A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.
The recently enacted financial rescue plan does nothing to stop this spiral. Credit will not flow and liquidity will not return to the banking system until financial institutions have confidence in the solvency and liquidity of other banks.
Because of the 20% fall in the price of homes since the bursting of the house-price bubble, there are now some 10 million homes with mortgages that exceed the value of the house. Residential mortgages are generally “no recourse” loans, meaning that if the homeowner stops making payments, the creditor can take the property but cannot take other assets or attach income. Individuals with loan-to-value ratios greater than 100% therefore have an incentive to default even if they can afford their monthly payments, and to rent an apartment or other house until house prices stop declining. When individuals default and creditors foreclose, the property is added to the stock of unsold homes. That depresses prices further, increasing the number and magnitude of negative equity houses.
The prospect of a downward spiral of house prices depresses the value of mortgage-backed securities and therefore the capital and liquidity of financial institutions. Experts say that an additional 10% to 15% decline in house prices is needed to get back to the prebubble level. That decline would double the number of homes with negative equity, raising the total to 40% of all homes with mortgages. The mortgages of five million homeowners would then exceed the value of their homes by 30% or more, which could prompt millions of defaults.
Feldstein is right, of course. All this “bailout” did was transfer these deflating assets from the books of Wall Street to those of the US taxpayer.
I think that in addition to transferring the debt, it will lead to hyperinflation. It will take about a year, but by this time next year I think we will see double digit inflation monthly combined with huge job losses on the order of 10-20%. I am no economist, but I can read history.
Yep — we should have taken our medicine, and allowed further bank closings.
We will pay the piper — only now, of course, we will suffer with the knowledge that an industry has been nationalized.
I’ll be voting against every single person I can who voted for the bailout.
I believe this problem has its roots in our energy dependency on foreign imports. The current transfer of wealth of $700 billion per year for energy overseas, does not even include the technologies such as compact fluorescent lamps, solar panels, wind turbines and other energy technologies, we used to make in America, to wean us off of foreign oil. As Sarah Palin said in the debate, think what this money circulating in our own economy would do.
Last year I sold my solar house in the face of 2200 foreclosed properties in Loudoun County. We got our money out of it. But we proved something else. When you invest in your home or your automobiles to reduce your energy independence it is good for you and for America. So, considering that we have had many of these energy technologies around since the days of Nixon, and he was, coincidentally, the first to say we needed to wean ourselves off of foreign oil, I say we only have ourselves to blame.