Arnold Kling  

An Important Point Concerning Mortgage Bailouts

Order, Disorder, and License R... Talk About Perverse Incentives...

Ed Glaeser writes,

A perpetual moratorium on foreclosures, for example, would be a foolish repudiation of the rights of lenders. Who would lend after that precedent?

A lot of people want to punish the lenders. So if you follow Dean Baker's plan (now endorsed by Andrew Samwick) and let mortgage borrowers become renters, then this takes away the lender's right to foreclose on the property. Glaeser makes the point that if lenders are going to be punished whenever mortgage loans go bad, they will have to factor that into their future decisions.

I know a lot of people think that the lenders "pushed" these loans on borrowers, but the Baker plan is not the punishment that fits that particular crime. The "pushing" crime would be taking a borrower who has built up some equity in the house and giving him a cash-out refinance that he cannot afford to repay. The Baker plan is designed to bail out somebody who purchased home at the peak of the market and thus made a bad investment. Shifting that sort of market risk from borrowers to lenders is a dubious policy.

Glaeser goes on to suggest some variations on the debt-equity swap idea. Obviously, he came up with the idea independently. But the reader who followed the link from Greg Mankiw to Glaeser emailed me with a subject line "your idea."

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COMMENTS (9 to date)
Karl Smith writes:

I am usually more sympathetic to "anti-market" views than most of the econ-blogosphere but this is really driving me up the wall.

Its the lender's fault? They pushed you into this loan? Really?

The number one entity preventing real estate deals from going down is the skeptical lender. Before 2002 everyone groaned about the lender. The seller, the buyer, the agent. Everyone.

The lender was almost invariably the teatotaling spoil-sport who was keeping everyone from realizing the enormous gains from trade.

So the lender finally loosens up a bit and lets the party get started. And lets not forget that lots of people got homes, lots of high quality residential capital got built and jobs were created in the aftermath of a stock market crash that had the potential to turn the US economy into Japan during the 1990s.

So now at the end, when some people have stayed at the punch bowl a little too late we are going to hang the lender. What a crock.

ErikR writes:

I don't understand why you think the Baker plan is so bad for the lenders. If there were no "bailout plan", then presumably the lender would foreclose and own the house, which is worth less than the outstanding loan balance. Then the lender (and a lot of other lenders) would have to sell the house. But this would be at firesale prices. So the lender takes a big loss.

It seems to me that the lender collecting rent from the former owner for some period of time (what is the time limit on the Baker plan before the lender can sell?) until the housing crisis has passed and the home may be sold for a decent price may be in the best interests of everyone.

Rick Stewart writes:

If ignored, this will be cleaned up relatively quickly. The pain will be shared by all the people who participated in creating it, be they borrowers or lenders.

If 'fixed' by the government, this will last a little longer, and the pain will be spread out among those people who had nothing at all to do with it (like me - neither a lender nor a borrower).

I vote for no fix.

General Specific writes:

Those losing their homes can find something else to rent. The penalty for pushing a loan on people is getting a house back that is worth a lot less than the loan.

ed writes:

Glaeser informs us that "shared-appreciation mortgages. are relatively rare in the United States but more common in the United Kingdom." Interesting.

I wonder why are they so rare over here?

Josh Adams writes:


If turning borrowers into renters is a better deal for the lenders than foreclosing and selling at firesale prices, we should rely on them to do it based on their own incentives. I blame the borrowers, and I always will. Personal responsibility, man.

General Specific writes:

I agree with Josh Adams that lenders should rent the homes as they see fit. The only issue to consider is whether there could be a market failure—everyone selling homes at once—that could be resolved better through regulation. Not unlike circuit breakers in the stock market.

But I disagree that we only blame the borrows. It’s a two way contract. The owners are legally liable for signing an agreement they couldn’t meet. And the lenders are stupid for offering the contract in the first place—without appropriate due diligence. The contract is going up in flames and both sides deserve to be burned.

ErikR writes:

Josh Adams:

That was not my question (what should be done?). My question was IF the Baker plan were implemented, how much would it hurt the lenders?

As it happens, being a libertarian, I agree with you about what should be done by the government (nothing, ideally). However, being a practical libertarian, I have noticed that the Dems and Reps control the government, and invariably they will do SOMETHING. Best if that something is close to what the majority of individuals would have done on their own.

Carla writes:

Forcing lenders to rent foreclosed homes to borrowers is good for society because it keeps supply and demand stable. I feel that many times those that loan mortages are not completely truthful with borrowers, such as with rates increasing after a certain number of years. By penalizing lenders the rate of bankruptcy will go down. It also should not affect the price of houses because supply and demand will not be affected. Although, demand will increase because people are losing their homes as well as supply because these forclosed homes will be availiable to buy, lenders will be forced to rent the homes to these people. They will automatically have a place to live and the house will not be available for others. So, these people should not affect the supply or demand curve, thus not increasing the price of houses.

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