A Modest Proposal for Curing the Housing Crisis

Nine billion for IndyMac bank, 80 billion for Fannie and Freddie, 60 billion for AIG, hundreds of billions more for an RTC-type fix – as Everett Dirkson (former Senate leader) used to say, “A billion here, a billion there, and pretty soon you're talking about real money!”

With the number and size of government bailouts increasing and with no end in sight, one has to wonder how will it end? Will the government ever get a handle on the deepening financial crisis?

While our political leaders seem to be running around plugging the leaking financial dike one hole at a time, many of us in real estate have been wondering why they don't simply attack the problem at the source? After all, it's pretty clear that the current financial difficulty is occurring as a direct result of the collapse of the housing market. Stabilize housing and the financial markets backing it should quickly come around.

Consider, rampant foreclosures are forcing prices ever lower in market after market across the country. This in turn causes financial institutions (both in the secondary market such as Fannie and Freddie and the derivative market such as AIG) who ultimately hold the mortgage paper on most of those foreclosed houses to see their asset's lose value – hence, the drawdown of their capital and, ultimately, their failure and the government bailouts.

However, while spending billions to bail out financial institutions who hold watered down mortgage paper may temporarily shore up financial markets, it does nothing to cure the problem, which is falling housing prices caused by ever increasing foreclosures. It's a bandaid, not a cure.

The right answer is to stop the foreclosures. If the foreclosures stop coming, then the housing market will have a chance to stabilize. Prices will level off. Home buyers confidence will return. And given the enormous hidden demand for housing, prices should even begin rising.

That will have the beneficial effect of making all the mortgage paper that financial institutions hold more valuable and will start turning the tide on the financial crisis.

So, how do we stop the foreclosures? That's the point of this modest proposal:

Instead of spending hundreds of billions of dollars to shore up failing financial institutions, why not spend tens of billions of dollars to salvage failing borrowers? (Every $1 spent at the source of the problem should yield $10 of benefit at the other end of the financial chain.)

The cause of the problem is mainly that ARMs (adjustable rate mortgages) are resetting to higher interest rates and higher monthly payments that borrowers (who were ill-advised to borrow the money in the first place) cannot afford. That results in the cascade of foreclosures that's sinking our financial system.

So instead of resetting the ARMs at higher rates and monthly payments, why not simply and arbitrarily rewrite all of those loans to keep those low teaser rates in place for an additional 5 years? For example, a borrower's mortgage is resetting from 3.5 percent to 6.5 percent? He can't make the payments.After 3 months of defaulted payments, let the government pay the difference for the lender to step in and automatically (without further threat of foreclosure or without concern if the borrower is an occupant or an investor) freeze the initial low rate (and the correspondingly low payment) at 3.5 percent for 5 years.

It's not as outrageous as it sounds. Yes, it would cost the government billions to do this. But not as many billions as the government is already spending to bail out the tail-end of the system – financial institutions who hold the mortgage paper on foreclosed properties.

And it would have the enormous benefit of keeping people in their homes, stopping foreclosures, and stabilizing the market. But, many will certainly complain, it's not fair! What about those millions of people who didn't get in over their heads and take out risky loans? Their tax dollars would be going to save the financial necks of those borrowers who don't deserve it. True, it isn't fair. But, when the ship is going down do you stand around arguing about whose fault it is? Or do you start bailing water? We need a turn around. And soon.

This modest proposal would serve the same purpose as the CCC and WPA served during the Great Depression. It would restore confidence and stop the bleeding. And it could actually save the government money. Who knows it might actually save the government!