affluent American household?" Our answer is if there are sufficient funds, they too can be beneficiaries of this program.For example, very affluent homeowners already get up to $30,000 a year of tax benefits from mortgage interest and real estate tax deductions. As for participating in the rest of the program, the government could limit its guarantee to mortgage debt that does not exceed the regional market price and allow the rest of the loan to be financed at market rates.
A disproportionately large percentage of the homeowners facing default or foreclosure are dealing with subprime and/or exotic adjustable-rate mortgages, including option ARMs and loans with teaser rates. The proposed program would make these types of instruments generally unnecessary, particularly if the government required lenders to use alternative credit scores based on things like regular rental and utility payments.
Further, we should develop a method by which banks could ignore, where appropriate, recent default and foreclosure records for credit-scoring purposes when the problems were caused largely by fraudulent or misleading mortgage instruments.
Additional safety and soundness could be built into these loans if the agencies guaranteeing the loan required full documentation of income (with appropriate flexibility for small-business owners and independent contractors) and implemented an independent and universal home appraisal system required for all government-guaranteed loans.
Once this homeownership program is in effect, provisions can be adjusted to provide similar opportunities for all potential homeowners with up to twice the median income. This would qualify over 90% of Americans, including virtually all in need of assistance.
Should these provisions be implemented, homeownership nationally could rise to a record 70% of households, helping close the minority homeownership gap and minimizing the need for most subprime and/or high-risk ARMs.