> housing prices in the US are grossly overvalued due to inefficiencies
> in the housing market ...
Yes, a disease has been identified. Now, as to the cure?
> [...] produced mainly by the idiocy of the American dream ...
Well, you lost me with this tut-tut'ing, but let's just say I disagree that the bubble had a main cause; I will, however, note that there's no such American Dream going on in the rest of the world where similar bubbles burst for many of the same reasons.
Tell your friends in Madrid or Dublin that they are suffering because of their American Dream.
> I just see no useful social purpose being served by inflated
> housing prices.
I don't think anyone is suggesting that the solution would involve inflating housing prices. But there's a huge hangover of debt, and despite record-low interest rates, most of the people who desperately need to take advantage of the lower rates just to cope with the recession cannot get them because of "market" barriers like loan-to-value limits that don't take into account the new reality. The solution, it seems to me, is to take a large chunk of that debt out of the market. AIG was hit by a classic run-on-the-bank, so what they needed was a bank that wouldn't foreclose.
Millions of people are in the exact same situation. And the collateral damage to the rest of the economy hits everyone, even smugsters in their non-American-dream co-op housing.
> It is like giving subsidies to typewriter manufacturers to
> maintain prices at certain level in the advent of personal computers.
There's your insistence on profit again: subsidies. AIG received no (direct) subsidy; they received a work-out with very harsh terms in return for a basically unlimited credit line that was manufactured inside a computer. There's a big difference there, even with your moralizing taken into account. I see no reason why the same could not be done with homeowners: "market rate financing for a realistic market value" of the house.
Here's an example sketch: Joe bought a house at the top of the market in 2007 for $400k, using a variety of now-seen-as-fradulent techniques that allowed him to move in for no money down. Today, the experts say his house is worth more like $250k, so his 5% mortgage is $150k underwater; his monthly payment is something like $2200. Bank of Dumberica says they will loan him $230k at 4%. We see the problem, right?
What I would do is set up an SPV (let's call it Frankie, since I think that cute name hasn't been used yet) to buy that $400k mortgage with an accounting entry in the NY Fed and take title to the house using eminant domain; if the amount siezed is greater than the original purchase price, Joe books a (5yr deferrable) tax event. Note that the original loan is now paid off in full, and the bank that has been sweating it for the last two years simultaneously has a loan-loss-provision that evaporates, and a large uptick in Tier 1 capital. The stock market soars, and municipal pension funds see an uptick as well. 401k and IRA investors dance in the streets.
On the very same day, Joe is offered a two-piece loan to buy back "his" house: a $250k 3% 40-year loan; and a $150k 2nd that is interest-only for 5 years, and is something like 1yr LIBOR + 1% (about 2% today). So long as the economy is where it is today for a while, that should stay low and this will give him breathing room to get back on his feet. The main loan is around $900/mo, and the 2nd is $250/mo. This allows Joe to get back on his feet with $1k/mo of additional spending power, the banks to get back on theirs, and the rest of us get to go on about our lives. Note also that Joe's taxes go up a little bit, because he's paying less deductable interest; this helps the deficit.
What happens next? Well, Frankie realizes that the NY Fed is a harsh landlord, so what they do is take the piles of loans they have made and offer them via MBO to the public in the form of a variety of duration bonds which are guaranteed by the US Government, and thus sell like hotcakes and for a very low yield -- certainly lower than the 3% they are charging Joe, but perhaps a little higher than Treasuries, to encourage pension funds to buy them. They use the proceeds to slowly, responsibly pay down the NY Fed loan such that in a few years, Bloomberg releases a story about how the American taxpayer "made money" on this loan; since the Fed can't legally keep profits they happen to generate, this money goes into the treasury, just like the AIG deal. And of course they book the spread into "rainy day" funds that help later when the normal rate of default returns.
In the long run, Frankie becomes the stable nexus of homeowner finance and most banks are forced out of the market; this is their punishment: they don't get to try to rip off Joe anymore. They can participate in Jumbo loans for rich people's 2nd (and 5th) houses, plus commercial real estate deals, but the vast majority of single-family-housing finance is taken over by Frankie. Message to the banks: go find someone else to destroy.
The last question is what happens to Joe? Hopefully what happens is that the economy recovers, Joe gets a raise, and he eventually pays off both loans. There have to be some harsh terms, however; I would start with these:
- No subordination of these loans for "equity line" activity; you're out of that business. Equity in a house in this program is no longer legally allowed to be collateral for a private loan.
- If you sell your house after 5 years, both loans are due and payable; if before 5 years, you can take the 2nd with you; if you book a gain, it is taxable -- no $250k/$500k exclusion for you. This continues for up to two tax years beyond the final payoff date of the 2 loans, so you can't just get a bridge loan, pay off Frankie, and then sell for an excludable gain if for some reason your local housing market takes off.
- Only eligible for the program if the house you live in is the only house you own, and if you bought it between Jan 2006 and December 2009. Those dates subject to some fudge factors later; no one gets in if they bought recently.
- The loans can't be dismissed for bankruptcy; this should take care of people like Wojtek who want to only see benefits accrue to Responsible Citizens.
What's missing from this fairy tale? Political will.
/jordan