Bush administration has recently indicated that the credit crunch has to be addressed at its source—in America’s housing market. Here are a few possible scenario:
Luigi Zingales, of the University of Chicago, thinks the government should temporarily impose a standardised way to rejig the terms of securitised mortgages. He proposes that a 20% fall in a neighbourhood’s house prices from the time when the borrower bought his house would automatically trigger an option to alter the terms of a loan. Lenders would be forced to write off a chunk of the original loan, shrinking the mortgage in proportion to the fall in house prices. In return they would receive a share of future house-price gains.
Martin Feldstein, who chaired Ronald Reagan’s Council of Economic Advisers (CEA) in the early 1980s, suggests creating “mortgage-replacement” loans to prevent distressed homeowners walking away from their debts. Under the plan, the government would provide low-cost (perhaps at 2%) loans to all mortgage holders, worth 20% of their outstanding mortgage debt.
Another former CEA chairman, Glenn Hubbard, along with his Columbia University colleague, Chris Mayer, take a more radical approach. House prices could collapse, they reckon, because the downward pressure from foreclosures is made far worse by the scarcity and expense of home loans. To address this, the government should use Fannie Mae and Freddie Mac, the nationalised mortgage giants, to provide home loans to new and existing borrowers on terms that would be available if markets were working normally. They reckon the cost of a 30-year fixed-rate Fannie or Freddie mortgage is normally around 1.6 percentage points above the yield on ten-year government bonds, currently 3.7%. So the government could offer a benchmark 5.25% mortgage deal—matching the lowest rate in the past 30 years.
