Today's new york times op-ed damning Geither for a pathetic, inadequate home mortgage rescue program is right on the mark.
But it begs the question - if not that, then what?
there has been surprisingly few solutions of useful value put forward to address the underwater morgage problem; families that owe more on their mortgage than the house is worth. it is a problem that cries out for an answer.
yet, a simple look at the cash flows of mortgages and taxes leads quickly to an obvious answer that i've never seen published.
the problem is at the center of our economic malaise and should be addressed directly for the following reasons:
1. houses losing value is how ghettoes are made. abandonment and disrepair become rampant in neighborhoods when it costs people to sell their home.
2. banks are struggling to cover the "bad loans" in their portfolio. while some of those bad loans were created by stupidity and dishonesty, some have been created by the values of houses decreasing below the purchase prices. by solving the problem of underwater houses you have directly and meaningfully solved a problem for the financial system - immeasurable bad loans on the books.
3. the glut of foreclosed houses on the market makes it difficult to find comparable sales and establish the true value of a home. banks deal with this uncertainly by not lending in familiar ways. reducing the number of foreclosures improves liquidity in the housing markets.
4. families paying too much for their house face the moral hazard problem: when doing the right thing, paying off the loan, is counter to their financial interests. for the american system to make sense, doing the right thing needs to be the same as doing the financially rewarding thing.
"so what's the solution?"
in economic language it's a classic "debt overhang" problem. because of the amount of debt held by the family they do not undertake new ventures or puchases that could be in their best interest. the only solution to the debt overhang problem is to reduce the principal owed by the family. basically, the only solution for the underwater house is to reduce the principal - forgive part of the debt - write a new mortgage with a smaller starting balance.
"wait, that sounds lke a lot of money."
its a lot less than you think when you first look at the cash flows of mortgage payments. keep in mind that homeowners can deduct mortgage interest from their tax calculation. so, the more interest you pay on your mortgage the less tax you pay. and vice versa, a lower interest payment means you pay higher taxes. that's because at a lower interest payment you have a smaller deduction and with a smaller deduction your adjusted gross income goes up and you pay taxes on the higher rate.
this is more interesting when you run some numbers. the average 30 year mortgage rate before the crash was 6.5%. so, for every $100,000 of mortgage you will pay $6,500 per year in interest to the bank (and a little less than that in future years). you deduct that $6,500 in interest when you file your taxes. so, at the 20% marginal tax rate you save $1,300 in taxes.
today's 30 year interest rate is more like 5%. so, for every $100,000 in mortgage you pay $5,000 in interest to the bank. you deduct the $5,000 in your tax filing and at the 20% marginal rate you save $1,000 in taxes.
by refinancing you will pay $300 more in taxes ($1,300 minus $1,000) but less to the bank and you will spend less overall for your housing. of course that's $300 in the first year, but it will continue to be in the neighborhood of $300 every year for the life of the loan. $300 times 30 years is $9,000 more in taxes by refinancing to a lower rate. (this should be discounted for inflation and other factors but i'm trying to illustrate a theory here and avoiding distracting complications.) while refinancing will save the family money overall, the amount paid in taxes increases by $9,000. by doing nothing but allowing the refinancing the government stands to gain $9,000.
if the government gave the family $9,000 up front, but then collected the $9,000 in extra taxes over the life of the loan it effectively costs the government nothing. it's all the same. the $9,000 the government gives to the family (by lowering the amount of principal owed to the bank) is paid back with additional taxes every year for 30 years. it doesn't cost the government anything. you can think of it as a personal loan that gets paid back to the government through regular tax filing.
"what are you telling me?"
i'm saying that the government can reduce the principal of underwater mortgages by 9% and get the money back with the additional income taxes paid by the family; when the mortgage rate decreases by 150 basis points. if they are going from a higher interest rate or to a lower interest rate the amount of write-off can be increased.
"still sounds like a lot of money"
well, you're not really "spending" money when comes back to you. it's more like lending it. but let's remember that the TARP authorization required 700 billion to purchase mortgages and help the homeonwers. so, the appropriation from congress is already in place to write down principal balances.
according to corelogic there is something like 200 billion in negative equity for mortgages with loan to value ratios (ltv) between 105% and 125%. there are a lot of houses underwater at a level greater than this. this little mechanism won't help those deeply underwater.
but how about it. use the TARP law to lower the principal balance of primary home mortgages at no real cost to the government. do you think Geithner is open to a suggestin?
(while i came up with this on my own, i can't say that nobody else has ever thought of it. all i can say is i haven't seen it if it exists. apologies to whomever may have been first)