Make no mistake: President Obama's recently announced $US75 billion housing plan is a long-term policy disaster insofar as it merely treats the symptoms of the calamity in an extremely costly manner via crude short-term interest rate relief – read good taxpayers bailing out bad – and remarkably does nothing at all to prevent the next generation of US borrowers experiencing exactly the same problems in the future. In fact, it can be argued that it only creates a higher tax burden for tomorrow's taxpayers.
Disturbingly, the Administration's response also exacerbates the underlying dysfunctionality that is the root cause of the US's housing market woes by, for example, offering defaulting borrowers scope to wriggle out of their home loan contracts through the judicial system (or, in the words of the Administration, "allow judicial modifications of home mortgages during bankruptcy for borrowers who have run out of options").
This will only undermine the enforceability of US mortgages and embed a new risk premium that will inevitably lead to higher future interest rates and likely funding uncertainty – why finance US mortgages when they can be overturned by the courts?
And by reinvigorating the two GSEs, Fannie Mae and Freddie Mac, to, ironically, "ensure the strength and security of the mortgage market", without any genuine reforms or discussion of their future, the Administration has demonstrated that it does not understand the fundamental flaws inherent in the US banking and finance system, which, as I have previously outlined, precipitated this crisis in the first place.
The Administration's asinine approach to dealing with the greatest economic challenge since the depression has, to be frank, left me despondent and thinking that the more gloomy prognoses – including those predicting a Japanese-style 'lost decade'–could well come to pass. This conclusion was certainly echoed in private discussions I had with respected academics during my recent visit to the US.
There remains, however, 'hope' that the more thoughtful decision-makers in the Administration, such as Housing Secretary Shaun Donovan, and President Obama's key economic advisor, Austin Goolsbee, will search out the superior long-term reforms that they so desperately need.
In this context, I was fortunate enough to be able to present several solutions to the Transforming America's Housing Policy summit for Obama Administration officials in New York a few weeks ago, which both Donovan and Goolsbee attended.
The summit's preamble was entitled, A crisis would be a terrible thing to waste, which could not have better captured the awkward cross-roads at which US policymakers find themselves. The difference between the US experiencing an interminable decline and recovering in the medium term to reclaim its place as one of the global economy's drivers of entrepreneurship and innovation, will arguably hinge on it response to this catastrophe.
The good news is that I believe there is a way forward, albeit one that will require courage, foresight and conviction on the part of the Administration's decision-makers. Given the life-defining stakes, it is never too late to recalibrate one's trajectory.
At the summit I presented a specific policy solution to the US's housing market problems, which appeared to be very well received and featured prominently in our panel's discussion on reclaiming the promise of home ownership. (This panel included the leading US academic economists, Robert Shiller and Raphael Bostic.)
The proposal also appeared to attract considerable interest from powerful US stakeholders, such as the influential Democratic Senator for New York, Charles E Schumer, whose advisors contacted me after the summit to convey their support.
As I outline below, this plan directly cauterizes the US's underlying housing market dysfunctions, delivers far greater and more permanent interest rate relief for distressed borrowers, allows banks to immediately recapitalise their balance-sheets with a $77 billion cash injection, and will ultimately cost taxpayers much less than the initiative the Administration has announced.
On all objective counts I find it hard to see how it does not unambiguously dominate the Administration's alternative. And based on consultations with US experts, I believe that it would be easier to implement since borrowers, lenders, investors and taxpayers would all be clearly better off than they are under the Administration's scheme.
As I've noted before, one of the most critical lessons from the global financial crisis has been that many households have far too much leverage – particularly in the US where the average borrower's mortgage is now worth an astonishing 95 per cent of their home (ie, 30 to 40 per cent are 'underwater'). And the only genuine policy solution to the resultant desire to deleverage is the development of external markets in housing equity – or 'shared equity' – which borrowers can use synergistically in combination with traditional debt finance.
Let me demonstrate how the application of a government-managed 'debt for equity swap' program would allow distressed US borrowers to radically deleverage their balance-sheets and, in turn, permanently reduce their mortgage repayments by 35 per cent or more in exchange for sharing some of the economic benefits of home ownership with taxpayers:
– Assume that the average 'distressed' borrower's loan-to-value (LTV) ratio (ie. their mortgage as a percentage of their home's value) is, say, 115 per cent (this is likely to be a fair approximation given the average LTV across the whole market is 95 per cent). Under this debt-for-equity swap proposal, the traditional lender would only write off 15 per cent of the value of their loan to bring the borrower's LTV back to 100 per cent of the property's value (as opposed to the lender writing off most of the loan's value, as would ordinarily be the case with a borrower in extreme default). A similar write-down is anticipated in the Administration's scheme.
(Note: You can view every article as one long page if you sign up as an Advocate Member, or higher).