Martin Feldstein’s Plan for Borrower Indentured Servitude
Martin Feldstein is a pretty well-known conservative economist, a former chairman of the Council of Economic Advisers under Reagan. In a potential Romney Administration he could have a major role. So it’s worth looking at his proposed solution to the housing mess along those lines, as something that the GOP nominee next year could actually pick up:
To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. If everyone eligible participated, the one-time cost would be under $350 billion. Here’s how such a policy might work:
If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. For the millions of underwater mortgages that are held by Fannie Mae and Freddie Mac, the government would just be paying itself. And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home. This would all be voluntary.
This plan is fair because both borrowers and creditors would make sacrifices. The bank would accept the cost of the principal write-down because the resulting loan — with its lower loan-to-value ratio and its full recourse feature — would be much less likely to result in default. The borrowers would accept full recourse to get the mortgage reduction.
This is the kind of proposal that looks good at first glance – a conservative is pushing principal reductions! – and falls completely apart upon scrutiny. Dean Baker gets further into this, but here are my problems. There’s a moral issue with the government bearing half of the cost of the principal reductions, when banks are guilty (a fact not mentioned in Feldstein’s piece) of destroying the residential housing market through systemic fraud. I don’t know why government would bear the cost of anything in that scenario.
But that can at least be explained away as a type of stimulus. The far more egregious part of this is the trade-off. Feldstein’s program is voluntary, so like HAMP, banks can pick and choose on whom to bestow the principal reductions. Performing loans for underwater borrowers are not likely to go into the program, even if they could use the help. But the bank essentially would get made whole on all loans in the program because of the recourse provision. As Dean explains:
However, there will be more questionable loans that will go into the program. Some of these people may be able to make their payments after the principle write-down. They will then get to live in their home until they move and in all probability never accumulate a dime in equity (but the bank got half of its loss picked up by the government).
Others will take the deal and then find themselves still unable to pay their mortgage — remember we still have 9.1 percent unemployment and most people in Washington don’t seem to give a damn. Under the Feldstein plan the debt will now become a recourse loan, which means that the bank can hound foreclosed homeowners until the day they die for any portion of the mortgage that is not repaid by the sale of the house.
This just turns debtors into indentured servants working for the banks. And the amount owed would be largely at the bank’s discretion; we’ve seen them lard up debt with phantom fees and bad appraisals. Every dime a borrower earns for the rest of their life would be subject to scrutiny by the banks.
Heck, this is even to the right of HAMP, which did not mandate recourse loans. It just funnels money to the banks so they can make up every dime on the bad loans they gave out, with the government and poor borrowers paying the price.