Fixing the Housing/Credit Crisis

The financial markets have been in turmoil over the unexpectedly high risks of complex bundles of mortgages. The Federal Reserve has lowered interest rates, and intervened to back the industry with guarantees and cash to help promote new loans. Many plans have been presented to resolve this crisis, but one aspect has not received enough attention. Here are some ideas to stabilize the credit markets, keep people in their homes, ease the pain to the lending institutions, and protect people and lenders from such future problems.

The Adjustable Rate Mortgage was invented by the financial industry as a way to extend housing credit to more people. The obvious goal was to make more money by making more loans, even if many of these loans were to speculators and to people who were stretching their budgets to the limit. For many years housing prices went up, and, most people did well, based upon two assumptions: (1) their incomes would increase enough to cover possible increases in their interest rates; and/or (2) they could sell their homes at a profit, if they could not make their increased payments.

We now have seen what happens when both assumptions turn out to be false. Many people are missing their mortgage payments, homes are going into foreclosure, and the lenders are posting multi-billion dollar losses.

Since the lenders encouraged many people to take ARM’s, they should absorb the pain rather than the homeowners or the government. On the other hand, lenders should be helped and not allowed to fail. The basic problem is the ARM, itself. Here is what we could do right now to stabilize the market and help people stay in their homes.

1. Limit any ARM interest rate adjustments to ¼ % per year, with a maximum interest rate no higher than conventional 30 year rates, when the adjustment reaches that level.
2. Once the ARM reaches the 30 year rate, provide no-cost conversions to a conventional loan, for the remaining life of the loan.
3. Roll back all ARM adjustments for the past year, which is when those adjustments began to outstrip people’s ability to pay their mortgages.
4. Either prohibit new ARM’s completely, or require borrowers to qualify at the highest interest rate specified in the loan.
5. Limit the highest interest rate specified in new ARM’s to current 30 year rates, plus no more than 2%.

These measures would lower the number of foreclosures substantially, enabling the market to better price loan instruments. Mortgage lenders would be able to lower their “risk premiums,” freeing up cash for the credit market. ARM’s would unwind over a long period, reducing the costs to lenders. Borrowers would have an easier time obtaining credit, and staying in their homes. All involved would benefit.

Something to think about.