Feldstein's Lender Bailout Proposal
By Arnold Kling
The federal government would lend each participant 20% of that individual’s current mortgage, with a 15-year payback period and an adjustable interest rate based on what the government pays on two-year Treasury debt (now just 1.6%). The loan proceeds would immediately reduce the borrower’s primary mortgage, cutting interest and principal payments by 20%. Participation in the program would be voluntary and participants could prepay the government loan at any time.
Feldstein’s proposal is aimed at borrowers with a little bit of equity in their homes. The idea is to lower their interest rates.
It is hard for me to see this as anything other than a lender bailout. It does give borrowers a subsidy, based on the fact that the government can borrow at low interest rates. However, the main effect is to take risk off the table for lenders. They would immediately receive 20 percent of the outstanding balance on loans that are of high risk for default.
Broadly speaking, there are two schools of thought about the housing market. One school believes that foreclosures will cause house prices to overshoot on the down side, so that government intervention to prevent foreclosures will help stabilize the market. The other school of thought, which we might dub the liquidationists, believes that the market needs to reach a natural equilibrium, in which people live in houses they can afford.
I am a liquidationist.