Fix the Housing Mess

Article Courtesy of the Wall Street Journal

About four years ago, as the housing bust worsened, our country faced an entirely predictable problem: A huge wave of foreclosures was headed our way. The issue of the day was how to stop it before it engulfed the entire economy. My suggestion then was to revive the Depression-era Home Owners’ Loan Corporation, which refinanced about a tenth of all the mortgages in America and closed its books with a small profit. Never mind the details; the suggestion was ignored. Maybe there were better ideas, anyway.

Sadly, however, we did almost nothing to stop the predicted foreclosure wave, which is now drowning us. The issue at this late date is how we can mitigate the damage.

One oft-repeated answer comes from the intellectual descendants of Andrew Mellon and Herbert Spencer: liquidate, liquidate, liquidate. Let the housing market find its natural bottom, and the chips fall where they may.

I beg to differ. Some of the reasons are humanitarian. Millions of foreclosures are ruining millions of lives and devastating many communities. We can do better than Social Darwinism.

But many of the reasons are strictly economic. The seemingly-endless housing slump is dragging down our economy. By now, massive underbuilding during the slump far exceeds the overbuilding during the boom. So, by rights, a shortage of houses should be pushing up house prices, incentivizing home builders, and boosting growth in gross domestic product. Instead, actual and prospective foreclosures hang over the housing market like a wet blanket.

That we let this happen is tragic. It’s not that policy makers did nothing. Starting half-heartedly in the Bush administration, and continuing (somewhat less half-heartedly) in the Obama administration, the government has tried any number of approaches to refinancing or modifying unaffordable mortgages. Let me count (some of) the ways: Hope Now, Hope for Homeowners, the Home Affordable Mortgage Program, the Home Affordable Refinancing Program, the Hardest Hit Funds . . . the list goes on. Some of these programs actually made a dent in the problem. But we needed a lot more than a dent.

Why the failure? Three formidable barriers have stood between us and success—and still do.

The first is money. Given the huge magnitude of the aggregate gap between house values and mortgage balances, a comprehensive anti-foreclosure solution requires hundreds of billions of dollars. (Note, however, that this money would be lent, not spent.) Compounding the tragedy, we now know that there was probably enough money in the Troubled Asset Relief Program (TARP) to do the job—but neither Treasury Secretary Hank Paulson nor Treasury Secretary Tim Geithner knew that at the time. Now TARP is no longer available, and we are still trying to fix this massive problem on the cheap.

The second barrier is a host of legal complications—stemming from such things as securitizations, second mortgages, and the like—that make it difficult to design and execute a comprehensive plan. The details would put you to sleep. But the bottom line is that most serious solutions entail modifying somebody’s property rights—which is something we don’t do lightly in America, and for good reason.

The third barrier may be the biggest: politics. Apparently, many Americans view it as unfair to bail people out of unaffordable mortgages. Do you remember the famous Rick Santelli rant on CNBC in February 2009—the one that gave the tea party movement its name? Mr. Santelli was griping about President Obama’s new foreclosure mitigation programs—the ones I just characterized as half-hearted. It would have been a brave politician indeed who pushed to make those programs larger and more generous.

So what can be done now? There is no silver bullet; we need different remedies for different types of (actual or prospective) foreclosures. And to succeed, we must overcome the three barriers. Foreclosure mitigation is expensive. It will encounter political resistance. It probably requires bending some property rights. Not very appetizing. But remember, the alternative may be continued stagnation, which is making everyone dyspeptic.

Here are some ideas.

• To get millions of refinancings done expeditiously, simplicity is essential. As nationalized companies that dominate the mortgage market, the government-sponsored enterprises, Fannie Mae and Freddie Mac, should be taking the lead, not watching their profits and mortgage-backed security (MBS) prices. If GSE managements won’t move, their regulator, the Federal Housing Finance Agency, should push them. If the regulator won’t push hard enough, the U.S. Treasury, their major shareholder, should. If Treasury officials won’t, President Obama should order them to. If the whole administration is too timid, Congress should change the law.

Here’s one concrete example of a legal barrier: When a mortgage owned by Fannie or Freddie is proposed for refinancing, it has the legal right to “put” the original mortgage back to the originating bank if there was even the slightest irregularity in the original documents. That right can make the originating bank afraid of refinancing, even if the homeowner is at risk of default. And if Fannie or Freddie does indeed block the refi, it will be left with the vast majority of the risk in the original mortgage, anyway.

• Most economists see principal reductions as central to preventing foreclosures. That takes money, of course—plus ignoring the Rick Santelli rant. Perhaps the cost to taxpayers could be reduced by giving the government—or even private investors—some of the upside when house prices finally start climbing. One encouraging sign is that settlement talks between the government and the five biggest mortgage servicers (Ally Financial Inc., Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co., and Wells Fargo & Co.) are reportedly coming around, at last, to principal reductions.

• Many vacant houses could be converted into rental units by enterprising developers. The government could make such investments more attractive, e.g., by using mechanisms similar to what the Federal Reserve and the Treasury did during the worst of the financial crisis. Back then the government lent money to investors who were willing to buy mortgage-backed securities; this time it could lend money to investors who are willing to invest in certain rental properties.

An old adage says, “Where there’s a will, there’s a way.” There is a way, or rather several ways, out of the mortgage mess. What we need now is the political will to take them.

Mr. Blinder, a professor of economics and public affairs at Princeton University, is a former vice chairman of the Federal Reserve.