In support of The USA Mortgage: Why Gary Becker is Wrong

New York City -- The New York Times reports this morning that the financial rescue framework to be announced by Treasury Secretary Geithner later today will not include a housing or mortgage component to help keep people in their homes.  Instead, what is best viewed as the third leg of the Administration's economic recovery program--the first two being the Recovery Act and the program to stabilize lending--will be announced next week.  $50 billion of TARP money is said to be on tap to address the housing problem NDN has long argued is central to working through the current crisis.  There is thus time to get this housing proposal right and, I hope, include a new low cost mortgage for American families.

There are a variety of proposed measures to help keep people in their homes.  One simple idea, vigorously opposed by the mortgage lobby but championed by Senator Durbin and many Democrats, would be to allow bankruptcy judges to modify mortgages as they currently may do with commercial loans.  Lenders (except Citi which has dropped its opposition) fear this because, they worry that borrower friendly judges by reducing principle would cloud recovery prospects for any loan.  Their worries are excessive because--even if modifications were allowed--the negative consequence of Chapter 13 are so large that most defaulting borrowers would not opt to go this route.  By the same token, while allowing modifications would improve the leverage of delinquent homeowners, help in some cases and is, thus, on balance a good idea, this change alone cannot resolve the mortgage crisis.

A second idea is to expand cookie cutter modification programs such as the FDIC's modification in a box.  Under this plan which the FDIC is using to modify loans it has acquired in taking over failed banks such as Indy Mac, loans are modified based on the borrower's ability to pay and payments cut to 31% or so of the borrower's income.  However, the borrower still owes the full principle amount upon sale.  So, in the end, this is a recipe for keeping people in their homes but underwater.  It has the downside of encouraging people to go into default to take advantage of the program and would not encourage new purchases of homes.  It is best thought of as a limited program.

A third idea is to encourage investors in the mortgage securities market to buy up mortgages to pump more money into the market.  The Fed has already been buying up mortgage backed securities of Fannie, Freddie and Ginnie Mae but, according to one study, without appreciably impacting the affordability of loans.  The Fed, might, however upon acquiring enough of these, begin to modify them in the event of foreclosure.  This approach is no silver bullet either.

The last idea which I believe has the best prospects of stabilizing the housing market is a 4% fixed mortgage (for the time being) to be guaranteed by the Federal Government.  The potential advantages of a simple, USA mortgage for the American public are huge.  First, a simple program would not discriminate against new buyers or those making their payments, eliminating any incentive to default or go into bankruptcy.  It would end defaults due to option ARMs and, take interest rate reset risk for homeowners off the table for many years to come.  Finally, by lowering the payments of American families it would free up considerable demand in the economy for many years.  It would, in short, go a long way to stabilize housing and strengthen the economy  Of course, certain banks still collecting on high interest loans would lose their supercharged returns.  But reducing risks of default would suitably compensate them.  Like some of the great social programs in American history, such as Social Security and the GI Bill, this program has the advantage of being a universal benefit and would be in the best spirit of putting all Americans on an equal footing.

However, no sooner did I put forth my idea for the USA mortgage than Republican support for a similar idea led to an avalanche of attack, from of all places, conservative economists.  Conservative Harvard urban economist Ed Glaeser said it reminded him of the New Deal and argued that Republicans should look to Ronald Reagan not FDR for inspiration.  And today, none other than Nobel Laureate Gary Becker attacks the idea in the Financial Times.  Becker won his Nobel Prize for extending economic ideas into non monetary social relations such as marriage, fertility and crime.  Along with only a handful of other economists, he helped engineer the spread of faith in markets.  Here's why he is wrong, however, on the 4% mortgage.

His argument against the 4% mortgage is largely that the program would require a substantial government guaranty, cost $100 to $150 billion net and raise home prices by at most 5% if at all.  Let me take these in turn.  First, the government is already guaranteeing about 5 trillion in mortgage backed securities since its seizure of the GSEs, Fannie and Freddie.  A properly structured loan program would be no more risky than these assets and increase guarantees, even using Becker's numbers by about 15%.  Second, the actual cost to the Treasury, if any, would be far less than under alternative scenarios where high interest mortgages would be more likely to encourage defaults.  However, perhaps the real flaw with Becker's argument is that this program is not about raising home prices.  Rather, it is about ending the raft of foreclosures from resets, stabilizing the market so that it can recover in due course and finally increasing demand in the economy by keeping payment manageable.  If it happens to increase home prices by 5%, than that is merely icing on the cake.

Indeed, the assault on the 4% mortgage idea by conservative economists--as brilliant as they may be in their academic work--is evidence that this is a benefit, above all, for ordinary American people, not for the free market faith.

The Obama Administration and Congressional Democrats should take the unexpected support for this idea by Senate Republicans and run with it.  A good starting point is including it in the housing plan to be announced next week  This is a rare opportunity to create a historic benefit for the American economy and the American people.