More on Refinancing Plan

Chris Mayer, one of the authors of the refinancing plan, a version of which is currently being considered by the administration, wrote in to the comments on an earlier post, protesting my characterization of his proposal. I have no argument with Chris about there being too many frictions in the refinancing process. I'm not sure that this is the best way to fix them, however, and I'm also puzzled by what problem the proposal aims to solve.  Is the goal to stabilize the housing market or to provide economic stimulus?  

If it is aiming to stabilizing the housing market, it is hard to see how a refinancing program, no matter how massive or generous, will accomplish that, as it doesn't address negative equity or unemployment. Too-high interest rates aren't what's driving forecloses.  Yes, there's a large gap between current mortgage rates and the Fed Funds rate, but mortgage rates on existing mortgages are not especially high as things go.  Lowering interest rates makes mortgages more affordable, but we don't have an affordability problem per se.  We have a problem of mortgages being too pricey relative to employment and relative to equity in the homes.  This proposal doesn't fix those problems.  

Likewise, nothing in this proposal helps stabilize home prices.  Refinancing doesn't make new purchases more affordable.  It just makes existing purchases more manageable--if the homeowner is employed.  It is true that in terms of monthly payments it doesn't really matter if principal or interest is reduced:  one could drop rates from 7% to 4% on a $200K 30y FRM and have a similar effect to writing down principal to $143.5K. So maybe there really would be an effect on strategic defaults, as people might not mind underpaying on a overpriced house.  But as long as there's negative equity, it makes selling the house very difficult.  I don't see this eating away at the huge shadow inventory that is depressing home prices and contributing to the balance sheet recession. 

If this is a stimulus measure, then yes, it will be a stimulus, but it will be a very oddly targeted one. I'm not sure it is as progressive as Chris Mayer describes. It will help those who are mortgaged, but not renters and not free-and-clear title holders. That is more or less targeted at the middle class, but it's hardly precise. Think of this as a version of the mortgage interest tax deduction, but made available only to existing homeowners, not prospective ones.  

In his version of the proposal, Mayers is very clear who will bear the cost of this--bondholders--who will get socked with a wave of prepayments and find the value of their assets decline.  It resembles a light-weight version of Roosevelt's 1937 zapping of gold indexation clauses from bonds. I'm a little uncomfortable with doing stimulus via expropriation of bondholders rather than via democratically controlled tax and transfer. It would be a surprisingly radical move from an administration that has protected banks (and to some degree bondholders) pretty consistently. (And it's a bit puzzling given Mayer's opposition to bankruptcy cramdown.) But given the deep dysfunction of Congress on fiscal issues, it is time to think outside the box.