A clever idea that shares the losses and the spoils for those responsible for the housing mess, and helps in keeping family in their houses and props up the market. What more can one ask for?
We Can Keep People in Their Homes
Let lenders profit later for easing terms now.
By ANDREW CAPLIN , THOMAS COOLEY , NOEL CUNNINGHAM and MITCHELL ENGLER
- The world’s turned upside down. For generations of Americans, family homes were assets to be bequeathed to our children. Today, instead, we are proposing to leave them billions of dollars in long-term debt issued by the federal government to prop up a housing market gone bad. This is unfair.
- Moreover, while the rescue plan may help the balance sheets of financial institutions, it does nothing to help the balance sheets of households. Their problems must be addressed.
- The way to do so is through the shared appreciation mortgage, or SAM. The concept is simple: Homeowners are offered the chance to write down a portion of their mortgage debt, but at the same time, they are required to share future appreciation gains with those who helped them out.
- Let’s take stock of the dead end into which we are currently careening. Today, as home prices plummet, a growing number of families are defaulting on their mortgages and being kicked out of their homes. By the time housing prices stabilize, as many as 20 million households may be upside down on their mortgages, creating incentives to default.
- These defaults set in motion a vicious cycle. Foreclosure is a slow and costly process. Foreclosed properties diminish the worth of nearby homes, driving yet more homeowners into default. Taxpayers are the next casualties. Fannie Mae and Freddie Mac using Treasury money to buy up subprime mortgages, and the bailout authorized by Congress earlier this month, put tax dollars behind the banks and other financial institutions that hold these mortgages.
- If we force lenders to write down yet more mortgages, they will just pass the loan losses on to the next generation. Our children — the future taxpayers of America — are the “losers of last resort,” responsible for today’s bad debts of the financial sector.
- The federal government needs to give taxpayers an ownership stake in the future. The SAM does just this. For example, a homeowner unable to support payments on a house purchased for $200,000 that today is worth only $150,000 might be offered a write-down of up to $50,000. But this would not be a free lunch.
- With the SAM, once the value began appreciating above $150,000, the mortgage holders would be due their share. The details of the write down and the appreciation sharing could be tailored to different circumstances. But one way to give lenders a share of the upside would be to pay back some of the write down if the house is later sold, in the scenario above, for more than $150,000. This is a model in which both parties benefit, preventing default while giving future taxpayers a fighting chance at some real upside to the investment we’re forcing on them.
- Many mortgages have been sliced and diced so that there is no single lender with whom to bargain. But there are paths to renegotiation that Congress or the Treasury could enact to create the incentives to make it happen.
- Appreciation sharing is a cost to the borrower. Thus, if the terms are set correctly, those with the means to get through the decline in their collateral without giving up some of their upside will find it in their interest to do so.
- The SAM was pioneered by banks in the U.S. some 40 years ago, but it has been allowed to languish due to an archaic, IRS-imposed block. (The IRS hasn’t ruled whether such a contract is a mortgage because it combines elements of equity and debt.) This block could be removed at the stroke of the Treasury secretary’s pen.
- Almost 75 years ago, in the depths of the Great Depression, the nation faced a housing market collapse even more brutal than today. The federal government responded with a strategy that allowed homeowners to keep their homes and kept the bottom from falling out of the real-estate market. Unprecedented at the time, the 30-year fixed rate mortgage has since become the gold standard in markets around the world.
- Today, facing a similar collapse, the federal government needs to be equally bold. SAMs are the new deal in housing that our children need.
- Mr. Caplin is an economics professor and co-director of the Center for Experimental Social Science at New York University. Mr. Cooley is dean of the Stern School of Business at NYU. Mr. Cunningham is a law professor at NYU. Mr. Engler is a professor at the Benjamin. N. Cardozo School of Law.
There is one risk of this otherwise smart plan. In the short-term, financial institutions will take some hit because of the writedowns (despite them having a stake in future recovery).
However, we think this risk is smaller than some (like Mankiw) assume as the alternative is a foreclosure, which is a fire sale which typically leads to losses for the financial institution instigating it anyway. And with foreclosures, there are no compensating future gains, and there is large collateral damage in the form of a household that is left with no house and a big debt.
What’s more, the cost (and gains) is shared by borrower and lender alike, both bare some responsibility for the mortgage that was not terribly sensible. It’s a form of poetic justice, one could argue.
It’s a clever idea.