Part 1: Summary
• Housing debt is at the center of the slow American economic recovery
• Home values are in a downward spiral endangering the entire economy
• The private residential mortgage market has inadequate infrastructure to reverse this trend
• Proposed solution-lower mortgage principle nationwide through a cooperative effort of the mortgage industry and the Federal Government.
• Consider modifications of existing mortgage agreements
If implemented, this plan would result in a win-win situation for both borrowers and creditors and benefit the entire country

Part 2: Background

 “There is widespread agreement among economists that housing debt is at the heart of the slow [economic] recovery, and that finding a way to bring it down faster would accelerate the recovery.”[1]The home values in the market are in a downward spiral which, if left unresolved, endangers the entire economy. In a recent article Joe Nocera, interviewed Laurie Goodman [senior managing director Amherst Securities], who states that there are 55 million home mortgages in the United States, and greater than 10 Million of them are reasonably likely to default, due to so many homes being “underwater” [meaning that the owners owe more on their mortgages than their home is currently worth]. This is due to the severe drop in home prices since the housing bubble burst in 2008. In addition the supply of available housing will continue to outstrip demand. It’s estimated that there could develop a glut in excess of 6.2 million houses. [2] There are fewer home buyers because multiple factors are at work.  These include the grim economic outlook, high unemployment, lack of personal savings for down payments, young adults returning home to live with their parents, and tightening mortgage lending standards.

 Goodman says that the combination of all these factors has led to a “death spiral” in the housing market initiated by supply/demand imbalance, leading to decreased home values, more home owners underwater, an increased number of defaults, more foreclosures, an increase in the supply/demand ratio, and so on and on spiraling downward!

  What can be done? One answer, given by those who assume the “free market” can solve all economic problems, is to let the spiral continue until it finally hits bottom.  In reply to them, Elizabeth A. Duke, a Federal Reserve governor, is quoted as saying “Regardless of how we got here, we, as a nation, currently have a housing market that is so severely out of balance that is hampering our economic recovery”.  William C. Dudley, the New York Fed president criticized the way the free market was functioning in regards the housing crisis; “The infrastructure of the residential mortgage market is wholly inadequate to deal with a systemic shock to the housing market. Left alone, this flawed structure will destroy much more value in housing than is necessary” [3]. In addition, the drop in home values has a negative impact on the development of small businesses. This was discussed by Martin S. Feldstein [4] Current underwater mortgages for many home owners prevent the use of  home equity loans to finance small business start-ups. Second, he stated that because of both mortgage debt and unemployment, there is often no market for even reduced price sale of houses. Owners cannot sell their houses and move to a geographic area where there might be better job prospects.

Some other solution than the free market is necessary. If we follow the advice of those that say “let the market sort it out”, we would simply watch as owners under water defaulted and walked away. However, as even one house falls empty, the value of neighboring houses falls. Looting of anything of value in the empty houses and after that, crime nests follow… Another important point is that, as Feldstein says, “A fall in house prices is not just a decline in wealth but a decline that depresses consumer spending, making the economy weaker and the loss of jobs greater.” All of which adds greatly to decreased quality of life for many as well as decreased suffering.

 At this point, IPPA also calls attention to an ethical issue that has prevented some owners of underwater houses from just walking away. In one study, 81% of Americans think it is immoral not to pay your mortgage if you can, and that shame or guilt will follow if you do not. [5] In other words, even though your house could not be sold at the value the existing mortgage payments reflect, you are still told that paying monthly for a value that does not exist is the right thing to do.  But is this a defensible moral mandate? We do not think so. A basic and universal ethical principle is fairness. Fairness concerns equal sharing of benefits and pains, within culturally variable limits. But there is no sharing of the pain of an economic crisis if the lenders have little pain (because they do not modify the mortgages and can sell the foreclosures), and the borrowers have all the discomfort. This is where our proposed solution comes in.

Part 3: A Reasonable Solution

  The basic problem in “underwater” homes is that, into the foreseeable future, the size of the existing mortgage exceeds the current home value. Most banks are not helpfully responding with mortgage modifications, and there are few buyers. As a viable policy to stop the “death spiral,” IPPA proposes a federal government plan to lower the mortgage principle to 110% of the estimated home value. As Milton Feldstein points out, ideally up to 11 million homes might qualify for principle reduction. If all eligible owners participate the one-time total cost is estimated at $350 billion. If the mortgage lender would agree to lower the principle to 110% the government would agree to cover ½ of the reduced amount and the mortgage holder the other ½. To balance this financial sacrifice, the home owner would, voluntarily, agree that the new mortgage would be a full recourse type [meaning that if the borrower defaulted the lender could go after other assets] to replace the original non-recourse loan. An alternative sacrifice for the home owner would be to agree that any profit realized from the sale of the home after principle reduction be shared evenly with the mortgage lender.

 Thus both borrowers and creditors would have to sacrifice but it would create a win-win situation as the home owner would get the mortgage reduction and the lender would be assured of a very low possibility of default because of the better loan-to-value ratio and its full recourse loan or profit sharing feature. Since a great many of the mortgages are under Freddie Mac or Fannie Mae the government would in reality be paying itself back. This plan by addressing the underlying problem, the great number of ‘underwater’ mortgages causing increased housing debt, should greatly increase the chances of stopping the spiraling mortgage default cycle.

 Principle reduction is an essential part of the States Attorney Generals’ proposed settlement with banks for the “robosigning “scandal. This plan would also appeal to voters [taxpayers] who would see it as a way of making banks pay for their “sins” in this whole mortgage debacle. There will always be people who don’t think home owners, who took these bad mortgages, should be bailed out. However, given the suffering of so many individuals and families as a result of the severe economic downturn, high unemployment and the possibilities of a spiral of home foreclosures, it seems to IPPA that the best economic and ethical solution to the crisis would be a carefully worked-out national plan for mortgage principle reduction.

1. Norris, Floyd “To Revive the Economy, Rescue Housing” New York  Times [NYT] 12/2/11 quoting Kenneth Rogoff, a Harvard economist.
2. Nocera, J “To Fix Housing, See the Data” NYT Oped 11/5/11.
3. Norris, Floyd. Ibid
4. Feldstein, Martin S. NYT Oped “How to Stop the Drop in Home Values”  10/12/11. Feldstein is a Professor of Economics at Harvard and was chairman of the Council of Economic Advisers under President Reagan from 1982-1984.
5. Surowiecki, James “Living by Default” The New Yorker 12/19 and12/26/11, p, 44]

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