Wednesday, October 01, 2008

The Wright Rescue Plan

Last Friday (see below), I posted some ideas about how to rescue the economy from recession. I alerted numerous individuals about the plan by email and also sought media attention for it, thus far to no avail (that I know of, anyway). During the course of email and blog comment discussions, it became clear to me that some readers had not grasped the plan's most important features. In this post, I will be more specific.

The heart of the plan is to give homeowners (including financial institutions that come to own homes via foreclosure) the option of refinancing with the Federal government at 7 percent for up to 50 years. The 7 percent will ensure that most Americans will not opt for the Federal refinance (re-fi) because most already have mortgages at a lower APR. The 50 years is to help lower the monthly payments of homeowners who got in over their heads.

The government will pay off the existing principal balance on the mortgage with Treasury bonds. Right now, the government can borrow at low yields. It is the only large economic agent at present that can with great certainty generate a positive spread between its assets (7% mortgages) and its liabilities (2-3% Treasury bonds).

The plan should provide immediate relief to the financial sector because it will effectively remove uncertainty about the value of mortgage-backed securities (and hence credit default swaps, etc.). Either:
a) borrowers will continue to pay their existing mortgages
or
b) borrowers will re-fi with the Federal government, thus removing the risk of their default from the financial system
or
c) borrowers will default, in which case the lenders can re-fi, which will replace the "toxic" asset on their balance sheet with a safe and liquid one (Treasuries).

With the uncertainty gone, the credit markets can again function and mortgage backed securities will rise in value and will begin trading again, ending the cycle of write downs that has caused the recent bankruptcies.

The Wright Rescue Plan is also much more politically astute than the administration plan because it offers aid to homeowners first. While the total amount of aid needed cannot be known with certainty, the plan is clearly not a "bailout" because the government will almost certainly profit from it (at least at today's gross spreads). The sums already appropriated to the Hope for Homeowners program may very well suffice. Finally, and I can not stress this point enough, the plan could be implemented without creating a new federal bureaucracy. The Treasury and IRS already know how much people earn, whether they have existing mortgages, and so forth. They also have the power to garner wages and track people across state lines, so defaults on the re-fi's should be low. If the government comes to own some homes through default, it alone can afford to hold them until the market turns or to re-purpose them. As noted in various posts below, governments have successfully run mortgage programs in the past.

4 comments:

Anonymous said...

This is a good workable plan that could be enhanced by adding an optional feature that allows borrowers to make bi-weekly (REF-http://www.navyfcu.org/loans/mortgage-biweekly.html) booked payments to accelerate the payoff.

The concepts & ideas mentioned in this blog are logical and helpful, especially those that generate cash for the federal treasury.

Please keep up the lessons from the past and your creative ideas and post more of your thoughts.

Please help us out with answers to the following questions:

1) How was the country funded before there was a tax on federal incomes.

2) How did the Credit Default Swap program add to the current situation?

RLH - San Diego County, CA

Robert E. Wright said...

That's a great idea about the biweekly option RLH!

As for your questions:

1) Before the federal tax on incomes, the national government funded itself primarily through tariffs. Excises were secondary. Direct taxes on real estate, land sales, and dividends from stock (see my recent post on this) were other sources but usually quite minor. Good replacements for the U.S. income tax would be a VAT, a national retail sales tax, and a carbon tax.

2) I explained that on Fox and over 1k people wrote to say they had never seen a clearer explanation. My slideshow can be viewed here: http://w4.stern.nyu.edu/news/docs/rwright/
I am not aware of the actual clip from the show on YouTube or anywhere else.

Robert E. Wright said...

Actually RLH, the credit default swaps part got cut, or rather changed to a vague allusion to credit enhancement.

CDS certainly played a major role in the latest wave of the crisis. Derivatives of all types probably played a role, in fact. The form the government bailout took is inexplicable otherwise.

DH Smith said...

Dear Professor Wright,

It's an interesting plan. All the plans, yours, Hubbard's, Zingales, Feldsteins, have merit I'm sure.

I'm just a plain old real estate practitioner and businessman here . . . I am thinking about simple things to get capital to re-form in capital markets too, and don't want to offer anything that is too obvious or miss a point of yours or the other professors because it is too complicated for me.

Maybe I could ask you to clarify somethng.

One section in your text says:

"The plan should provide immediate relief to the financial sector because it will effectively remove uncertainty about the value of mortgage-backed securities (and hence credit default swaps, etc.). Either:
a) borrowers will continue to pay their existing mortgages
or
b) borrowers will re-fi with the Federal government, thus removing the risk of their default from the financial system
or
c) borrowers will default, in which case the lenders can re-fi, which will replace the "toxic" asset on their balance sheet with a safe and liquid one (Treasuries)."

It's your letter c) that I confess Idon't get, after some burning of brain cells. Borrowers default and the lenders re-fi . . . who and what? Do you mean they go to the Treasury and intermediate a refinance for the deadbeat borrower? Do you mean they go the Treasury and borrow on those concessionary terms against what is now their REO?

Thanks for your attention,

kind regards,

DH Smith