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Restructuring home loans

November 1, 2008 | 4 Comments | Joshua Gans

Now that the financial system has stabilised, there are many plans out there to deal with home loan restructuring: you know the stuff that got us into this mess in the first place. They are nicely summarised by The Economist. In reading this, what struck me is how these were all anticipated 5 years ago in Australia with the Prime Minister’s Home Ownership Taskforce. That Taskforce was set up by John Howard and ignored completely by his government. It had three main ideas:

1. Encourage home equity finance: this is where lenders take an equity position in a dwelling rather than a loan with interest payments.

2. The Housing Lifeline: this is where the government provides a line of credit to distressed home owners and renters who face income shocks. The loan is then paid back through the tax system, like HECS is.

3. Measures to increase supply: this is where the government changes regulations to ensure that the housing stock can expand.

All three of these have now been proposed as means of dealing with the source of the financial crisis. Luigi Zingales proposes that:

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.

This is essentially government provided home equity finance. Rismark commercialises these and it would be desirable to base this on their proven model.

Martin Feldstein proposes that:

suggests creating “mortgage-replacement” loans to prevent distressed homeowners walking away from their debts. Under the plan, the government would provide low-cost loans to all mortgage holders, worth 20% of their outstanding mortgage debt.

The bait for homeowners would be lower interest costs. Mr Feldstein thinks the scheme’s loans would need to have a fixed interest rate of around 2% to make a material dent in debt-service costs. In return borrowers would take on a slice of debt that they cannot welsh on: the replacement loan would not be secured on the home, but the government would have first claim on the borrower’s future earnings in the event of a default.

This is the Housing Lifeline model. In Australia, it was recently re-proposed by the ACTU who clearly have a greater interest in the poor than the previous government did. The US could learn from Australia’s already successful deployment of income contingent loans.

The third has kind of been proposed (but in reverse) to boost housing prices by destroying housing stock in the US. No one is really taking that one seriously that idea.

My point is that Australian policy investigation (although not implementation) was well ahead of the game here. Those in the US could do well to read the papers written in those calmer times.


Comments

4 Responses to “Restructuring home loans”

  1. Chris Joye on November 1st, 2008 10:00 pm

    Could not agree more, Josh.

  2. David on November 1st, 2008 10:22 pm

    The financial system has stablised? Oh really now?

  3. Joshua Gans on November 2nd, 2008 4:11 pm

    Yes pretty much (although I guess you never know); it has been a few weeks since a major failure. Now we will see how big of a recession the real economy has.

  4. Mick on November 2nd, 2008 9:32 pm

    Destroy housing stock? What madness.