A modest proposal: Buy ALL the mortgages, not the toxic derivatives
I am not an economist, but I can do arithmetic.
Current book value of all US housing mortgages is about $10.5 Trillion. Many of these mortgages are headed for default, and it is estimated that the net valuation (mortgage balance minus resale value) of the defaulted properties could reach approximately negative $1 Trillion. This pattern of increasing defaults is well established and will not quickly reverse.
Because of laws dating from the First Great Depression, banks cannot easily go after the mortgage holders for that net negative; they will have to eat the loss. With the total capitalization of the US banking system being just $1.3 Trillion, it is readily apparent that this deluge of defaults could destroy the whole of the banking industry – and the rest of us with it.
If, however, the government – that is, all of us together – take responsibility for ALL the mortgages and back them for full value, we can for just (just!) a $1 Trillion commitment put an end to the immediate problem.
We, collectively, would buy ALL the mortgages from banks and other secured lenders at book value in return for promissory notes backed by the full faith and credit of the United States. We will pay down those notes with proceeds from future mortgage installment payments and any mortgage payoffs, as well as such payments as can be garnered from selective restructuring of some of the threatened mortgages, the sales of any foreclosed properties, and drawing down as needed from the capitalization commitment amount of $1 Trillion.
The banks will thus be relieved of their entire existent mortgage burden and can go about their other businesses significantly less encumbered.
Holders of the various derivative tranches are currently faced with the natural consequence of the mortgage defaults; a fall in value to zero or near to it. These were highly speculative investments and anyone who didn’t appreciate that was certainly an unwary buyer. However, many of the people who will bear the consequences are elderly, infirm, of limited financial means and entirely innocent of anything more than being willing to entrust their future financial well-being to large firms with previously good reputations. It would be a shame if they are, through their innocence, made to suffer.
By this mechanism of buying ALL current mortgages, however, the now-worthless derivatives will be restored to as much value as they ever had. Everyone wins, now and in the future.
We need not a replica of the original HOLC, but a MEGA-HOLC – one on, ahem, steroids. It doesn’t make financial sense to keep pouring trillions of dollars into the unstable banking system trying to paper over the accounting problems with valueless mortgage derivatives when we could just buy ALL the outstanding mortgages and be out no more than $1 Trillion and have the chance of making back enough money to eventually cover that up-front cost and, maybe, keeping some of those underwater mortgagees in their homes.
Concurrent with this bailout of the banking sector, there will have to be some righting of past errors. For starters, with the toxic derivatives restored to a semblance of healthiness the banks' balance sheets should look much better and they won’t need as much of the TARP money that they’ve already received. They should start paying it back.
Additionally, our bailing them out doesn’t mean they are free to repeat the idiocy that got them – and us – into trouble. Strict regulations have to be implemented, to bring us back to the status quo ante prior to the loosening of mortgage regulations under Clinton. Those moves, however well-intentioned, were a mistake. To the extent that we decide in future to give some assistance to home ownership for the lower classes, there are other approaches that would work better than loosening of regulatory credit requirements. Tax breaks for builders and owners of smaller, energy-efficient housing constructed around commons greenswards with locally generated power and integrated infrastructure, essentially pre-planned villages, would be one common-sense approach.
And it must be noted that resolving the mortgage crisis doesn’t do away with the rest of the banking sector’s problems. They’ve overextended credit in all manner of means, including automobiles and credit cards, so now the American people as a whole are indebted to an extent greater than our annual GDP.
This general excess of consumer indebtedness is another tangled problem of immense proportion, and needs to be discussed as a separate post. If it is not properly dealt with, economic collapse will follow regardless of what is done about the mortgage problem. The new BARF Plan won’t do it, just another top-down wrong-headed backasswards approach, but again that will have to be a separate post.
Separating out just the mortgages from the rest of the banking problems is doable, and if done in toto rather than dealing only with the toxic elements it will be beneficial to all parties including especially the American people. This should be the next step towards economic recovery, using the second TARP funds installment of $350 Billion to get started.
It is a big, bold program of historic and heroic proportions that is simple to understand and financially sound – an investment by the people in the people that keeps management of our invested money out of the hands of those who created this problem. There is no reason to wait, nor is there reason to tie mortgage ownership restructuring to any of the other banking problems as TARP and BARF try to do.
There is even a suitable acronym, courtesy of Roubini: H.O.M.E. (Home Owners’ Mortgage Enterprise). There is also a simple catch-phrase –
“This act is the American People, Investing in Ourselves” – so the required elements of communication are met.
Do it, and do it now.