Arnold Kling on Feldstein’s proposal

“Feldstein writes,

The federal government would offer every homeowner with a mortgage the opportunity to replace 20 per cent of that mortgage with a low interest government loan – up to a loan limit of $80,000. . .that reflects the government’s lower borrowing rate. Creditors would be required to accept this partial mortgage pay-down and to reduce the monthly interest and principal by the same 20 per cent. That mortgage replacement loan would not be collateralised by the house but would be a loan that the government could enforce by lodging a claim on an individual who does not pay.

Feldstein is worried about house price declines "overshooting" their proper value. If he knows what the proper value of everyone's house is, he should set up a hedge fund to buy houses that fall below that value, while shorting the market-traded house price indexes in cities where house prices are still too high.”

Arnold Kling, “Three Quick Takes”, Econlog Blog (27 August 2008).

http://econlog.econlib.org/

Arnold Kling is a noted economist who has worked for the Federal government for many years in different capacities and as a professor at several universities. He is a founder and co-editor of EconLog, a popular economics blog that reflects Libertarian thinking.

Dr. Kling comments here on the proposal by Martin Feldstein that was the subject of yesterday’s Tdj. In Feldstein’s Op Ed, as noted in the Tdj, he set forth a proposal intended to provide a floor on falling house values. The proposal advocated that the Federal government provide “mortgage replacement loans” intended to stop defaults by homeowners when their equity in their home turned negative as a result of a decline in the price of their house.

I commented in that Tdj that while the economy was weak, it was not clear we were in a recession and not clear that house prices would continue to fall and cause defaults. Today it was reported that economic growth in the second quarter of the year was much stronger than originally thought, and rose at an annual rate of 3.3 per cent, a pace somewhat above the long-term trend for the U.S. economy. Let me add, the Federal government budget is in deep deficit, and any ideas to spend more money should be scrutinized carefully.

Here Dr. Kling gives another reason to question Feldstein’s proposal: It is easy to set forth broad ideas about what we, meaning the government, might do, but it is quite another thing to actually implement any proposal. To actually implement the Feldstein proposal the government would have to know what the market value of any house would be in an undefined market. Since this is unknown, one cannot actually put the proposal into practice. Moreover, Kling notes, if anyone knew what the proper value of a house was, when it fell below that value they could buy it for less than it was worth, and later, when the price returned to its higher “proper” level, sell it for a profit.

In other words, Kling is saying the information necessary to implement this proposal is not known, and if it were, we would not need the government to implement the policy because the private sector would automatically undertake it.