The Tipping Point: Rebirth of HOLC?
As the economy continues to worsen and confidence generally erodes as reflected in part by the Dow Jones Index dropping 25 percent since the beginning of 2009, the question arises: is there indeed a magic bullet to turn the world economy around?
Some have suggested that Wall Street’s exportation of toxic mortgage-backed securities to investors throughout the world was “evil genius” if in fact it was a plan to create the equivalent of a Trojan horse by destroying the rest of the world’s economy. Of course, the problem with that theory is that we took our own economy down in the process. In order to undo the damage and pain that we have inflicted, America needs to unwind or rewind the process. It is hard to envision how to do that unless we dust off our history books and look at what FDR did in a similar situation.
During the depression housing prices had dropped 30 percent. 50 percent of all homeowners were in default and a vast majority of homes were underwater, meaning that there was no equity or negative equity in such homes. This situation is similar to ours now, where rational homeowners have no incentive to keep paying their mortgages. In fact, right now in Florida, a whopping 20 percent of all mortgages are at least 30 days behind, which means that the foreclosure rate will likely double. Our government has to realize that eventually, a tipping point will occur. Even the homeowners, who may be under water but are still paying their mortgages, have to ask why they are the only chumps on the block still paying. When we get to that point in our social and economic fabric it may get so torn that it will be difficult for us to re-stitch it.
So what is the answer?
First and foremost, the government has to get over the whole moral hazard issue. The idea that the government can’t reward bad behavior is now a hollow argument when AIG, and GM did so many things wrong, yet have received tens of billions of dollars in bailout funds and will likely not fully survive. It is fair to say that AIG and its counter parts in default swaps took huge risks and should have been big boys and been responsible for their decisions. Yet, the Federal Reserve decided that the havoc and chaos that would ensue by allowing these titans to fall was a price that, as a society, we could not endure.
The same holds true for the average Joe and our housing market. Lets face it; the real estate industrial complex represents 25 percent of the entire GNP. Thus, if people feel no obligation to continue to pay their mortgages forget about AIG, we all have a much bigger problem than worrying about AIG’s obligations to Goldman Sachs and Bank of America – who, might I add, received billions back from AIG thanks to Uncle Sam!
Thus, the answer is so simple and may not even cost the government more than $200 billion over 18 years. The US government needs to bring back a new version of the Home Owners Loan Corporation (HOLC) that could effectively issue non-recourse loans to homeowners. These loans are equal to the difference between a homeowner’s outstanding mortgage principal balance and the market value of the home. The proceeds of these loans will go to the banks and be applied to pay down the excess mortgages – thus immediately reducing the monthly payments that each homeowner owes the banks.
However, more importantly, the plan would allow the toxicity of the mortgage-backed securities to quickly disappear almost like a strong dose of an antibiotic to a raging bacterial infection. If the mortgage-backed securities became well again, liquidity would quickly return to the markets, and the banks balance sheets would rapidly improve the stock market – and, most importantly, people’s pensions would not be at risk.
The HOLC was formed in 1933. By the time it wound down, it had only foreclosed on 20 percent of its mortgages and ended up effectively breaking even. Assuming that the cost to the government would be an initial outlay of $200 to 300 billion overtime, the government could realistically expect to see back 80 percent of its investment or a relative small “loss” of $60 billion over seven years.
The key to implementation is simplicity so that everyone understands how we all benefit. Plain and simple, if the swimming pool is drained all boats will float. No more complex administrative policy discussion, what America needs is a simple focused philosophy. If Main Street benefits so does the stock market, and our pensions, and our European friends to whom we sold “infected” securities. In fact, unwinding this mess is simple, start at the bottom and work your way up the ladder. Not the other way around. And guess what, a bailout that trickles up is sure better than a bailout that does not trickle down.