Senator Jeff Merkley of Oregon is out today with an ambitious plan to try to stimulate the economy by facilitating large-scale refinancing of so-called underwater mortgages. This is important because one way that low interest rates can help in a weak economy is that people with mortgages on their homes take advantage of the opportunity to refinance and boost their disposable income.
This channel hasn’t worked very well during the current crisis because lots of homeowners are “underwater.” That means the underlying asset they own—the home—is now worth less than the amount they owe the bank for the loan that bought them the home. The problem here is that the way a mortgage works is that a bank agrees to give you money, and in exchange you agree to let the bank take your house if you don’t pay back the loan. Since the loan is backed by a tangible asset—a house—you can get it on more favorable terms than an unsecured loan. When you refinance, you get a new loan whose purpose is to let you pay off the old loan. But when you’re underwater, you can’t get a secured loan for the full amount you need and this makes it impossible to refinance.
Merkeley’s proposal is to set up an entity—comparable to the HOLC of the New Deal—whose purpose is to borrow a gigantic sum of money from financial markets at today’s ultra-cheap US government cost of funds, and then buy up all the outstanding underwater mortgages that are out there. Then the new entity will offer each underwater homeowner one of three refinancing options:
— A plan that keeps your monthly payments roughly constant but shortens the life of the mortgage.
— A plan that cuts your monthly payment by just extending a new full-length loan at a lower interest rate.
— A plan that cuts your monthly payment a lot by in effect extending the life of your loan.
The logic here is that individual household needs vary. Some people are under severe financial distress and really need those low payments. Others are actually doing okay, but have had wealthy wiped out by the housing crash and feel left out in the cold by narrowly targeted bailouts aimed at the worst hardship cases. Those families will benefit from option number one, basically a wealth building strategy for the middle class.
How to pay for this? Well if you read the plan you can see the detailed explanation, but the main component is simply that we’ll be exploiting the gap between the federal government’s extremely low cost of funds and the very high rates that a lot of underwater homeowners are currently stuck with. You can offer households a much better deal than they currently have while still lending at a profit. Something the document alludes to is that this is also basically something the Federal Reserve could do unilaterally. If you’d like to see more details from Merkeley himself in the form of a folksy YouTube video, that’s also a possibility. My view is that the fiscal aspects of this plan are a little bit besides the point and it’s unfortunate that the current state of our political discourse forces the important aspect of the plan—reducing monthly payments or shortening loans—to tack on a lengthy accounting dialogue. But such is life.
The chances of Congress actually doing this are slim to none, but folks at the Fed, at the Treasury, and at the Federal Housing Finance Authority ought to take note and do what they can to approximate the impact of this plan.