Tuesday, November 11, 2008

A Great Idea Lost in the Din

Glen Hubbard, the Dean of the Columbia University Graduate School of Business and Professor Chris Mayer, came up with a bold proposal for the residential mortgage mess back in early October. Here is a link to FAQ about their plan on the Columbia University GSB site:


I look at it this way. 1. Q: What is the home owner's worst nightmare? A: Being foreclosed out of one's home, creating heartache for the family, and losing your credit rating for the future.

2. Q: What is the last thing that banks want? A: To foreclose on a home and to be an owner of residential property. Why? Homes in foreclosure go into a parallel universe with fly-by-night service providers who promise a lot and do nothing. The home sits there and deteriorates through a winter, the grass goes unmowed, and this quickly affects the market value of adjacent homes that might themselves be coming on the market. This process does not work for the bank. It is a remedy that is worse than the disease. So, we come to the conclusion that avoiding foreclosure is not an issue of moral hazard or of bailing out people who made foolish decisions, but something that is really in no one's interest.

The Hubbard-Mayer proposal is the only one I've seen that addresses this reality. Much of the current Wild West buffet of bailout-du-jour strategies serve only to address the balance sheets of the financial institutions. There is much more at stake than this, as the banking system contagion feeds back, through the mechanism of declining GNP and employment,onto home prices. Since this has already begun, the proposal probably needs a bit of tweaking, but this is minor.

Their proposal excludes investors and speculators, and basically resets all interested homeowners to a 5.25% fixed rate mortgage based on a reasonable loan-to-value ratio, provided the homeowner can support the new mortgage. A new SPE would administer the program and write-downs from the current mortgage and value situation would be shared between the originator of the old mortgage and the new Federal SPE. The homeowner would give up 20% of the future home appreciation to the government when the home were sold.

There is a lot to like about the proposal, because it doesn't whittle away at the problem, it cuts the Gordian Knot.

No comments: