Martin Feldstein on the Financial Crisis

Writing in The Wall Street Journal, highly respected economist Martin Feldstein proposes that the government provide low-interest loans to consumers in return for mortgage debt.

These government loans would not be secured by the borrower’s home. The loan would need to be paid back even if the home goes into foreclosure and would not be eligible for relief in bankruptcy.

The idea behind Feldstein’s plan is that falling housing prices are at the root of the financial crisis. As home prices fall, homeowners end up with mortgages that are larger than the values of their homes, making it financially beneficial for the homeowner to simply walk away.

These foreclosures put even more downward pressure on housing prices, exacerbating the problem. Feldstein’s plan would help to reduce the loan-to-value ratio of existing mortgages, and thus lessen the incentive to default.

Feldstein’s proposal is interesting and very original. I have to say, though, that there is one thing about it which really troubles me.

The goal of the Feldstein plan is to keep housing prices high. In general, economists are strongly against government interventions in markets designed to affect prices — whether it’s central banks trying to defend currencies, or wage and price controls like those Nixon instituted.

An important question to ask is: if there was a house-price bubble (which it sure seems like there was), would it just be better to quickly get house prices back into equilibrium and take our lumps, or should we try to forestall prices getting back to where they should be?

My instinct is that it is best to take our lumps as quickly as possible.

People who own houses are a lot poorer than they thought they were at the peak of the housing bubble. My gut feeling is that the sooner folks accept this and make decisions going forward that recognize this, the better.

If the mortgage-backed securities are worthless, then they are worthless. The people who hold them have lost a lot of money; the people who sold them to the people who now own them made a lot of money. We sort out who is bankrupt and who isn’t, deal with those who are bankrupt, and then get on with things.

Feldstein’s response, no doubt, would be that we are going to get caught in a reverse price bubble — where buyers stay out of the market in anticipation of future house-price depreciation — which would make falling housing prices a self-fulfilling prophecy. That would be a mess.


Did anyone else notice a similarity between Feldstein's proposal and the "American Homeownership Resurgence Plan" McCain proposed in the presidential debate tonight?

It' no secret that McCain consulted with Feldstein...

... and now it appears he is taking his advice.

Jake Summers


Republicans whine about taxes on capital, not on labor. Over the last 25 years they have consistently moved all taxation onto the backs of average citizens. They have done this basically by reducing all taxes on capital and business. This also makes it difficult for small business to compete and protects the big business model.

Basically the Americans that want the income tax removed are correct. There should be zero direct tax on labor. It is the base of your society, you don't tax it. Our founding fathers saw it as Aristocracy and fuedalism. That is exactly what it is today and we must reduce the taxes on labor and move it where it belongs which is on profits and luxuries.

The best way to assist those near the poverty line is zero taxation on things they need and allowing them to keep the fullest value of their labor.

Even worse, in globalization trickle down economics fails. You cannot have a work force on the other side of the planet with the same education and skills that only makes a few dollars day and remain competitive. Americans are not super humans and are just as average as these workers. So all trickle down creation has bypassed the American people and gone to countries like China and India. It was a massive redistribution of wealth to those nations. All the while those with capital loved the market arbitrage. Wouldn't you like to simply cross the road and increase your wages by 500 percent while doing the exact same job you were doing? So capital moved a few chess pieces and Americans started surviving on credit.

Here we are. Fixing it with price fixing is a waste of time and effort. This will not work as wages, especially as we go into a severe recession on main street, will not rise. Wages cannot rise as long as people with the same education, access to capital and tools are direct competition.

Our wages must fall to the global average. If the average wages globally are about 10 dollars a day we have a long way to fall. That weight is far stronger than being able to pull wages up. Housing prices will fall and likely continue to fall for a decade or longer if speculators are kept out of driving prices up. Housing prices cannot rise until global wages rise.


CT reader

I read Mr. Feldstein's proposal, and believe that other alternatives would be more beneficial:

1-If we are giving below market loans, why not give them to Veterans coming back from the war? We did that after WWII and it worked very well.

2-Provide a tax credit to buyers. The market will establish the price of homes, and young buyers will be able to afford homes if prices are not kept artificially high.

3-Bring back the old passive loss rules, which allow landlords to deduct their losses on rental properties regardless of their income. This will surely bring qualified buyers back into the market.

4-If a homeowner trashes a home prior to foreclosure, this should become part of his credit report.

5-Banks should allow buyers to assume the existing mortgage at no cost. If the buyer chooses, he can get another loan and pay closing costs. The ability to assume the loan will save the buyer a few thousand dollars, thus making a new home more affordable. It also gets the seller out of a mortgage that he cannot afford.



I agree with the above posters about homes being overpriced. The government has actually discouraged rising wages by limiting unions' powers to strike and boycott. Why hasn't anyone mentioned that Bush stopped the West Coast Longshore strike so Walmart could stock up for Christmas? That was government intervention in the economy. Until workers can once again afford housing on a quarter of their wages, housing is too high. Most renters pay half of their income in rent. I am waiting for a bailout of the American workers by rebuidling infrastructure. So far, only the speculators have gotten promises.

Joe Smith

Interesting contrast between Canada and the United States. After much drama and multiple votes in Congress the United States has a plan to possibly buy $350 Billion in mortgages from American banks. Canada today announced as an administrative matter that Canada Mortgage and Housing Corporation (a government agency which guarantees home mortgages for a fee) would be buying $25 Billion dollars worth of mortgages from Canadian banks. Given that Canada's economy is one tenth the size of the US the Canadian move is as significant in relative terms as the US move and is being implemented with a lot less fuss and bother.

Thriller Jesus

As Colin pointed out, any "reverse bubble" Feldstein may fear can only go so far before it runs into rental market prices. If there is no rental market in your area, then you are facing a ghost town affect anyway and are likely to be so far underwater that Feldstein's proposal will not help you.

That said, I don't think Feldstein's proposal will be a better option for most unless it also forgives some percentage of the negative equity. This is all assuming you are looking to prop up housing prices. Which I'm not. I take my market corrections lumpy.


For all the talk about propping up home values, it goes against the grain of letting the market decide the equilibrium. Home prices are still way above the affordability of most consumers. The bubble was created by artificially low interest rates and non-qualication of borrowers that encouraged rampant speculation. Tax exemption or deductions on second or third homes should also be banned. People also confuse the remedies which can be fiscal (i.e. taxes), monetary (i.e.interest rate) or both. How many people factored them and their constant change in their decisions?

The law that abolished renter's credit also encouraged buyers to blindly jump into the housing market as they saw that they can reap rewards by taking unnecessary risks. Underlying all these is the bigger issue of wealth and income distribution in this country. Unless those issues are addressed all economic problems will simply shift from one area to another.


T V Selvakumaran

Q5. Why have the markets for mortgage securities continued to remain illiquid?

A. The main reason that the markets for mortgage securities have been illiquid for a prolonged period of time is that the home-owner who is the only party with a credible and serious interest as a buyer of the mortgage securities has been shut out of the market. Instead of directly involving the home-owner, Wall Street has been peddling bizarre theories about risk management that has resulted in this huge mis-allocation of this $700 billion recently. By providing the information for a direct match-up of the home-owners on Main Street and the security-owners on Wall Street, the government could implement a low-cost eBay-type bidding system that would enable the home-owners to bid for the various tranches in the mortgage securities issued on their homes -- those tranches that the banks want to get rid of. This way the home-owners stand to benefit from a reduction in their debt obligations. The security-owners gets a floor on the prices of the mortgage securities and because of the decent prices, their capital gets replenished. Moreover, the home-owners' debt reduction can be structured in a way that encourages good behavior, and timely re-payment of the rest of the mortgage loan. This process would cost less than $1 billion for the government and achieves the objectives of liquidity and re-capitalization stated in the $700 billion bill. In addition, this direct match-up plan reduces foreclosures by reducing the home-owner's debt. Professor Martin Feldstein has also proposed a plan to reduce foreclosures. In his plan the government re-negotiates the home-owners' loans to provide debt reduction through low-interest loans, in return for enhanced claims on the home-owner. In my plan, the government's role is solely to provide reliable information.



It doesn't matter how far house prices fall, with unemployment still relatively low eventually houses will be seen as cheap and people who didn't overstretch themselves with debt during the bubble will jump in and stabilise prices.

Doctor Gonzo

As always with these plans, I ask myself, "How would this affect those people who saw this coming and wisely did not purchase a house they could afford?" This plan would artificially keep housing prices too high, once again screwing over those of us who did not buy into a bubble.

Let it crater. I'm tired of getting the short end of the stick because I didn't buy too much house and thus I am not getting bailed out. Where is the reward for those of us who are financially literate and played by the rules?

James A

As I let partisan politics encroach on my thoughts, two things:

1) Why did you reference Nixon when talking about intervention? Would not the policies of Jimmy Carter (think hyper-inflation, long gas lines) not be more relevant to government intervention?

2) If you and "true" economists are so against government intervention, then why is the majority of economists for Obama (see earlier Freakonomics postings), who advocates increased government oversight and intervention into our daily lives?

Just trying to see through the irony here. Work with me.


I agree. I'd rather see a change, even temporary, that would allow a write-down of mortgages without causing tax for the borrower. A number of checks in the system prevent writing down mortgages, from banking laws to tax laws.


Is Feldstein still peddling this nonsense? It was shown to be stupid seven months ago.

Joe Smith

Where is the incentive for the rational homeowner in that proposal. They swap a non-recourse debt for something that will follow them for the rest of their life?

I've had 27 years experience helping bankrupts and the faster they can get through the process and start over the better.

No amount of intervention, other than deliberate inflation, can sustainably push the price of old houses above the cost of building equivalent new houses.


Now why would in negative equity situation or expects to be in a negative equity situation take this deal?

They will be swapping part of their mortgage for the same level debt - which contains full recourse and exclusion from bankruptcy. Someone that still ends up in foreclosure could be in debt to the government for decades afterwards.

This plan would probably be most appealing to homeowners who would still have postive equity after another 15% - 20% price drop. They would use it as an interest rate buy down.

if he truly wants to prevent negative equity foreclosures, the excess principal will need bought down and/or written off before the borrower stops making payments.

Laura B

I don't think the foreclosure crisis is a result of people walking away from their homes because they realize that the mortgage is going to cost them more than the home is worth. Look at the neighborhoods being hit the hardest, believe me, they are not neighborhoods full of people wealthy enough to walk away from the thousands of dollars they have already invested. The foreclosure crisis is a result of predatory lending, of mortgage brokers convincing people that they could pay for homes out of their means when in all likelihood, they could not. Now housing prices in those same neighborhoods are falling because nobody wants to live on a block with 7 vacant homes. Keeping housing prices high will only make it more difficult for people who have lost their homes to find affordable housing. In the last several decades we have already done away with so much of the subsidized affordable housing in this country, lets not widen the divide by making home ownership even less affordable than it already is.



I vote for taking our lumps now as they have a strange way of getting bigger over time.

Housing prices should be market driven and if the capital isn't there to purchase a home on credit home owners will have to lower their prices to attract buyers.

There should be some way to determine what the "ideal" amount of residential capital should be in the market place on a per capita basis.

The fed can then add or subtract to keep this number at its expected level, which may stabilize price fluctuations over the long run.


Right wingers are always whining about "high taxes" hurting the economy. One thing that is seldom recognized is that high home prices are in effect a "tax" on productive businesses. To attract employees, they must pay them an income sufficient to afford housing. As housing prices have escalated into the stratosphere over the past 4 decades, am I the only one who sees the parallel decline in real economic activity?

Here in Calgary, we are seing this limitation. House prices have gone up by more than 4 fold in less than 15 years and now, nobody can afford to come here to take the many jobs that go unfilled. Over the long term, this has a corrosive effect on job creation in all places.

We need to let them crash to an affordable level.

Colin Suttie

In reply to Adam, it is fairly straightforward to arrive at an intrinsic value for a home - as long as there is a rental market, the home is worth some multiple of the yearly rent. When I bought my first home in the UK in the 1990s, the annual rental return for a similar property was about 12%. When I left Australia last year, it was impossible to buy a home in any state capital there with a rental yield in excess of the cost of borrowing money - in some cases the rental return net of property taxes, maintenance costs etc. was close to zero, not even considering the cost of finance.

Addressing the broader point & agreeing with the author, clearly the price of property throughout the western world is vastly above any intrinsic value - why should governments intervene to prop up an over-inflated market (in anything)? Anybody who didn't use their house as an ATM for the last few years, or didn't buy a whole bunch of houses to flip based on the "greater fool" theory, shouldn't be too badly affected by reducing house prices (apart from the few who had to buy at the top of the market, including myself).

History suggests that government intervention to prop up over-inflated prices is unlikely to succeed.



This doesn't make sense to me. Why would a homeowner who's underwater on his non-recourse mortgage want to make part of that mortgage collectible after the fact?

If, as the article claims, there is a financial incentive to just walk away and let the bank foreclose, providing cheap money from the government (that *has* to be repaid) shouldn't change that incentive much. I guess the ones who are dumb enough to agree to it in the first place will have an incentive to stay in their homes afterward, but that doesn't seem like a great economic strategy to me.