Arnold Kling  

Feldstein's Lender Bailout Proposal

Civil Disobedience Alert... George McGovern, Libertarian...

Martin Feldstein writes,

The federal government would lend each participant 20% of that individual's current mortgage, with a 15-year payback period and an adjustable interest rate based on what the government pays on two-year Treasury debt (now just 1.6%). The loan proceeds would immediately reduce the borrower's primary mortgage, cutting interest and principal payments by 20%. Participation in the program would be voluntary and participants could prepay the government loan at any time.

Feldstein's proposal is aimed at borrowers with a little bit of equity in their homes. The idea is to lower their interest rates.

It is hard for me to see this as anything other than a lender bailout. It does give borrowers a subsidy, based on the fact that the government can borrow at low interest rates. However, the main effect is to take risk off the table for lenders. They would immediately receive 20 percent of the outstanding balance on loans that are of high risk for default.

Broadly speaking, there are two schools of thought about the housing market. One school believes that foreclosures will cause house prices to overshoot on the down side, so that government intervention to prevent foreclosures will help stabilize the market. The other school of thought, which we might dub the liquidationists, believes that the market needs to reach a natural equilibrium, in which people live in houses they can afford.

I am a liquidationist.

Comments and Sharing

COMMENTS (7 to date)
eric writes:

Feldstein assumes zero defaults. What if a lot of people default, and all at once (defaults tend to be bunched in time). They get a free pass, and what was a costless solution, now is very costly.

spencer writes:

liquidationist turned the 1929 recession into the depression.

Snark writes:

Liquidationist- An equilibrium opportunity housing lender.


liquidationist turned the 1929 recession into the depression.

No, liquidationists allowed the 1929 recession to turn into a depression. Interventionists prolonged it.

Which was the greater evil?

Jim writes:

At least there was the Benefit of the depression that it taught some lessons.

Many of the people who lived through it learned those lessons and still carried their knowledge when I worked with them but they have retired and the lessons have not been learned from books.

I am with Arnold on this one.

Alex writes:

I'd love to see a government intervention solution where the government isn't taking it in the shorts. While there are some defaults and some issues right now with these mortgages / MBS, the vast majority are performing. The market is suffering mainly from liquidity issues, not default issues (so far). I might buy into an intervention if the government could profit. An example is the gov setting up a fund and buying the highest quality mortgages from banks or super senior AAA tranches of MBS off the market at $.80 on the dollar. The reality is that thus far no AAA super-senior piece of a sub-prime MBS has defaulted (as far as I know). There is a lot of garbage out there, but there are a lot of performing assets too.

Every plan comes out with the gov (taxpayers) on the short end of the stick. There is surely a basket of assets out there that the a government fund could buy up and make a good rate of return net of default and operational costs.

I’m not necessarily for ANY government intervention, but if that is the path we are on, why can’t the intervention be profitable?

Ulsa writes:

The global markets are becoming more interlinked, so when the American market sneezes the markets in the rest of the world catch a cold. With the problems in the housing market recently, American markets have been sneezing a lot. One of the things that eliminates consumer and producer surpluses for banks, firms, and consumers is volatility, uncertainty, and risk in the markets. Just for the Federal Reserve to prolong the uncertainties of the American market by not intervening costs money to a lot of other markets. The Fed can eliminate deadweight loss for producers and consumers by minimizing uncertainty by bailing out the borrowers.

Crazy Politico writes:

Feldstein's proposal is a bail out mostly for lenders, and the few who would use it that have some equity in their property. With no equity a simple real estate calculator shows that you'd end up paying more, not less per month when the repayment of the government loan is included. Unless, of course you can get below the magic 80% LTV and kill PMI off.

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