Friday, October 14, 2011

How the government can stimulate the economy

Conservative economist, Milton Feldstein, has proposed a solution to falling home prices that would stimulate the economy.

Since most people's form of wealth is in their homes, and since home prices continue to fall because so many are in homes where their mortgages are greater than the home values, the economy is at the mercy of home prices and we all live in a prolonged era of high unemployment, limited consumer demand, and a stagnant economy.

Feldstein's solution is to stimulate spending by stopping the decline in home prices caused by floods of mortgage defaults which are driving prices down.  His suggestion is for the government to reduce mortgage principle when it exceeds 110% of the home value.  He calculates that this would be a one time cost of $350 billion, and would be shared 50 - 50 by the government (taxpayers) and the banks (who created the housing bubble for their own ludicrous bonuses in the first place).  In addition, the borrowers would also pay a price, and that would be a price of risk.  The borrowers would get the lower mortgage, but the terms of the new mortgages would be different. If they defaulted on their mortgage, all of their assets would be available for collection, i.e their loans would become full recourse loans, rather than nonrecourse loans they currently have where only the house is taken in case of default.

This arrangement would have both borrowers and lenders making sacrifices to refinance at lower principles, and the government makes a one time payment in order to stop the housing slide and allow people the economic breathing room to spend more rather than be crushed under housing debt they can't handle.  And the banks finally would get to clean their balance sheets with honest loans with high probabilities of payment.

Like other Martin Feldstein proposals, this makes a lot of sense to me, and will likely be ignored.  I think it would work.