Helping Homeowners Without Helping Banks: The Economist's Solution
TPMCafé (Talking Points Memo), January 18, 2009
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Why is that every time people in Washington come up with a scheme to help homeowners, most of the money ends up in the pockets of the bankers? Most of the latest plans center on the idea of buying up underwater mortgages from banks at hugely inflated prices and then guaranteeing new mortgages at close to the market price of the house.
The banks gets the money, the homeowner ends up in a home with little or no equity. Only in Washington can this be called "helping homeowners."
But, at no extra cost we could employ the economist's solution, which would actually help homeowners. The deal is simple: offer the homeowners the money.
Here's how it works. Suppose someone owes $300k on a home that is currently worth $200k. Under many plans being floated, we would hand the bank $250k for their old mortgage and then guarantee a new mortgage to the homeowner for around $200k. This means that we are giving the bank approximately $50k since that is the difference between what the government is giving them and what they would get on the market. (Given foreclosure costs, the government's gift to the bank is actually considerably more than $50k, but we'll ignore that one for now.)
If we want to structure this in a way to help the homeowner, after working out the deal with bank, we then ask the homeowner whether she would prefer the $50k that the government is about to hand to the bank, or would rather take the home with no equity.
If she takes the money, she could do whatever she wants with it. She could walk away and use the money as a down payment for another home. She could rent for a year until prices adjust and then buy a home at a more reasonable price, or she could buy a car, take a vacation, pay for her kids' tuition. It's her call. She could even use the money to make mortgage payments for a couple of years on her current home.
If we gave homeowners the choice of pocketing the money that we would otherwise hand to the banks then we could say that we are actually helping homeowners. Otherwise, the deal is helping banks and should be described that way.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.