Main Street Rescue - Designing HOLC 2.0

Odds are the revised Paulson plan will pass the Senate today and House tomorrow. If the plan fails, America will need an alternative. And even if it passes, America may still need additional support. In either case, we should start thinking seriously about a Main Street rescue, something akin to the Home Owners' Loan Corp. of 1933. The next President will probably have to.

John Kennedy once said that success has many fathers, but failure is an orphan. But in this case, America's financial mess now has many foster fathers. You personally may have played by the rules, but the whole world owns this baby now.

If we are to look for the biological parents of this crisis, we know for certain the identity of the mother: her name is Ms. Housing Bubble. Many would agree that Mr. Leverage was involved, but frankly, his DNA has been part of every financial crisis for the last few centuries.

Housing on Main Street is overbuilt, and every home-owner who was told that housing values never decline now knows better.  Supply and demand applies to all markets. By over-stimulating demand to a ridiculous degree, Congress forced Fannie and Freddie to put excess Housing on Main Street.

Wall Street is in trouble because it got in the business of selling mortgage-backed securities based on infinitely chopped up mortgages from around the U.S. So long as those mortgages were paid on time (and housing values rose), all was well. But once the housing price bubble burst, the related securities became of questionable value.  As more and more homes face foreclosure because the "home-owners" can't or won't make payments, everyone has a problem. "For sale" signs litter Main Street, and values drop further, creating an extended domino effect.

The ultimate remedy is probably for the government to rescue Main Street directly through mortgage interventions, which I wrote about a few days ago. An op-ed in today's Washington Post proposes something similar in "The Trickle-Up bailout" by Jonathan G.S. Koppell and William N. Goetzmann:

The financial crisis is a liquidity crisis, yes, but it is ultimately a product of homeowner failures to pay. Unless this fundamental problem is fixed, we will continue to see -- and need to treat -- the symptoms. The proposed bailout ignores this. Yet the sum being demanded from taxpayers is almost certainly more than sufficient to pay off all currently delinquent mortgages.

If the government did this, all the complex derivatives based on these mortgages would be as good as U.S. Treasuries. Their fair value would jump to 100 cents on the dollar, rescuing teetering financial institutions. The credit markets would be resuscitated overnight. Foreclosures would stop.

Unfortunately, the authors make the same mistake Hillary Clinton made in calling for a new HOLC. They envision a bailout of home-owners who cannot afford their home, paid for by everyone else who lived within their means (even the millions of Americans who are full-time renters). It's been 75 years since HOLC 1.0, so you would think we might have learned how to build a better version.

Koppell and Goetzmann say, "unfairness is a small price to pay to avoid a rapid transition to a socialist economy," but they are only looking at the sticker price of a new HOLC.  Let's say their plan would have the government buy up 1 million homes at an average cost of $200,000.  That's $200 billion right there, but the government wouldn't own the homes, which under their plan would be retained by the irresponsible parties. Instead, the government would pay some hefty percentage of that value just to convert the mortgages to something more affordable, so let's say it would cost $50 billion.

That's a pure $50 billion bailout to the worst offender, not an investment by taxpayers.  It would be a terrible subsidy for bad behavior and, worse, the moral hazard problem would be immediate. What would stop fiscally sound neighbors from suspending their own mortgage payments in such a plan? Without a cap, the price would balloon from $50 to $500 billion in the blink of an eye.

Look, the only smart way to design a HOLC 2.0 Main Street Rescue is to leave the bailout out. I do think it would be incredibly wise to fix the mortgage mess from the bottom up, which would relieve lenders while also stabilizing housing markets (at least from overcorrecting), but only if the at-risk property is fully transferred to the taxpayer. The existing resident should be converted from an evictee to a renter, because, let's all admit, they are not a home "owner" in the face of a foreclosure. The lender would not be made 100 percent whole in this plan, maybe just 90 percent.  But liquid!  And the lender would be better off than going through months or years of foreclosure and eviction proceedings.

A HOLC 2.0 can work wonders, but only if it gets the incentives right. If HOLC is recreated unchanged (in a country where many homes are refinanced and leveraged), it will make matters much worse.  And that, my friends, will be just like how the government handled Great Depression 1.0 - fixings things by killing market incentives.

Do we really want to go there again?

Comments

[Charlie Poole]

Main Street? Wall Street? The distinction is meaningless now that the contagion has spread throughout the economy and around the world. We are all Wall Street now.

[Dai Alanye]

Sounds like a great idea, but...

Anyone who's been a landlord knows that renters come with plenty of problems, starting with the fact that most of them fail to keep up the property. Low-income renters tend to be worse than average, and resentful renters are the worst.

Your proposal would convert a great number of unsophisticated buyers into resentful renters, cheated (in their minds) first by the lender and secondarily by the government that is supposed to care for them. The properties would be often trashed, losing a great deal of value.

Those with a romantic view of the poor will wish to dispute this, but experience shows it to be accurate. I soon learned to stop renting, simply rehabilitating the properties and selling them.