Menzie Chinn Watches the Turnaround of the U.S. Current Account
The Current State of Dodd-Franik

David Wessell on Dodd-Frank

David Wessel writes:

Capital - WSJ.com: The latest flash point in the debate over the nation's bursting housing bubble is this: Since so many American houses are worth less than their mortgages, should the government do more to get lenders to settle...?

Of the 80 million houses in the U.S., about 55 million have mortgages. Of those, four million are behind on payments. Foreclosure proceedings were begun on about 1.5 million homes last year, up more than 50% from 2006. This year will be worse. The Treasury, according to presentations its officials have made recently, predicts house prices could fall another 10% to 15% before touching bottom.

Moody's Economy.com estimates that one in roughly 12 American families with mortgages -- four million in all -- already... are... "underwater." The firm predicts that by early 2009 nearly one in four, or 12 million... underwater. Most will continue to pay mortgages on time. Many won't....

Lenders... prefer to avoid foreclosure if possible.... Better to cut a deal than end up with an empty, decaying house.... In ordinary times, a lender shouldn't need prodding from the government to do what's in its self-interest. But these aren't ordinary times. The drop in home prices is pervasive, mortgage markets messy and complexities caused by turning mortgages into securities many....

Mr. Frank would offer lenders and eligible borrowers a deal: If the lender agrees to cut the debt so the homeowner owes no more than 90% of the house's current value, and the Federal Housing Administration (or an outfit to whom it outsources this) determines the homeowner can afford a new loan, then the lender gets rid of the mortgage and the FHA insures a new mortgage for the remaining balance.

The lender takes a hit, but gets rid of the risk.... [T]he lender has to chip in another 5% of the property's current value. The homeowner has to surrender some profits, if any... when the house is sold.

The White House condemns this.... [T]he Treasury argued in a recent PowerPoint presentation: "Homeowners who can afford their mortgage but walk away because they are underwater are merely speculators." (It's a bit jarring to hear the Treasury vilifying people who are acting in their economic self-interest.)...

Despite the restrictions, the plan could allow some homeowners to get a deal they don't deserve; that's the unfortunate byproduct of any rescue. But the Treasury and Fed surrendered the let-the-market-work-it-out high ground when they agreed to risk nearly $30 billion of taxpayer money to shield Bear Stearns, its creditors and counterparties from losses....

[T]he Congressional Budget Office... predict[s] only 500,000 mortgages would be refinanced.... So, perhaps it's best considered a prudent experiment for coping with a bad situation that might get worse: Create a mechanism now so the bugs are worked out, in case home prices plunge more than anticipated...

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