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October 02, 2008

Let's Fix the Foundation

Glenn Hubbard and Chris Mayer
Dean and Russell L. Carson Professor of Finance and Economics
Senior Vice Dean and Paul Milstein Professor of Real Estate
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In an Oct. 2 column published in the Wall Street Journal (“First, Let's Stabilize Home Prices”), Dean Glenn Hubbard and Prof. Chris Mayer propose that bolstering housing prices will improve the intent of the Treasury’s bailout plan. They write:

We propose that the Bush administration and Congress allow all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25% (matching the lowest mortgage rate in the past 30 years), and place those mortgages with Fannie Mae and Freddie Mac. Investors and speculators should not be allowed to qualify.

The historical spread of the 30-year, fixed-rate conforming mortgage over 10-year Treasury bonds is about 160 basis points. So a rate of 5.25% would be close to where mortgage rates would be today with normally functioning mortgage markets. One of us (Chris Mayer) recently published a study showing that — assuming normally functioning mortgage markets — the cost of buying a house is now 10% to 15% below the cost of renting across most of the country. Rising mortgage spreads and down-payment requirements are what’s still driving down housing prices. We need to stop this decline.

The direct cost of this plan would be modest for the 85% of mortgages where the homeowner owes less on the house than it is worth. Lower interest rates will mean higher overall house prices. The government now controls nearly 90% of the mortgage market and can (and should) act on this realization. Remove the refinancing option and you can have lower rates without substantial cost to the taxpayer. Homeowners would have to give up the right to refinance their mortgage if rates fall, although homeowners could pay off their mortgage by selling their home. For borrowers with lower credit scores, the mortgage rate would be greater than 5.25%, but it would be less than their current rate.

Now, what about mortgages on homes that are worth less than the total amount of the loan? These mortgages could be refinanced into a 30-year fixed-rate loan to be held by a new agency modeled on the 1930s-era Homeowners Loan Corporation. New mortgages would be made of up 95% of the current value of a home.

The government might use two approaches to mitigate its losses. It could offer owners and servicers the opportunity to split the losses on refinancing a mortgage with the new agency. Servicers would have to agree to accept these refinancings on all or none of their mortgages, to avoid cherry-picking. Or the government should take an equity position in return for the mortgage write-down so that the taxpayers profit when the housing market turns around.


by craig | October 02, 2008 at 3:26 PM

As economic and real estate academics, can you really be serious with this article? Rates are at historic lows. Most people (wether they know it or not) have longer investment horizons than a few years and know that it doesn't have to be pegged to the Treasury borrowing rate as spreads will eventually increase to show the risk of housing as an investment versus government backed debt). Housing prices are in correction mode which is necessary to make houses affordable to our up-and-coming homne buyers. Once the most recent terrible economic data flushes through the world there may be no money for houses no matter what the interest rate. We are weeding out extravagance and overborrowing and government-sponsored housing price bubbles. Why do we want to dump more money into fluffly home prices created by greed-driven bankers, pandering politcians and shady mortgage brokers. No federal politicians have ever been in my neighborhood and I want to keep it that way.

by cmh | October 03, 2008 at 9:59 PM

How does this address the problem that in median home prices were 4.3 times median incomes in 2007? This multiple ranged between 3 and 3.7 from 1975 to the late 90s. I don't think anyone is getting loans for more than 4 times their income any time soon. Wouldn't this suggest that mortgages for homes bought in 2005 or 2006 are much more than 5% over-valued?

by Michael Manocchio | October 10, 2008 at 2:25 PM

Is it absolutely inconceivable that we simply need to allow the system to correct without any intervention? Bad policies on top of failed policies (regulatory, monetary, and otherwise) probably won't lead to healthy growth in the future.

by samuelcaleb | October 10, 2008 at 11:22 PM

Why do we want to dump more money into fluffly home prices created by greed-driven bankers, pandering politcians and shady mortgage brokers. ========== samuelcaleb

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