Whenever I used to listen to former Treasury Secretary Hank Paulson talk about our economic troubles he reminded me of another Paulson-- the comedian Pat Paulson. An earlier version of Stephen Colbert, Pat Paulson ran for President in the 1970s and 1980s campaigning with the memorable slogan: "I increased my standards, now up yours".
Indeed, Hank Paulson did up his standards. At the end of the Bush administration he no longer preached that markets should solve the problems they created. Nor was he willing to let financial institutions, such as Lehman Brothers, go bankrupt.
Paulson's Wall Street bailout plan helped Wall Street survive and revive. But he did nothing, nor did the Bush administration, for the people at the other end of the crisis—the homeowners who took out mortgages that then became toxic assets for banks and other financial institutions.
Sadly, President Obama and the Democratic Congress have not done much better. The result is that many US households have enormous mortgage debt and negative equity in their homes. As the unemployment rate rises and household incomes continue to fall, things are only going to get worse-- unless something is done to bail out homeowners.
Here are three things that Congress and President Obama can do quickly and easily to help the housing market, providing much needed assistance to American families, and also preventing the need for another big Wall Street bailout.
First, convert current tax deductions for mortgage interest and property taxes into refundable tax credits.
Most middle-income homeowners get meager tax breaks on these payments because they are in low tax brackets. Low-income homeowners (and those who have lost their jobs) get nothing back because they don’t itemize deductions and owe little in taxes. A refundable tax credit would provide the same benefit to all homeowners.
Making this change effective January 2009 would give many middle-income and low-income homeowners a large tax break immediately, also stimulating the economy.
To minimize the cost, and prevent large benefits from going to the wealthy, we just need to cap the maximum credit available.
Second, we must do something about interest rates. Despite media hype about sub-prime mortgages, the real villain is the adjustable rate mortgage, or ARMs, whose rising rates leave homeowners unable to pay their mortgages. Starting last July and continuing through all of 2010, there will be a sharp increase in the number of adjustable rate mortgages that will be resetting. In brief, American homeowners are ARMed and in dangerous condition.
Fifty years ago, in such a situation, people could go to their local bank and negotiate a lower rate. Everybody would benefit-- banks would get repaid rather than owning abandoned property, and families could stay in their homes.
This is not an option today. Due to deregulation, financial institutions usually sell the mortgages they make. Even if your bank wants to help you, it can’t renegotiate the terms of what it doesn’t own. Parts of each mortgage are held all over the world. Renegotiating with all parties is difficult and time consuming; everyone has veto power. Adding insult to injury, the financial institutions that gave bum mortgages now earn a lot of money from late fees and other charges that stem from delinquencies; so they have an economic incentive not to help families facing higher rates.
This is where the government can help. Even Adam Smith, the father of economics and a strong advocate of free markets, recognized that interest rate limits might be necessary. They are urgently needed now.
Capping rates will make it easier for households to pay their mortgages and keep their homes. Those holding mortgage packages will benefit from fewer delinquencies and foreclosures, and so it will it be less likely that another bailout of financial institutions will be needed.
Third, a massive debt problem makes it hard for homeowners to pay their mortgages and more likely that they will abandon their homes.
According to Federal Reserve surveys, middle-income households are nearly $20,000 in debt; many have consumer debt many times greater. This figure excludes all mortgage debt and home equity loans.
The Bankruptcy Abuse Prevention and Reform Act of 2005 made it harder and more expensive for households to wipe out their debts under Chapter 7. Many households must now use Chapter 13 and must repay much of their debt.
Returning temporarily to pre-2005 bankruptcy laws would help households eliminate their consumer debt and free up more money for mortgage payments.
There is no shortage of things we can do. It is time for Congress and the President to get to work-- the American homeowner needs a bailout.
Failure to do something soon will only result in another financial crisis—with severe economic consequences as well as severe political consequences at the polls in November 2010.