To be honest, I don't know the exact details of how this Wall Street "fire" ought to be fought. I suspect it should involve two simultaneous strategies:
1. A government fund to buy distressed derivatives, which would inject capital into the system and provide some mechanism for pricing these opaque securities. The first step toward recovery is making the securities liquid again, meaning that they can be bought and sold at a predictable price, even if it's a low price.
2. A government fund to buy mortgages in foreclosure, or at risk of foreclosure, from lenders at a discounted price. So if I've got a $200,000 mortgage and I can't make the payments anymore, the government would buy it from my lender for something like $180,000. The lender still gets a haircut, but probably ends up better off than taking on the administrative expense of foreclosure and then having to sell the house in a dismal market.
The government would then restructure my loan with terms that I could afford, such as stretching the payments over 40 years instead of 30, or perhaps even lowering the value of the outstanding loan.
As a homeowner, I, too, should have to pay a price for borrowing more than I could afford. The government should be entitled to any profits on the eventual sale of my home up to the amount of whatever break they've given me. So if the Treasury knocks my mortgage down from $200,000 to $160,000, and I'm eventually able to sell the house for a profit, I should send a check to Uncle Sam at closing for $40,000 -- plus interest.
That's the essence of a sensible plan: Restore stability to the housing market at realistic prices; and inject liquidity into Wall Street, again at realistic prices. Just to stop the fire from spreading.
I don’t know whether to feel gratified or terrified that an economist Greg Mankiw references came up with practically the same plan I did. Although I wasn’t going to take the whole profit at resale. And my government wouldn’t charge interest.
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Since I keep adding BUB posts, I updated this on December 13, 2008, to put all BUB posts in their own category. That way they can easily be found without my having to keep updating all the existing ones each time I add a new one.
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2 comments:
Some days I'm for a total free market solution to the current financial problems (although I realize there is no such thing as totally free markets) but most days I realize that something had to be done. Do think though that Paulson and Bernanke - although their strategy may have been correct - mishandled its presentation in a way that magnified the crisis enormously and has led to unjustified panic.
I'm totally against a bail out of mortgage holders unless they have significant age or illness problems or were victims of fraud (fraud does not include not reading and/or understanding your mortgage documents). Still, that solution does become more palatable when paired with your idea of repaying the taxpayer (or at least the government) should the home later be sold at a profit.
I agree that Paulson and Bernanke did us no favors by giving us a one-week drop-deadline. As I commented elsewhere, surely they could at least have given us the fortnight Dr. Johnson believed would concentrate our minds. Plus what does it say about these great financial minds that they only noticed the oncoming disaster when it was a week away?
I mostly would have preferred a free-market approach to the meltdown, i.e, everybody takes their lumps. Once we decided a bail out was necessary, though, I would have preferred we bail out the people on the bottom of the pyramid rather than the people on the top. This was *not* because I thought the "little people" were any more deserving of mercy than the fat cats but because:
a) if we're going to save people who did dumb things I'd rather save the homeowners who borrowed a little too much than the financial brains who leveraged a gazillion dollars; and
b) if the root cause of the meltdown was bad mortgages then fixing the financial system's current problem still leaves them exposed to the further trouble coming down the road as more ARM loans reset in the next few months - so it made more sense to me to clean up the underlying cause once and for all.
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