Tuesday, November 18, 2008

Economist says federal government should eliminate negative equity with partial full recourse loans

Today The Wall Street Journal has an article by Martin Feldstein (on p A21), “How to help people whose home values are underwater: The economic spiral will get worse unless we do something about negative equity,” link here. Mr. Feldstein was Chairman of the Council of Economic Advisers under Ronald Reagan.

He writes that the United States is the only major country that does not offer lenders “full recourse” on defaulted mortgages. Now, I know that in the 1990s this was not necessarily true, as I wrote on Nov. 1 on my main blog, here. Default judgments happened then. They may not be practical now, but then how could they work in Europe or Australia? But Mr. Feldstein correctly says that removing negative equity will be one of the new president Obama’s highest priorities.

He suggests that upsidedown loans get help by 20% replacement with “full recourse” loans from the federal government. He also suggests cooperative write-downs in the loan balances from lenders, essentially removing negative equity and the incentive to default. Perverse incentives and unintended consequences must be thought through very carefully. Feldstein is critical of more superficial proposals from Barney Frank and Chris Dodd.

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