Martin Feldstein on the U.S. housing crisis

“The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend. The sharp decline since then means that today's prices are about 15 per cent above the trend level. But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. ....

Negative equity mortgages are a big source of instability because US home mortgages are generally "no recourse" loans, implying that if an individual defaults on his mortgage the creditor can take the property but cannot claim other assets or income to pay the remaining loan balance. ....

This is a difficult problem and there are no easy solutions. I have proposed a programme of "mortgage replacement loans" that I believe would stop the downward spiral of house prices. The basic idea is to provide an incentive to stop defaults among those who now have positive equity but are vulnerable to a further price decline. 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 .... 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.

With the mortgage replacement loan, people who now have a mortgage equal to 90 per cent of their house value would see that mortgage fall to just 72 per cent of the house value, implying that it would take a very unlikely price fall of more than 28 per cent to push those individuals into negative equity.”

Martin Feldstein, "How to shore up America's crumbling housing market", Financial Times (27 August 2008).

http://www.ft.com/cms/s/0/29e69ebc-736f-11dd-8a66-0000779fd18c.html


Martin Feldstein (1939-) from 1972 to 2008 was President and CEO of the National Bureau of Economic Research (NBER), except for the period 1982-1984 when he was President Reagan's chief economic adviser. He is Professor of Economics at Harvard University.

The economy remains vulnerable to the problems of the housing sector and many other financial strains. But let us keep in mind that despite it all, to date at least, the real economy has not slipped into recession, and this despite record energy prices and rising inflationary pressures.

Perhaps Feldstein’s ideas are good, but perhaps it is too early to say we should panic and implement this or any other idea that involves spending at a time when we already have a large deficit. Granted the financial situation in the mortgage sector in precarious. But there are times when one should simply wait and see what happens. This is probably one of those times.

Thanks to Larry Willmore for this Tdj.