Wednesday, February 3, 2010

Here's One Way to Do It: A Plan for the Crisis

The first part of this plan relies on the banks. The banks would lower the mortgage payments on any of the mortgages they have that are in danger of being foreclosed. The percentage lowered is not set in stone, but I will set it as a 30% reduction. Let us assume someone has a $100,000 mortgage. The bank would then lower that number to $70,000. Now, with a significantly cheaper mortgage, many people can, and will, make the payments on their homes. The bank will then receive an option on any increase of the home price up to 10% of the original reduction. So, in our example, if the house appreciated 50% to $150,000, the bank would take $33,000, $3,000 more than its initial reduction.

The next part of the plan requires the government to play a role. In my example, the government would set up an agency. This agency would, in a sense, subsidize part of the reduction of the mortgages by the banks. Let us say that the bank has 50 of the $100,000 homes. If the bank were to reduce all the mortgages by $30,000, that would add up to $1.5 million in reductions. To take some of the financial pressure off the banks, this government agency would subsidize, say, 33% of the $1.5 million, which comes out to $500,000. The bank would then pay interest of 5% per year for 20 years back to the agency. In my example, the agency was government sponsored, and although I do highly encourage a public company to offer this service, there is also no reason why private companies could not lend money to the banks for these same purposes.

The goal of the plan is to curb in the surge in foreclosures that the U.S. has experienced. I do not mean to promote a perfect solution: many people have, and will, lose their homes. However, it is important that we recognize that this crisis was, in a sense, caused by a lack of incentives to be responsible. There was no reason for the banks, or anyone else, to want to thoroughly check the quality of the mortgages being given. If there is an overarching point I wish to make, it is that there must be incentives for the banks to help these struggling homeowners. It may sound self-evident, but it is poor incentives that got us in the current situation. It will take well placed ones to get us out.

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