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.