More than a stimulus
The stimulus bill wasn’t quite enough. There had been criticism that the American Recovery and Reinvestment Act didn’t address the heart of the current crisis - falling housing prices. Now we know why: yesterday President Obama unveiled a $275 billion plan dedicated to this very cause.
Currently, one in ten houses are in some stage of foreclosure. This is an astoundingly high number. Why does it matter? These home mortgages are the original building block of this credit crisis; when bundled and sold off in tranches, they are the toxic assets we hear about so often. Every additional foreclosure means those assets become that much more toxic and increasingly difficult to value. Perhaps most importantly, it’s not just that these delinquent mortgages are on the books of the banks, but rather that they were bought and sold using vast amounts of leverage. A small downward adjustment in the value of these mortgages has an amplified effect on the holder of the asset.
Stop the bleeding in the housing market, the theory goes, and we can correctly prices these assets and begin to move them off the books.
How does this plan address this? According to the New York Times, there are three ways:
The first would help homeowners who are still current on their payments, but who are paying high interest rates and cannot refinance because they do not have enough equity in their homes, a problem afflicting growing numbers of people as housing values tumble.
A second component would assist about four million people who are at risk of losing their homes. It would provide incentives to lenders who alter the terms of loans to make them affordable for the troubled borrowers.
A third component would try to increase the credit available for mortgages in general by giving $200 billion of additional financial backing to Fannie Mae and Freddie Mac.
Will it work? That, of course, is now subject to considerable debate. So far I’ve heard generally positive feedback. My own opinion is that housing prices are still overvalued - and Tyler Cohen agrees:
Housing prices ought to be lower, and as quickly as possible. So aiding homeowners cannot be justified on the grounds of propping up prices, which is difficult to accomplish anyway. Such aid has to be justified in some other way. The main argument is that our ex post procedures for foreclosures are not what we would have chosen ex ante, had we known that such a severe housing and financial crisis could be possible. That opens up some room for beneficial intervention, but a good plan it still hard to pull off.
For a further analysis of popular opinion on the blogosphere, read this roundup by Mark Thomas. As with most of these large government interventions, the devil is in the details, so it’s important to keep a close eye on how the plan evolves.
